3.3 Only Equity Interests Can Be Noncontrolling Interests

ASC 810-10

45-16A Only either of the following can be a noncontrolling interest in the consolidated financial statements:

A financial instrument (or an embedded feature) issued by a subsidiary that is classified as equity in the subsidiary’s financial statements
A financial instrument (or an embedded feature) issued by a parent or a subsidiary for which the payoff to the counterparty is based, in whole or in part, on the stock of a consolidated subsidiary, that is considered indexed to the entity’s own stock in the consolidated financial statements of the parent and that is classified as equity.

45-17 A financial instrument issued by a subsidiary that is classified as a liability in the subsidiary’s financial statements based on the guidance in other Subtopics is not a noncontrolling interest because it is not an ownership interest. For example, Topic 480 provides guidance for classifying certain financial instruments issued by a subsidiary.

45-17A An equity-classified instrument (including an embedded feature that is separately recorded in equity under applicable GAAP) within the scope of the guidance in paragraph 815-40-15-5C shall be presented as a component of noncontrolling interest in the consolidated financial statements whether the instrument was entered into by the parent or the subsidiary. However, if such an equity-classified instrument was entered into by the parent and expires unexercised, the carrying amount of the instrument shall be reclassified from the noncontrolling interest to the controlling interest.

For a portion of a subsidiary’s net assets and net income to be attributable to an entity other than the parent, the other entity must hold an equity ownership interest in the subsidiary. That is, noncontrolling interests are strictly interests that are classified in equity. As noted in ASC 810-10-45-16A through 45-17A, liabilities (including equity instruments classified as liabilities under U.S. GAAP) cannot be considered noncontrolling interests. This distinction is important given the prevalence of equity instruments that may not qualify for equity classification (e.g., mandatorily redeemable preferred stock).

For simple capital structures involving only equity-classified common stock, the noncontrolling interest is the portion of the subsidiary’s equity not owned by the parent. For more complex capital structures, a reporting entity will need to use considerable judgment when determining whether an ownership interest represents a noncontrolling interest. While a legal-form liability is never considered a noncontrolling interest, not all equity instruments may be considered noncontrolling interests. Interests that require judgment include, but are not limited to, the following:

Freestanding put and call options on a subsidiary’s common stock.
Embedded put and call options on a subsidiary’s common stock.
Shares of preferred stock issued by a subsidiary.
Freestanding put and call options on a subsidiary’s preferred stock.
Embedded put and call options on a subsidiary’s preferred stock.
Financial instruments indexed to a subsidiary’s own equity.
Share-based payment awards.
Units issued by a subsidiary that is a limited liability company or limited partnership.

Although the classification of these interests is not the subject of this Roadmap, it is important to note that the scope of the noncontrolling interest literature begins with the identification of an instrument as an equity interest and the instrument’s classification as such on the balance sheet.

Certain equity interests, although legal-form equity, must be classified outside of the equity section of the balance sheet on the basis of their specific characteristics; see Deloitte’s Roadmaps Distinguishing Liabilities From Equity and Share-Based Payment Awards for guidance on the proper classification of legal-form equity instruments and share-based payment awards as either liabilities or equity on the reporting entity’s balance sheet. Other equity interests that contain certain redemption features may require classification within the “temporary” equity section of the balance sheet. Temporary equity classification does not preclude such interests from being included within the scope of the noncontrolling interest literature; however, there are additional classification and measurement considerations related to such interests. Chapter 9 of this Roadmap discusses those considerations.

Example 3-5

Company A has a 90 percent controlling common equity interest in Subsidiary Z. The remaining 10 percent common equity interest in Z is held by unrelated third parties. The common equity interests are classified as equity on Z’s balance sheet. Subsidiary Z has outstanding debt obligations held by Entity G, an unrelated party, and has issued mandatorily redeemable preferred stock to Entity B, an unrelated party. This mandatorily redeemable preferred stock is classified as a liability on Z’s balance sheet.

The diagram and table below summarize how the various debt and equity interests in Z would be classified in Z’s stand-alone financial statements and A’s consolidated financial statements.

Interest	Classification in Z’s Stand-Alone Financial Statements	Classification in A’s Consolidated Financial Statements
90% common shares held by A	Equity	Equity — controlling interest
10% common shares held by unrelated third parties	Equity	Equity — noncontrolling interest
Mandatorily redeemable preferred stock held by B	Liability under ASC 480	Liability7
Debt obligations held by G	Liability under ASC 470	Liability8

3.3.1 Other Equity Interests — Carried Interests or Profits Interests

Certain interests participate in returns after other investors have achieved a specified return on their investments. Two common examples of these interests are carried interests and profits interests (referred to collectively in this section as “other equity interests”).9 Carried interests are often held by private equity, hedge fund, and other investment managers, while profits interests are often held by employees. When the issuer of other equity interests is consolidated by a reporting entity, the reporting entity should classify and measure those interests in the consolidated financial statements on the basis of the interests’ economic substance. Often, other equity interests are legal-form equity instruments that also have the characteristics of a substantive class of equity.10 In such cases, those interests would be appropriately classified as noncontrolling interests in the reporting entity’s financial statements.

If other equity interests are legal-form equity but do not have the characteristics of a substantive class of equity, classification as noncontrolling interests would not be appropriate. For example, in certain circumstances, classification and measurement of carried interests as a compensatory arrangement may be warranted. In these instances, because the equity instrument is not an equity interest in substance, the reporting entity would classify the instrument as a profit-sharing or liability arrangement rather than as a noncontrolling interest. This might often be the case, for example, when an employee’s continued service is required for the employee to receive distributions on his or her other equity interests.

The same economic participation in profits described above may result from the execution of a contractual arrangement not in the form of legal equity that provides an incentive fee. Because the instrument in such a case is not legal-form equity, the instrument can never be classified as a noncontrolling interest.

Footnotes

The mandatorily redeemable preferred stock held by B does not qualify for classification as a noncontrolling interest because it is classified as a liability under ASC 480 in Z’s stand-alone financial statements.

The debt obligations do not qualify for classification as a noncontrolling interest because they are classified as a liability under ASC 470 in Z’s stand-alone financial statements.

See Section 6.2.3 for a discussion about the attribution of carried interests.

At the December 2006 AICPA Conference on Current SEC and PCAOB Developments, Joseph Ucuzoglu, then a professional accounting fellow in the SEC’s Office of the Chief Accountant, delivered a speech that we believe would be appropriate for an entity to consider when determining whether other equity interests have the characteristics of a substantive class of equity. For a relevant excerpt of this speech, see Section 2.6 of Deloitte’s Roadmap Share-Based Payment Awards.

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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.