Appendix F — Deconsolidation/Derecognition

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.

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”):

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.

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.

The parent must apply the equity method of accounting prospectively from the date control over the subsidiary is relinquished and should not revise its presentation of prior-period balances. Similarly, application of the equity method of accounting as if the loss of control occurred at the beginning of the current fiscal period or year is prohibited. This position was reiterated by an SEC staff member, Associate Chief Accountant Stephanie Hunsaker, in a speech at the 2007 AICPA Conference on Current SEC and PCAOB Developments. The remaining investment after the deconsolidation should be reflected in the balance sheet at the end of the period as a single line item.

The parent should perform an assessment under ASC 205-20 to determine whether the deconsolidated subsidiary qualifies as a discontinued operation (see Deloitte’s Roadmap Impairments and Disposals of Long-Lived Assets and Discontinued Operations for additional details related to this assessment). If the deconsolidated subsidiary qualifies as a discontinued operation, the parent should present the gain or loss on deconsolidation in income from discontinued operations. If the deconsolidated subsidiary does not qualify for discontinued operations treatment, the parent should present the gain or loss on deconsolidation in income from continuing operations, typically as nonoperating income.

The parent must account for its retained interest prospectively as an investment, including presentation as a single line item in the balance sheet, from the date control over the subsidiary is relinquished.

This discussion does not address contingent payment arrangements that are separate transactions. That is, it only discusses arrangements in which the payment is contingent consideration. Further, it is assumed in this discussion that the seller has determined that the arrangement does not meet the definition of a derivative instrument. If the arrangement met the definition of a derivative, it would be accounted for under ASC 815.

Accounting for contingent consideration was discussed in EITF 09-4. At its September 9–10, 2009, meeting, the EITF considered two approaches for a seller’s accounting for a contingent consideration arrangement upon deconsolidation of a subsidiary or derecognition of a group of assets that meets the definition of a business; however, the Task Force did not reach a consensus on this Issue. Accordingly, there has been diversity in practice related to a seller’s accounting for a contingent consideration arrangement. Nevertheless, reporting entities should establish an accounting policy for the initial measurement of these types of arrangements and should apply the chosen policy option to all future transactions. In addition, if a reporting entity believes it can support an alternative accounting treatment for a specific contingent consideration arrangement (other than the two approaches described below), it should consult with independent accountants. The two approaches are as follows:

• Approach 1 — The seller includes the initial fair value of any contingent consideration arrangement as part of the overall gain or loss on deconsolidation of a subsidiary. Supporters of this approach point to ASC 810-10-40-5, which states that the seller (parent) should include the “fair value of any consideration received” when calculating the gain or loss on deconsolidation of a subsidiary (emphasis added). Accordingly, the “consideration received” should include the fair value of any contingent consideration arrangements between the seller and buyer. Under this approach, the seller would recognize a contingent consideration receivable for the future amounts due from the buyer.
  If a seller adopts this approach to initially account for a contingent consideration agreement, the seller may, on a transaction-by-transaction basis, either (1) subsequently remeasure the contingent consideration at fair value as of the end of each reporting period (in accordance with the fair value option under ASC 825) or (2) subsequently apply the gain contingency guidance in ASC 450-30.
• Approach 2 — The seller accounts for the contingent consideration arrangement as a gain contingency in accordance with ASC 450. This approach is consistent with the accounting that entities applied to such transactions before the FASB issued Statement 160 (codified in ASC 810). Under this approach, the seller typically recognizes the contingent consideration receivable in earnings after the contingency is resolved. Accordingly, to determine the initial gain or loss on deconsolidation of a subsidiary, the seller would not include an amount related to the contingent consideration arrangement as part of the consideration received unless the recognition criteria in ASC 450 are met. Supporters of this approach believe that the FASB did not intend to change practice when it issued Statement 160 (codified in ASC 810).
  If the seller selects this approach to initially account for a contingent consideration agreement, it should continue to apply this approach in subsequent periods until the contingency is resolved.
  Example F-4

  Parent A has a wholly owned subsidiary with a carrying amount of $100. Parent A decides to sell 100 percent of this subsidiary to Company B, a third-party buyer. As part of the purchase agreement, B agrees to pay A (1) $150 upon the close of the transaction and (2) an additional $50 if the subsidiary’s earnings exceed a specified level for the 12-month period after the close of the transaction. Upon the close of the transaction, A calculates the fair value of the contingent consideration portion of the arrangement to be $30. In addition, the arrangement does not meet the definition of a derivative and is not a separate transaction.

  Parent A would compute its initial gain on the sale, which would be recognized upon the close of the transaction, under the two approaches as follows:

  

SEC registrants may also be required to report a deconsolidation or derecognition in registration statements and other nonpublic filings. See Section 8.3 of Deloitte’s Roadmap Impairments and Disposals of Long-Lived Assets and Discontinued Operations.

The deconsolidation of a subsidiary or derecognition of a group of assets would therefore be considered a disposition. Consequently, if deconsolidation or derecognition occurs as a result of a loss of control (e.g., a VIE reconsideration event as described in Chapter 9), the registrant must consider the requirements in Form 8-K, Item 2.01. See the highlights of the March 2015 CAQ SEC Regulations Committee joint meeting with the SEC staff.

The nature of the registrant’s disclosures depends on whether the deconsolidated subsidiary or derecognized group of assets (1) represents a business for SEC reporting purposes and (2) is significant. The definition of a business in Regulation S-X, Rule 11-01(d), for SEC reporting purposes differs from the definition of a business in ASC 805-10 for U.S. GAAP accounting purposes. Accordingly, the registrant must first perform an evaluation under Rule 11-01(d) to determine its SEC reporting requirements. See Section 2.1 of Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions.

Item 2.01, Instruction 4, further states, in part:

If the deconsolidated subsidiary or derecognized group of assets does not meet the definition of a business for SEC reporting purposes, the registrant should regard the deconsolidation or derecognition as an asset disposition. Further, as specified in Instruction 4(i), the registrant should report the asset disposition in accordance with Form 8-K, Item 2.01, if the registrant’s and its other subsidiaries’ equity in the net book value of such assets, or the amount received for the assets upon such disposition, exceeds 10 percent of the total assets of the registrant and its consolidated subsidiaries.

If the deconsolidated subsidiary or derecognized group of assets meets the definition of a business for SEC reporting purposes, the deconsolidation or derecognition should be regarded as a business disposition.

Under condition (ii) mentioned above, the disposition of a business is significant if any of the results of the three significance tests in Regulation S-X, Rule 1-02(w) (i.e., the asset, investment, or income test), exceed 20 percent. Registrants are not required to provide the historical financial statements of the disposed-of business in the Form 8-K.5 For additional guidance on the disposition of a business, see Section 2100 of the FRM.

In addition, Form 8-K, Item 9.01(b), requires registrants to provide, in accordance with Regulation S-X, Article 11, pro forma financial information for any transaction required to be described under Form 8-K, Item 2.01 (see Section F.4.3 for guidance on pro forma requirements). The Form 8-K, including the pro forma financial information, must be filed within four business days after the consummation6 of the disposition. The 71-day extension in Item 9.01 that is available for acquisitions is not available for dispositions (see Question 129.01 of the SEC staff’s Compliance and Disclosure Interpretations of Form 8-K).

For a deconsolidation or derecognition, a registrant generally needs to file Item 2.01 within four business days after the reconsideration event’s occurrence. See the highlights of the June 2009 and September 2009 CAQ SEC Regulations Committee joint meetings with the SEC staff for discussions of reconsideration events and the deconsolidation of a VIE. Since a registrant may identify a reconsideration event only during the interim or annual financial reporting process, if such an event results in the deconsolidation of a VIE, the registrant should consult with legal counsel if it believes that it can use, as an alternative, the date on which it files financial statements reflecting the deconsolidation (rather than the date of the reconsideration event itself).

Because the calculation for the income test is based on a measure of income from continuing operations, the reporting of a discontinued operation could affect the results of the significance test in the prior year(s) for a registrant’s investees. Consequently, as a result of retrospective adjustments for discontinued operations, a previously insignificant equity method investee may become significant and a registrant may be required to file the investee’s financial statements (or summarized information under Rule 4-08(g)) in the registrant’s next Form 10-K even if the registrant did not have to provide these items in a prior Form 10-K. Accordingly, registrants should consider the guidance in Section 8.6.2 of Deloitte’s Roadmap Impairments and Disposals of Long-Lived Assets and Discontinued Operations if a deconsolidation meets the discontinued operations criteria in ASC 205-20.