Appendix F — Deconsolidation/Derecognition

F.2 Scope of Deconsolidation of a Subsidiary or Derecognition of a Group of Assets

ASC 810-10-40-3A provides separate guidance on the scope of the deconsolidation and derecognition guidance in ASC 810-10-40-5 related to the loss of control of (1) a nonprofit activity or business and (2) a subsidiary that is not a nonprofit activity or business.

For a reporting entity to lose control of a business (see ASC 805-10-55-3A for the definition of a business, and see Deloitte's Roadmap Business Combinations for further discussion), there does not need to be a separate subsidiary established (i.e., a group of assets representing a business can be derecognized from a larger legal entity). The deconsolidation and derecognition guidance in ASC 810-10-40 does not apply to a conveyance of oil and gas mineral rights or to a transfer of a good or service in a contract with customer if the loss of control was related to a subsidiary or to assets that would meet the definition of a business.

The deconsolidation and derecognition guidance in ASC 810-10-40-5 also applies to subsidiaries that are not a nonprofit activity or business unless the substance of the transaction is addressed by other GAAP, including but not limited to the guidance on:

Gains and losses from the derecognition of nonfinancial assets (ASC 610-20). See Section F.2.1.
Revenue transactions (ASC 606). See Section F.2.2.
Transfers of financial assets (ASC 860). See Section F.2.3.
Exchanges of nonmonetary assets (ASC 845). See Section F.2.4.
Conveyances of mineral rights and related transactions (ASC 932).

In accordance with ASC 810-10-40-3A, a reporting entity should not ignore other GAAP that would otherwise have been applicable simply because, for example, the reporting entity transferred an equity interest in a subsidiary to effect the transaction.

F.2.1 Nonfinancial Assets

Upon the loss of a controlling financial interest in a subsidiary that does not represent a business in a transaction that, in substance, represents the transfer of nonfinancial or in-substance nonfinancial assets (or both) to a noncustomer, a reporting entity applies ASC 610-20 to determine any gain or loss on the derecognition of such assets. (See Section 17.2.1 of Deloitte’s Roadmap Revenue Recognition for a discussion of in-substance nonfinancial assets that are within the scope of ASC 610-20.) If the counterparty is a customer, the reporting entity should apply ASC 606. ASC 610-20 does not apply to transactions that meet the definition of a business; gains or losses associated with such transactions are determined in accordance with ASC 810-10-40.

The flowchart below outlines considerations related to the application of ASC 606, ASC 810-10-40, ASC 860, ASC 610-20, or other U.S. GAAP to the transfer of a nonfinancial asset or in-substance nonfinancial assets (or both). We believe that a reporting entity must first conclude that it has lost a controlling financial interest under ASC 810-10 before applying the guidance in this flowchart.

See Chapter 17 of Deloitte’s Roadmap Revenue Recognition for additional details regarding sales of nonfinancial assets and in-substance nonfinancial assets within the scope of ASC 610-20.

F.2.2 Revenue Transactions

In certain situations, the loss of control of a subsidiary that does not represent a business may be, in substance, a revenue transaction. For example, a consolidated subsidiary may have service contracts that earn a stream of revenue, and the reporting entity may sell an interest in the revenue from those contracts to a third party. Depending on the facts and circumstances, a reporting entity that determines that it no longer has a controlling financial interest in the subsidiary may conclude that the transaction is an in-substance revenue transaction within the scope of ASC 606.

F.2.3 Deconsolidation of In-Substance Financial Assets

Financial assets include “common” financial assets, such as loans, mortgages, credit card balances, and receivables, as well as marketable and nonmarketable debt securities, stock purchase warrants, common and preferred stock investments, and other equity investments such as general or limited partnership interests. A reporting entity should apply ASC 860 in lieu of ASC 810 when it has an investment in another consolidated legal entity whose only assets are financial assets. See Section 11.1.2 for additional presentation considerations related to beneficial interests in a CFE.

A reporting entity must analyze the economic characteristics and risks of the legal form of equity being transferred or sold when derecognizing a legal entity whose only assets are financial assets. Specifically, the reporting entity should focus on whether collateral/creditor rights exist in the equity securities, among other considerations, to determine whether the underlying transaction is, in substance, an asset-backed financing arrangement for which ASC 860 should be applied. This view is consistent with the views of an SEC staff member, Professional Accounting Fellow Armando Pimentel, who stated the following at the 1997 AICPA Conference on Current SEC Developments (the “1997 SEC staff speech”):

The FASB has indicated that a parent company’s investment in its consolidated subsidiary is not a financial asset, and the Staff agrees with this position because any sale of the equity securities of the subsidiary represents the sale of an interest in subsidiary’s individual assets and liabilities, which are not necessarily financial assets under the definition in SFAS 125.

The Staff recently responded to an inquiry from a registrant regarding the proper accounting guidance to follow in recording a sale of all of the equity securities of a consolidated subsidiary whose only asset was a cost-method investment, which is considered a financial asset under SFAS 125. The Staff concluded that the provisions of SFAS 125 should apply when an entity sells the equity securities of its consolidated subsidiary if all of the assets in the consolidated subsidiary are financial assets.

This conclusion arose from the Staff’s concern that, otherwise, a company whose transfer of assets would not qualify as a sale under SFAS 125 criteria could sidestep those requirements by simply first transferring the assets to a newly created wholly owned subsidiary and selling the equity securities of that subsidiary. The company might then assert that SFAS 125 did not apply, because the transaction involved the sale of equity securities of the subsidiary, and account for the transfer as a sale under other GAAP that addresses the sale of assets and liabilities.

Similar views were also expressed by Brian Fields at the 2009 AICPA Conference on Current SEC and PCAOB Developments (“2009 SEC staff speech”). Mr. Fields noted that an entity whose transfer of financial assets would not qualify as a sale under the guidance in ASC 860 might attempt to structure a transaction in a manner that sidesteps the criteria for sale accounting. In such a structure, the entity would first transfer the financial assets to a newly created subsidiary (e.g., SPE) in exchange for all senior and subordinated interests in the subsidiary. All interests are in legal-form equity and do not contain a maturity date. The entity then sells the senior interests to outside investors. The activities of the subsidiary are significantly limited and do not have the breadth and scope of activities of a business. Because it may seem that the sale of the senior interests represented an equity transaction involving owners, the entity might assert that the guidance in ASC 860 does not apply and account for the sale of the senior interests as the issuance of a noncontrolling equity interest rather than as collateralized debt. Mr. Fields cautioned that “when a subsidiary is created simply to issue beneficial interests backed by financial assets rather than to engage in substantive business activities,” the sales of beneficial interests in the subsidiary “should be viewed as transfers of interests in the financial assets themselves” and ASC 860 would apply.

While the 1997 and 2009 SEC staff speeches focused primarily on attempts to structure transactions in a manner that sidesteps the criteria for sale accounting in ASC 860, we believe that the principles in the two speeches apply more broadly because they are examples of an overarching principle in ASC 860. That is, on the basis of consultations involving discussions with the SEC staff, we believe that these principles apply broadly to legal entities that hold only financial items. We do not believe that the accounting model should change by virtue of a clearly inconsequential amount of nonfinancial assets in the entity.

F.2.3.1 Deconsolidation of Assets Previously Transferred

If a reporting entity transfers assets to a consolidated legal entity that is subsequently deconsolidated, the reporting entity must apply the requirements in ASC 860 to the assets that were initially transferred to determine whether it is able to derecognize the previously transferred assets.

F.2.3.2 Electing the Fair Value Option on a Retained Interest Upon Deconsolidation

When a legal entity is deconsolidated, the reporting entity may elect the fair value option for its retained interest in the newly deconsolidated legal entity. While the fair value option can be elected on an item-by-item basis (e.g., for the residual but not the senior interests held in a CLO), the election must be made when each investment is first recognized, and it is irrevocable once made.

F.2.4 Nonreciprocal Transfer to Owners

ASC 810-10-40-5 states that if a parent loses control of a subsidiary through a nonreciprocal transfer to owners, such as a spin-off, the guidance in ASC 810-10 on measuring the gain or loss will not apply to the transferred portion. Rather, the transferred portion should be accounted for under ASC 845-10. Therefore, a reporting entity should not evaluate nonreciprocal transfers to owners under ASC 810-10.

F.2.5 Multiple Arrangements Accounted for as a Single Disposal Transaction

In some instances, a parent may cease to have a controlling financial interest in a subsidiary through two or more transactions. The gain or loss recognition by the parent would differ depending on whether the parent accounts for the two or more transactions as multiple transactions separately or as a single transaction. Consider the following:

Example F-3

Entity A intends to sell its wholly owned subsidiary, Subsidiary B, for a loss. The current carrying value of B is $100. Entity A structures the sale into two arrangements. In the first arrangement, A sells a 49 percent interest for $40 on July 1, 20X9. In the second arrangement, A sells the remaining 51 percent interest for $41 on September 1, 20X9.

The table below illustrates the total loss that A would record in its consolidated statement of income depending on whether it accounts for the multiple arrangements separately or as a single transaction.

To address the different results that may occur, as illustrated above, and the potential for structuring, ASC 810-10-40-6 provides guidance on a parent’s cessation of a controlling financial interest in a subsidiary through two or more arrangements (transactions).

The indicators in ASC 810-10-40-6 are intended to prevent abuse by entities attempting to minimize earnings implications by using multiple arrangements to dispose of a subsidiary. However, in Statement 160 (codified in ASC 810), the FASB observed in paragraph B57 of the Basis for Conclusions that the opportunity for entities to conceal losses through such structuring is reduced by the impairment guidance in Statement 142 (codified in ASC 350) and Statement 144 (codified in ASC 360). Under this guidance, a more-likely-than-not expectation to sell or dispose of a reporting unit (or a significant portion of one) or a long-lived asset (asset group) would trigger an entity’s requirement to perform impairment testing for goodwill and other intangible assets (under ASC 350) and long-lived tangible assets (under ASC 360).

Regardless, when assessing the guidance in ASC 810-10-40-6, reporting entities should ensure that they analyze all terms and conditions of multiple arrangements, including their combined economic effect and intent, to determine whether such arrangements should be accounted for separately or as a single transaction.

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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.