Chapter 3 — Scope
Chapter 3 — Scope
3.1 Introduction
For a reporting entity to determine whether it should apply the
guidance on the measurement and recognition of noncontrolling interests, the entity
must first evaluate the scope of that guidance. Aside from providing explicit scope
limitations for certain transactions that lead to decreases in ownership without an
accompanying change in control (see Section 7.1.1), ASC 810-10 does not explicitly
address the scope of its guidance on noncontrolling interests. Rather, ASC 810-10-20
defines a noncontrolling interest as the “portion of equity (net assets) in a
subsidiary not attributable, directly or indirectly, to a parent” and further states
that a “noncontrolling interest is sometimes called a minority interest.”
This definition applies to all entities that prepare consolidated
financial statements. Although the definition is brief, it contains multiple
components, analyzed below, that are imperative for assessing whether the guidance
on noncontrolling interests is applicable. The decision tree below illustrates how
to determine whether there are any noncontrolling interests.
Note that a noncontrolling interest exists only from the perspective
of the parent that prepares consolidated financial statements. Specifically, the
reporting entity’s perspective will determine what noncontrolling interests exist.
See Section 3.2.1 for
more information.
3.2 Portion of a Subsidiary Not Attributable to the Parent
ASC 810-10
45-15
The ownership interests in the subsidiary that are held by
owners other than the parent is a noncontrolling interest.
The noncontrolling interest in a subsidiary is part of the
equity of the consolidated group.
45-16
The noncontrolling interest shall be reported in the
consolidated statement of financial position within equity
(net assets), separately from the parent’s equity (or net
assets). That amount shall be clearly identified and
labeled, for example, as noncontrolling interest in
subsidiaries (see paragraph 810-10-55-4I). An entity with
noncontrolling interests in more than one subsidiary may
present those interests in aggregate in the consolidated
financial statements. A not-for-profit entity shall report
the effects of any donor-imposed restrictions, if any, in
accordance with paragraph 958-810-45-1.
A noncontrolling interest arises in the consolidated financial statements of a reporting entity (a parent) that consolidates a legal entity (a subsidiary) it does not wholly own. For the user(s) of the parent’s consolidated financial statements, this differentiates the portion of the net assets in such statements that ultimately accrues to the parent (and the parent’s shareholders) from the portion that accrues to third-party investors in the subsidiary.
The example below illustrates how a reporting entity would identify noncontrolling interests.
Example 3-1
Company B is a public reporting entity that manufactures corn chips and matches.
Equity ownership of B is widely distributed since B’s common
stock is traded on a public exchange. Company B has expanded
as a result of the organic growth of Subsidiary J, a corn
chip manufacturer that B wholly owns. In addition, B has
acquired an 80 percent equity interest in Subsidiary X, a
match manufacturer, and a 50 percent equity interest in
Joint Venture Z, another match manufacturer.
Company B has a controlling financial interest in J and X and, in accordance
with ASC 810-10, consolidates these subsidiaries. The equity
interests issued by J and X are appropriately classified in
the equity section of B’s consolidated financial statements.
While B holds a 50 percent interest in Z, it does not have a
controlling financial interest in Z and therefore does not
consolidate Z. A summary of B’s equity interests is
presented below.
To identify the noncontrolling interest when preparing its consolidated financial statements, B should first identify its consolidated subsidiaries. As stated above, J and X are consolidated by B.
Company B should then determine whether other parties hold ownership interests in its consolidated subsidiaries and, if so, whether such interests are classified as equity in the subsidiaries’ financial statements. While J is a wholly owned subsidiary, 20 percent of the equity interest in X is held by an unrelated third party and is classified as equity in X’s financial statements. As a result, B must present the 20 percent interest in X that is held by the third party as a noncontrolling interest in B’s consolidated financial statements since this presentation differentiates B’s 80 percent equity interest in X from the 20 percent equity interest in X that is held by the third party.
Note that even though an unrelated third party owns 50 percent of Z, because B does not consolidate Z, it will not present the interests of the third party as a noncontrolling interest.
3.2.1 Noncontrolling Interest in a Subsidiary Owned by the Parent or Affiliate of a Reporting Entity
In a consolidated group that includes multiple levels of reporting entities
(e.g., a consolidated group that comprises a parent,1 a first-tier subsidiary2 wholly or partially owned by the parent, and a second-tier subsidiary
wholly or partially owned by the first-tier subsidiary), additional complexities
may arise with regard to the recognition and measurement of the noncontrolling
interests in the financial statements of each individual reporting entity (i.e.,
the parent and first-tier subsidiary in this instance).
Specifically, when preparing its consolidated financial statements, a reporting entity must first identify its controlling interests in all of its subsidiaries, recognizing that its controlling interests might be held directly or indirectly by one or more entities in the same consolidated group. All interests classified in equity that are not directly or indirectly considered part of the controlling interest will be separately recognized and measured as noncontrolling interests. The examples below illustrate the complexities that can arise in the identification of controlling and noncontrolling interests in multitiered legal entity structures.
Example 3-2
Assume the same facts as in Example 3-1,
except that Subsidiary J holds a 60 percent controlling
equity interest in Subsidiary N and consolidates N. A
summary of B’s equity interests in J, X, Z, and N is
presented below.
If J is the reporting entity, it must present noncontrolling interests in its consolidated financial statements to differentiate between its 60 percent controlling equity interest in N and the 40 percent equity interest held by third parties.
If B is the reporting entity, there are no noncontrolling interests in J since B wholly owns the equity of that specific legal entity. However, B must classify the 40 percent equity interest in N held by third parties as a noncontrolling interest when preparing B’s consolidated financial statements because B’s wholly owned subsidiary J does not itself wholly own N.
Example 3-3
Assume the same facts as in the example above, except that the remaining 40
percent equity interest in Subsidiary N that is not
owned by Subsidiary J is directly owned by Company B.
The diagram below illustrates the equity interests of B
and J.
As indicated in Section
3.2, ASC 810-10-45-15 defines
noncontrolling interests as the “ownership interests in
the subsidiary that are held by owners other than the
parent.” We believe that since J is the first-tier
parent of N, it is appropriate for J to present B’s 40
percent equity interest in N as a noncontrolling
interest in J’s consolidated financial statements. For
users of J’s consolidated financial statements, such
presentation differentiates J’s direct 60 percent equity
interest in N from the 40 percent equity interest in N
that is held by B. That is, the presentation of B’s
direct 40 percent equity interest in N as a
noncontrolling interest in J’s consolidated financial
statements signals to users of J’s financial statements
(which could include stakeholders other than equity
investors) that J’s claim on the net assets of N is
limited to J’s 60 percent equity interest.6
In contrast, when preparing its own consolidated financial statements, B would not identify any noncontrolling interest in N since B holds 100 percent of the equity interests in N as a result of (1) B’s 40 percent direct equity interest in N and (2) B’s 60 percent indirect equity interest in N through B’s ownership of J. Such presentation signals to users of B’s consolidated financial statements that B is entitled to 100 percent of N’s net assets as a result of the aggregation of B’s direct and indirect equity interests in N.
Example 3-4
Assume the same facts as in Example 3-2,
except for the following:
-
Company B owns 90 percent of Subsidiary J, and the remaining 10 percent ownership interest in J is held by Unrelated Third-Party Investor 1.
-
Company B, J, and Unrelated Third-Party Investor 2 hold direct ownership interests in Subsidiary N of 60 percent, 25 percent, and 15 percent, respectively.
The diagram below illustrates the ownership interests of the various entities.
As indicated in Section
3.2, ASC 810-10-45-15 defines
noncontrolling interests as the “ownership interests in
the subsidiary that are held by owners other than the
parent.” When preparing its consolidated financial
statements, B may identify a noncontrolling interest of
17.5 percent in N (10 percent noncontrolling interest in
J multiplied by J’s 25 percent equity interest in N,
plus the 15 percent noncontrolling interest held by
Unrelated Third-Party Investor 2). Such presentation
would signal to users of B’s consolidated financial
statements that B is entitled to 82.5 percent of N’s net
assets as a result of the aggregation of B’s direct and
indirect equity interests in N.
Connecting the Dots
An ultimate parent may hold equity interests in a second-tier subsidiary (1)
directly, (2) indirectly through a first-tier subsidiary that is the
immediate parent of the second-tier subsidiary, or (3) indirectly
through another first-tier subsidiary that is an affiliate (e.g., a
sister company) of the immediate parent. We believe that in a manner
consistent with Example 3-3, the
equity owned by the ultimate parent or the affiliate of the immediate
parent should be presented in the immediate parent’s consolidated
financial statements as a separate component of the immediate parent’s
stockholders’ equity that is classified and measured as a noncontrolling
interest. The ultimate parent’s or affiliate’s share of the immediate
parent’s consolidated net income (arising from the ultimate parent’s or
affiliate’s direct interest in the second-tier subsidiary) is shown in
net income attributable to the noncontrolling interest, which is a
single line item presented below the immediate parent’s net income.
For instance, assume the same facts as in Example 3-3, except that the
remaining 40 percent equity interest in N that is not owned by J is
directly owned by X. In J’s consolidated financial statements, the 40
percent interest held by X would be presented in J’s equity as a
noncontrolling interest, and X’s share of N’s net income would be shown
in net income attributable to noncontrolling interests.
Footnotes
1
May also be referred to as the ultimate parent.
2
May also be referred to as the immediate parent of the
second-tier subsidiary.
3
Second-tier subsidiary’s
ultimate parent.
4
Second-tier subsidiary’s
immediate parent.
5
Second-tier subsidiary.
6
Although an alternative
presentation of a parent’s or affiliate’s
noncontrolling interest may be used under specific
facts and circumstances, the SEC staff may
question that presentation. SEC registrants that
are considering the use of an alternative
presentation are encouraged to preclear it with
the SEC staff before issuing their financial
statements.
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
7
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.
8
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.
9
See Section 6.2.3 for a discussion about the attribution of
carried interests.
10
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.