Chapter 4 — Intercompany Matters With Noncontrolling Interest Implications
Chapter 4 — Intercompany Matters With Noncontrolling Interest Implications
4.1 Introduction
A parent-subsidiary relationship may give rise to complexities,
particularly when a subsidiary is not wholly owned by its parent. This is because
the purpose of consolidated financial statements is to present a parent and its
subsidiaries as if they were a single economic entity, which is appropriate since
the parent-subsidiary relationship itself arises out of the parent’s presumed
ability to control the activities and transactions of its subsidiaries. However,
when a subsidiary is not wholly owned by its parent, certain situations may
challenge the parent’s ability to easily present its financial statements as if the
parent and its subsidiary were a single entity.
4.2 Multiple Legal Entities Representing a Single Reporting Entity
Through consolidation, a parent and its subsidiary form a single reporting
entity for accounting purposes while remaining separate legal entities for
operational purposes. Sometimes, a parent and its subsidiary may not have been
formed in contemplation of each other and may not share common management. The
disparate ownership interests and management structures that exist in a parent and
its subsidiary can give rise to certain complexities when the separate financial
statements of the two entities are combined into one set of consolidated financial
statements.
4.2.1 Parent and Subsidiary With Different Fiscal-Year-End Dates
ASC 810-10
45-12 It
ordinarily is feasible for the subsidiary to prepare,
for consolidation purposes, financial statements for a
period that corresponds with or closely approaches the
fiscal period of the parent. However, if the difference
is not more than about three months, it usually is
acceptable to use, for consolidation purposes, the
subsidiary’s financial statements for its fiscal period;
if this is done, recognition should be given by
disclosure or otherwise to the effect of intervening
events that materially affect the financial position or
results of operations.
Under ASC 810-10-45-12, a parent and its subsidiary are not required to share a
fiscal-year-end date. However, the difference in fiscal-year-end dates should
not be more than approximately three months. See Section 11.1.3 of Deloitte’s Roadmap
Consolidation — Identifying a Controlling Financial
Interest for a comprehensive discussion of reporting and
disclosure considerations that arise when a parent and its subsidiary have
different fiscal-year-end dates, including (1) the effect of material
intervening events, (2) reporting in the initial quarter after the parent’s
acquisition of the subsidiary, and (3) classification of the subsidiary’s loan
payable.
SEC Considerations
On August 17, 2018, the SEC issued a final
rule amending some of the Commission’s disclosure
requirements, including certain disclosure requirements in SEC
Regulation S-X. Among the amendments in the final rule is the removal of
Rule 3A-02(b) from Regulation S-X. Before the final rule became
effective on November 5, 2018, Rule 3A-02(b) used the phrase “93 days,”
as opposed to the phrase “about three months” in ASC 810-10-45-12, and
required disclosure of (1) the closing date for the subsidiary and (2)
the factors supporting the parent’s use of different fiscal-year-end
dates.
In U.S. GAAP, the specific number of days is not provided. Entities should use judgment in determining whether a period on the margin of three months (e.g., 94 days or 89 days) is appropriate.
4.2.2 Parent and Subsidiary Accounting Policies
Financial statements are more transparent and relevant if the policies used to
account for similar assets, liabilities, operations, and transactions are the same.
Therefore, in the absence of justification for differences between them, the
accounting policies of a parent and its subsidiaries should be conformed in the
parent’s consolidated financial statements.
If an adjustment is made to conform the accounting policies of a
subsidiary to those of the consolidated group, the entire adjustment should be
allocated retrospectively among the controlling and noncontrolling interests. This
view is consistent with the underlying assumption that consolidated financial
statements represent the financial position and operating results of a single
business unit.
See Section
11.1.5 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial
Interest for further discussion.
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.
4.4 Capitalization of Retained Earnings by a Subsidiary
ASC 810-10
45-9
Occasionally, subsidiaries capitalize retained earnings
arising since acquisition, by means of a stock dividend or
otherwise. This does not require a transfer to retained
earnings on consolidation because the retained earnings in
the consolidated financial statements shall reflect the
accumulated earnings of the consolidated group not
distributed to the owners of, or capitalized by, the
parent.
A parent that consolidates a legal entity, regardless of whether the parent wholly owns the legal entity, will generally be able to move assets and liabilities between the parent and the subsidiary at its discretion. When a parent causes a subsidiary to declare and issue a stock dividend (or perform a similar transaction), the transaction does not affect equity attributable to the parent or noncontrolling interest unless the stock dividend is not distributed pro rata to each owner. Pro rata distributions have no effect on equity attributable to the parent or noncontrolling interest because consolidated financial statements already present the retained earnings of the subsidiary and parent together. If the stock dividend is not distributed pro rata to each owner (i.e., the controlling interest and noncontrolling interest), a change in ownership interest without a change in control results, and the guidance discussed in Sections 7.1 through 7.1.3 will apply.