4.3 Transactions Between Parent and Subsidiary
ASC 810-10
45-1 In
the preparation of consolidated financial statements,
intra-entity balances and transactions shall be eliminated.
This includes intra-entity open account balances, security
holdings, sales and purchases, interest, dividends, and so
forth. As consolidated financial statements are based on the
assumption that they represent the financial position and
operating results of a single economic entity, such
statements shall not include gain or loss on transactions
among the entities in the consolidated group. Accordingly,
any intra-entity profit or loss on assets remaining within
the consolidated group shall be eliminated; the concept
usually applied for this purpose is gross profit or loss
(see also paragraph 810-10-45-8).
45-18 The amount of
intra-entity income or loss to be eliminated in accordance
with paragraph 810-10-45-1 is not affected by the existence
of a noncontrolling interest. The complete elimination of
the intra-entity income or loss is consistent with the
underlying assumption that consolidated financial statements
represent the financial position and operating results of a
single economic entity. The elimination of the intra-entity
income or loss may be allocated between the parent and
noncontrolling interests.
4.3.1 Intercompany Transactions
ASC 810-10-45-1 and ASC 810-10-45-18 require intercompany transactions to be
eliminated in their entirety. In recognition that transactions between a parent
and its subsidiaries are those of a single economic entity from a consolidation
perspective, only transactions with parties outside the consolidated group are
presented in consolidated financial statements. This is because transactions
between entities within a consolidated group do not result in the culmination of
the earnings process.
The full elimination of intercompany transactions is not affected by the existence of noncontrolling interests. However, the manner in which the elimination of intercompany transactions is attributed to controlling and noncontrolling interests may be affected by:
- The subsidiary’s status as a VIE (see Section 6.5 for more information).
- The nature of transactions involving sales of goods between the parent and a subsidiary that has been consolidated under the voting interest entity model (refer to Sections 6.4 through 6.4.2 for a discussion of considerations related to downstream and upstream sales).
4.3.2 Intercompany Ownership Interests
As noted in Section
4.3.1, intercompany transactions and balances must be eliminated
in consolidated financial statements. The requirement to eliminate intercompany
balances may be easy to apply in circumstances involving simple transactions
(e.g., a direct loan between a parent and its subsidiary) but may become more
difficult to apply in other situations. For example, a parent’s consolidation of
a subsidiary is often based, in part, on its ownership of common stock of that
subsidiary. Sometimes, the subsidiary may also hold equity interests in its
parent (e.g., as part of an investment strategy that predates consolidation). On
a consolidated basis, such cross holdings represent reciprocal interests.
4.3.2.1 Subsidiary’s Ownership Interest in Parent (Reciprocal Interests) — Subsidiary Reporting
A subsidiary may hold an investment in its parent’s common stock. The
Codification does not address the reporting by a subsidiary in its separate
financial statements of an investment in its parent’s common stock.
The EITF addressed this issue at its May 21, 1998, meeting on EITF Issue
98-2. The Task Force tentatively concluded that a subsidiary should account
for an investment in the common stock of its parent in a manner similar to
how it accounts for treasury stock and should present that investment as a
contra-equity account in its separate financial statements. However, at the
July 23, 1998, EITF meeting on the same issue, the Task Force withdrew that
tentative conclusion and noted that (1) an entity’s policy with respect to
the accounting for investments in the stock of its parent should be
disclosed and (2) an entity that changes an existing policy must demonstrate
that the change in accounting is preferable in the circumstances.
Certain characteristics of transactions involving the parent’s common stock may
make it difficult to separate the parent from the subsidiary. Specifically,
because a parent’s consolidation of its subsidiary is predicated on control,
there is a presumption that a parent directs its subsidiary’s transactions.
This presumption, which implies that a parent that is seeking to acquire its
own shares may be indifferent to doing so directly or through a subsidiary
whose actions it controls, would typically lead to the conclusion that an
investment in the parent’s stock should be presented in the equity section
of a wholly owned subsidiary’s separate financial statements and should be
accounted for in the same manner as treasury stock (i.e., initially measured
at cost in accordance with ASC 505-30, with no subsequent change in basis
for changes in fair value, regardless of whether the shares are publicly
traded).
However, we believe that there are certain circumstances in which a
subsidiary might have acquired shares of its parent’s stock separately and
apart from any direction of the parent, thus overcoming the aforementioned
presumption. In such circumstances, and under the assumption that the parent
is substantive (e.g., the parent has substance beyond its ownership of the
subsidiary), it may be appropriate for the subsidiary to present those
acquired shares as investment securities in the subsidiary’s stand-alone
financial statements.
Indicators that a subsidiary’s acquisition of shares of its parent’s stock was
not a treasury stock transaction directed by the parent include
the following:
-
The acquired shares will be used in the near future (less than one year) to settle an independent third-party obligation of the subsidiary incurred as a result of its own operations.
-
The acquisition of the shares was in the ordinary course of business and was funded by the subsidiary from its own operations.
-
The acquired shares do not constitute a significant percentage of the parent’s total shares outstanding.
-
The investment in the parent’s stock is immaterial to the total assets of the subsidiary.
-
The shares of the parent’s stock (1) are held by a newly acquired subsidiary and (2) were held by the acquiree before the business combination occurred.
These indicators are not intended to be all-inclusive, and no single indicator
is determinative.
The determination of whether a subsidiary has overcome the presumption that its
acquisition of shares of its parent’s stock is a parent-directed treasury
transaction is a matter of judgment and should be based on an evaluation of
the specific facts and circumstances.
Example 4-1
Company A, a public reporting entity, has a controlling interest in Subsidiary B, an insurance company that offers policies that allow policyholders to cause B to invest in equity securities on their behalf. While making these purchases on behalf of policyholders, B will retain legal title to these securities. Company A’s stock, which is widely held and actively traded, is a security that the policyholders may select. In these circumstances, the manner in which B acquired shares in A (i.e., in response to policyholder investment selections) would overcome the presumption of control of such acquisition by the parent company, and B would record the shares as investment securities in its stand-alone financial statements.
4.3.2.2 Subsidiary’s Ownership Interest in Parent (Reciprocal Interests) — Consolidated Reporting
ASC 810-10
45-5
Shares of the parent held by a subsidiary shall not
be treated as outstanding shares in the consolidated
statement of financial position and, therefore,
shall be eliminated in the consolidated financial
statements and reflected as treasury shares.
As noted in Section
4.3.2.1, a subsidiary in certain instances may account for
holdings of its parent’s shares as an investment (as opposed to a treasury
stock transaction). However, in a manner consistent with the single economic
entity concept and the guidance in ASC 810-10-45-5, reciprocal interests
should generally be presented as treasury shares on the parent’s
consolidated balance sheet regardless of the extent of the parent’s
ownership interest in its subsidiary. That is, 100 percent of a subsidiary’s
interests in its parent should generally be reported as treasury shares in
the parent’s consolidated financial statements even if the subsidiary is not
wholly owned by the parent.
Example 4-2
Company A is a public entity whose common shares are actively traded on the New York Stock Exchange. Company A has 10,000 shares of its common stock issued and outstanding. Company A has an 85 percent controlling interest in Subsidiary B.
Subsidiary B is a privately held company that has 5,000 shares of its common stock issued and outstanding. Unrelated third parties own the remaining 15 percent (750 shares) of B’s common shares.
Subsidiary B purchases 1,000 shares (10 percent) of A’s stock in an open-market transaction at $35 per share.
The diagram below illustrates the ownership interests of A and B after B’s purchase of A’s common shares.
To record B’s acquisition of A’s shares on A’s consolidated balance sheet, A records the following journal entry:
Note that B’s shares of A’s stock indirectly entitle B’s shareholders (and,
therefore, holders of the noncontrolling interest in
B) to a portion of A’s earnings. Two methods of
attributing the consolidated earnings of A to A’s
shareholders and holders of the noncontrolling
interest in B are described in Section
6.6.