4.3 Contribution of Nonmonetary Assets

4.3 Contribution of Businesses or Assets for an Investment in an Equity Method Investee

An investor may contribute a business or assets in exchange for an equity method investment or an interest in a joint venture. The accounting for the contribution of a business or assets will generally depend on (1) whether the investee (i.e., the counterparty) is considered to be a customer in the transaction; (2) the nature of the asset that was contributed; and (3) in some cases, the legal form of the transaction.

The flowchart below illustrates the relevant questions for the determination of the accounting that should be applied when an investor contributes a business or assets in exchange for a noncontrolling ownership interest in another entity (including a noncontrolling ownership interest in a joint venture or other equity method investment). It is important to note that there are specific accounting considerations associated with the contribution of a business or assets to a joint venture upon formation. See Chapter 8 for details.

If the transfer includes other contractual arrangements that are not assets of the seller to be derecognized (e.g., guarantees), those contracts are separated and accounted for in accordance with other ASC topics or subtopics.

4.3.1 Determining Whether the Counterparty (Equity Method Investee) Is a Customer

A transfer of a nonfinancial asset or an in-substance nonfinancial asset in a contract with a customer is within the scope of ASC 606. For example, if the nonfinancial asset is an output of the entity’s ordinary business activities (e.g., a homebuilder’s sale of real estate), the arrangement would be accounted for under ASC 606. See Section 5.1.5.1 for a discussion of how to apply the intra-entity profit and loss elimination guidance to transactions within the scope of ASC 606. However, if the nonfinancial asset is not an output of the entity’s ordinary business activities (e.g., a financial services company’s sale of its headquarters), ASC 610-20 would apply.

4.3.2 Contribution of a Business or Nonprofit Activity

A transfer of a subsidiary or a group of assets that is a business or a nonprofit activity (as defined in ASC 810-10-20) that is not a conveyance of oil and gas mineral rights or a transfer of a good or service in a contract with a customer within the scope of ASC 606 is within the scope of ASC 810. If the parent ceases to have a controlling financial interest in the subsidiary but still retains an investment that will be accounted for under the equity method in accordance with ASC 323-10, the parent should deconsolidate the subsidiary and recognize a gain or loss in accordance with ASC 810-10-40-5. As of the date the loss of control occurs, the former parent remeasures, at fair value, its retained investment and includes any resulting adjustments as part of the gain or loss recognized on deconsolidation.

When evaluating whether the investee constitutes a business, the investor should determine whether (1) the individual assets and liabilities are concentrated in a single asset or group of assets and (2) inputs, a substantive process, and outputs are maintained at the subsidiary. See Section 2.4 of Deloitte’s Roadmap Business Combinations for more guidance on the definition of a business.

4.3.3 Contribution of Financial Assets

ASC 860-20

25-1 Section 860-20-40 provides derecognition guidance a transferor (seller) applies upon completion of a transfer of financial assets that satisfies paragraph 860-10-40-5’s conditions to be accounted for as a sale. Upon completion of such a transfer, the transferor (seller) shall also recognize any assets obtained or liabilities incurred in the sale, including, but not limited to, any of the following:

Cash
Servicing assets
Servicing liabilities
In a sale of an entire financial asset or a group of entire financial assets, any of the following:
1. The transferor’s beneficial interest in the transferred financial assets
2. Put or call options held or written (for example, guarantee or recourse obligations)
3. Forward commitments (for example, commitments to deliver additional receivables during the revolving periods of some securitizations)
4. Swaps (for example, provisions that convert interest rates from fixed to variable).

See Examples 1, 2, and 5 (paragraphs 860-20-55-43 through 55-59) for illustration of this guidance.

30-1 The transferor shall initially measure at fair value any asset obtained (or liability incurred) and recognized under paragraph 860-20-25-1.

In accordance with ASC 860, a transferor “shall initially measure at fair value any asset obtained (or liability incurred) and recognized under paragraph 860-20-25-1.” A transfer of a financial asset for an equity method investment may be within the scope of ASC 860 (see Section 5.7 for additional discussion). For example, when an equity method investment is exchanged for another equity method investment, generally the investor should first consider whether derecognition of the equity method investment being transferred in the exchange is appropriate in accordance with ASC 860, which addresses the transfer of financial assets. This is consistent with guidance in ASC 845-10-55-2, which states that the exchange of an equity method investment for another equity method investment should be accounted for under ASC 860.

However, ASC 860 is intended to apply to exchanges of equity method investments in unrelated investees, in which the substance of the transaction is an exchange of one investment for a “new” investment in an unrelated investee (as discussed in the example below). Therefore, when determining the appropriate accounting for the exchange transaction, the investor should evaluate both the form and substance of the transaction. In certain circumstances, the substance of the exchange transaction may be analogous to a partial dilution of the investor’s investment in exchange for another equity method investment, which would result in partial gain recognition in accordance with ASC 323-10-40-1 (see the discussion of change in level of ownership or degree of influence in Section 5.6) rather than full gain recognition under ASC 860. The two examples below illustrate situations in which full gain recognition under ASC 860 and partial gain recognition in accordance with ASC 323-10-40-1, respectively, may be appropriate.

Example 4-3

Entity A has a 35 percent interest in Entity B that it appropriately accounts for by using the equity method. Entity C has a 40 percent interest in Entity D that it appropriately accounts for by using the equity method. Entities B and D are in similar industries and perform the same functions. Basis differences, intra-entity profit and loss eliminations, and tax impacts have been ignored for simplicity.

Entity A is contemplating a transaction in which it will transfer a 30 percent interest in B to C in exchange for a 30 percent interest in D. Therefore, after the transaction, A will own 30 percent of D, and C will own 30 percent of B. Both A and C will have the ability to exercise significant influence over their respective investments upon completion of the exchange.

Even though B and D are in similar industries, the substance of this transaction is that A is exchanging its equity method investment for a “new” equity method investment. Therefore, A should account for this transaction in accordance with ASC 860. As long as all the conditions for derecognition under ASC 860 are met, A would recognize the full gain (or loss) equal to the difference between the selling price (fair value of a 30 percent interest in D) and the carrying value of the interest sold at the time of the sale (i.e., book value of a 30 percent interest in B).

Example 4-4

Entity A has a 40 percent interest in Entity K. Entity B and Entity C each have a 30 percent interest in K. Entities A, B, and C appropriately account for their investments in K under the equity method. The book value of the interests of A, B, and C in K are $800,000, $600,000, and $600,000, respectively, and there are no basis differences between their investment balances and underlying interests in K’s net assets. Further, intra-entity profit and loss eliminations and tax impacts have been ignored for simplicity.

Entities A, B, and C entered into a transaction with Entity E to merge K and E into a new entity, Newco. As part of the transaction, A, B, C, and the E shareholders will each contribute their interests in K and E, respectively, to Newco.

After the transaction, Newco’s ownership structure will be as follows (assume that K was the acquirer of E, and therefore, Newco recognized E’s net assets at fair value):

Therefore, upon the transaction’s execution, A’s ownership interest in K effectively decreases from 40 percent to 25 percent. That is, A effectively exchanges 15 percent of its ownership interest in K for a 25 percent interest in E.

Because of the significance of A’s retained interest in K through its investment in Newco, we believe that the transaction’s substance is analogous to a partial dilution of A’s investment in K in exchange for a partial ownership interest in E. The economic outcome is the equivalent of K’s acquiring E’s business in exchange for its own equity, thereby diluting A’s, B’s, and C’s previously held ownership interest in K.

On the basis of the substance of the transaction, A should account for the transaction as a partial sale of its investment in K and should recognize a gain of $600,000, calculated as follows:

Entity A’s cost basis of its investment in Newco is $1.4 million, which is calculated as the $500,000 book value of A’s 25 percent interest in K that was retained ($800,000 × 25% ÷ 40%) plus the $900,000 fair value of A’s 25 percent interest in E that was acquired ($3,600,000 × 25%). Therefore, A would record the following journal entries:

Conversely, if the transaction’s substance was a transfer of a financial asset for another financial asset within the scope of ASC 860 (and derecognition was appropriate), a full gain on the sale of A’s equity interest in K of $1.2 million would be recognized, calculated as the difference between the selling price (i.e., fair value of A’s interest in Newco of $2 million) and the book value of A’s interest in K that was sold ($800,000).

4.3.4 Contribution of Nonfinancial Assets or In-Substance Nonfinancial Assets That Do Not Constitute a Business or Nonprofit Activity

ASC 610-20

32-2 When an entity meets the criteria to derecognize a distinct nonfinancial asset or a distinct in substance nonfinancial asset, it shall recognize a gain or loss for the difference between the amount of consideration measured and allocated to that distinct asset in accordance with paragraphs 610-20-32-3 through 32-6 and the carrying amount of the distinct asset. The amount of consideration promised in a contract that is included in the calculation of a gain or loss includes both the transaction price and the carrying amount of liabilities assumed or relieved by a counterparty.

32-4 If an entity transfers control of a distinct nonfinancial asset or distinct in substance nonfinancial asset in exchange for a noncontrolling interest, the entity shall consider the noncontrolling interest received from the counterparty as noncash consideration and shall measure it in accordance with the guidance in paragraphs 606-10-32-21 through 32-24. Similarly, if a parent transfers control of a distinct nonfinancial asset or in substance nonfinancial asset by transferring ownership interests in a consolidated subsidiary but retains a noncontrolling interest in its former subsidiary, the entity shall consider the noncontrolling interest retained as noncash consideration and shall measure it in accordance with the guidance in paragraphs 606-10-32-21 through 32-24. (See Case A of Example 2 in paragraphs 610-20-55-11 through 55-14.)

In the event a transfer is not with a customer, as defined in ASC 606, and not a transfer of a business or nonprofit activity, the transferor should consider whether the transfer is within the scope of ASC 610-20, which applies to the transfer of nonfinancial assets and in-substance nonfinancial assets. The ASC master glossary defines a nonfinancial asset as “[a]n asset that is not a financial asset. Nonfinancial assets include land, buildings, use of facilities or utilities, materials and supplies, intangible assets, or services.” ASC 610-20-05-2 states, in part, that “[t]he term transfer in this Subtopic is used broadly and includes sales and situations in which a parent transfers ownership interests (or variable interests) in a consolidated subsidiary or other changes in facts and circumstances that result in the derecognition of nonfinancial assets or in substance nonfinancial assets that do not constitute a business.”

Sales or transfers of nonfinancial assets (or in-substance nonfinancial assets) to another entity in exchange for a noncontrolling interest in that entity are referred to as partial sales (e.g., a seller transfers a building [or an asset] to a buyer but either retains an interest in the building [or the asset] or has an interest in the buyer). These types of transactions should generally be accounted for in accordance with ASC 610-20 when the transaction results in the derecognition of the transferred assets and does not meet any of the scope exceptions in ASC 610-20-15-4. See Deloitte’s Roadmap Revenue Recognition for additional discussion of the scope exceptions.

In accordance with ASC 610-20, the transferor should account for any noncontrolling ownership interest received as noncash consideration, which should be measured at fair value in a manner consistent with the guidance on noncash consideration in ASC 606. Specifically, ASC 606-10-32-21 and 32-22 require the entity to first measure the estimated fair value of the noncash consideration received and then consider the stand-alone selling price of the goods or services promised to the customer only when the entity is unable to reasonably estimate the fair value of the noncash consideration received.

ASC 610-20 applies to gains and losses upon derecognition of nonfinancial assets and in-substance nonfinancial assets. However, there could be transfers of nonfinancial assets or in-substance nonfinancial assets with a noncustomer that are not directly within the scope of ASC 610-20 because the entity does not meet the derecognition criteria. For example, an entity that transfers a license of intellectual property (IP) should not account for the transaction under ASC 610-20 because the entity is not derecognizing the IP. In other words, the entity is not transferring the actual asset but is instead licensing the rights to the IP. Because there is no clear guidance on how to account for the transfer of a license of IP that is not part of the entity’s ordinary activities, we believe that the entity would apply the licensing guidance in ASC 606 by analogy when evaluating the recognition and measurement of consideration received in exchange for transferring the rights to the IP.

See Deloitte’s Roadmap Revenue Recognition for further information regarding the application of ASC 610-20 and considerations related to derecognition and gain or loss measurement.

Example 4-5

Entities A, B, and C form Company D. Company D does not constitute a business and is not a customer of A. In exchange for 33.3 percent of D’s common stock, A contributes land that has a carrying value of $1 million but a fair value of $4 million. Entities B and C contribute nonfinancial assets of the same fair value to D.

Upon making its contribution, A derecognizes the carrying value of the land ($1 million) and records the fair value of its investment ($4 million) in D’s common stock, recognizing a gain on contribution of $3 million ($4 million fair value less $1 million carrying value).

4.3.5 Contribution of Real Estate or Intangibles

ASC 970-323

30-3 An investor that contributes real estate to the capital of a real estate venture generally should record its investment in the venture at fair value when the real estate is derecognized, regardless of whether the other investors contribute cash, property, or services. The transaction shall be accounted for in accordance with the guidance in paragraphs 360-10-40-3A through 40-3C. Some transactions are sales of an ownership interest that result in an entity being an investor in a real estate venture. An example of such a transaction includes one in which investor A contributes real estate with a fair value of $2,000 to a venture and investor B contributes cash in the amount of $1,000. The real estate is not considered a business or nonprofit activity and, therefore, is within the scope of Subtopic 610-20 on gains and losses from the derecognition of nonfinancial assets. Investor A immediately withdraws the cash contributed by investor B and, following such contributions and withdrawals, each investor has a 50 percent interest in the venture (the only asset of which is the real estate). Assuming investor A does not have a controlling financial interest in the venture, investor A applies the guidance in paragraphs 610-20-25-5 and 610-20-25-7. When investor A meets the criteria to derecognize the property, investor A measures its retained ownership interest at fair value consistent with the guidance in paragraph 610-20-32-4 and includes that amount in the consideration used in calculating the gain or loss on derecognition of the property.

Contribution of Services or Intangibles

30-6 The contribution of real property or an intangible to a partnership or joint venture shall be accounted for in accordance with Subtopic 610-20. The contribution of services or real estate syndication activities in which the syndicators receive or retain partnership interests are accounted for in accordance with the guidance in Topic 606 on revenue from contracts with customers.

The Codification excerpts above were updated by ASU 2014-09 (as amended by ASU 2017-05), which provides guidance on the recognition and measurement of transfers of nonfinancial assets and is codified in ASC 610-20. ASU 2017-05 amended the guidance in ASC 970-323 to align it with the requirements in ASC 606 and ASC 610-20. Accordingly, the guidance outlined in Section 4.3.4 is consistent with the guidance on contributions of real estate and intangibles under ASC 970-323.

Under the guidance in ASC 970-323-30-6 above, the contribution of services or real estate syndication activities in which the syndicators receive or retain partnership interests will be accounted for in accordance with ASC 606. See Deloitte’s Roadmap Revenue Recognition for further information regarding the application of ASC 606 and ASC 610-20.

4.3.6 Transactions Addressed by Other Guidance

The deconsolidation and derecognition guidance in ASC 810-10-40-5 applies to the contribution of an interest in a subsidiary that is not a nonprofit activity or a business unless the substance of the transaction is addressed by other U.S. GAAP, which would include, but not be limited to, the following:

Revenue transactions (ASC 606). See Section 4.3.1.
Exchanges of nonmonetary assets (ASC 845).
Transfers of financial assets (ASC 860). See Section 4.3.3.
Conveyances of mineral rights and related transactions (ASC 932).
Gains and losses from the derecognition of nonfinancial assets (ASC 610-20). See Section 4.3.4.

In essence, an investor should not ignore other U.S. GAAP that would otherwise have been applicable simply because, for example, the investor transferred an equity interest in a subsidiary to effect the transaction.

The application of the derecognition guidance in ASC 810-10 is discussed in further detail in Appendix F of Deloitte’s Consolidation Roadmap.

Footnotes

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.