Chapter 5 — Initial Recognition and Measurement | DART

Chapter 5 — Initial Recognition and Measurement

5.1 Introduction

Noncontrolling interests represent the portion of a less than wholly owned subsidiary’s equity that is attributable to an owner other than the parent. Noncontrolling interests are typically recognized for the first time upon the occurrence of either of the following:

The initial consolidation of a subsidiary not wholly owned by the parent (see Section 5.2).
The parent’s sale of shares in a wholly owned subsidiary over which the parent retains control after the sale (see Section 5.3).

In each case, the requirement to initially recognize noncontrolling interests is linked to a preceding conclusion that the subsidiary is appropriately consolidated under ASC 810-10. Interests held in nonconsolidated legal entities do not represent noncontrolling interests and are instead governed by other U.S. GAAP. The path to reaching a consolidation conclusion is discussed in Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest.

The initial measurement of noncontrolling interests is principally a balance sheet matter. Subsequent changes in the percentage of a subsidiary’s equity interests held by noncontrolling interest holders typically result from transactions between owners (e.g., the sale of an ownership interest to [by] a noncontrolling interest holder by [to] the reporting entity).

The remainder of this chapter is limited to addressing the amount at which noncontrolling interests are measured upon initial recognition. The accounting for subsequent changes in the percentage of a subsidiary’s equity interests held by noncontrolling interest holders (typically arising from incremental sales, acquisitions, issuances, or redemptions of subsidiary shares) is addressed in Chapter 7.

5.2 Initial Measurement of Noncontrolling Interests When a Reporting Entity First Consolidates a Partially Owned Subsidiary

The conclusion that a reporting entity should consolidate a partially owned legal entity and simultaneously recognize and measure a noncontrolling interest for the first time can result from a business combination (see Section 5.2.1) or an asset acquisition (see Section 5.2.2).

5.2.1 Noncontrolling Interests Recognized Concurrently With a Business Combination

If a reporting entity acquires a controlling financial interest in a legal entity that meets the definition of a business, it should account for the transaction as a business combination under ASC 805. That guidance generally1 requires an acquiring entity to initially recognize the assets and liabilities of, and noncontrolling interests in, the acquired business at fair value. Regardless of whether all assets or liabilities are recognized at fair value, noncontrolling interests recognized as the result of a business combination are always measured initially at fair value.

A business combination can arise in any of the following ways:

Through a single transaction.
In stages.
When a reporting entity becomes the primary beneficiary of a VIE.

The initial measurement concept is unaffected by how the business combination arose.

5.2.2 Noncontrolling Interests Recognized Concurrently With an Asset Acquisition

If a reporting entity acquires a controlling financial interest in a legal entity that does not meet the definition of a business, it should account for the transaction as an asset acquisition.

The accounting for noncontrolling interests recognized in an asset acquisition depends on whether the subsidiary is a VIE — that is, whether the voting interest entity model or the VIE model is applicable:

Voting interest entity model — An asset acquisition in which the legal entity acquired is not a VIE is accounted for in accordance with the “Acquisition of Assets Rather Than a Business” subsections of ASC 805-50. Specifically, a reporting entity would account for such an asset acquisition by using a cost accumulation model under which the cost of the acquisition, including certain transaction costs, is allocated to the assets acquired on the basis of relative fair values, with some exceptions. If the reporting entity acquires less than 100 percent of the legal entity’s net assets, it should recognize a noncontrolling interest at an amount equal to the noncontrolling interest’s proportionate share of the relative fair value of any assets and liabilities acquired.
VIE model —An asset acquisition in which the legal entity acquired is a VIE is accounted for in accordance with ASC 810-10-30-4. In an asset acquisition in which a reporting entity acquires less than 100 percent of the net assets of a legal entity that is a VIE, the reporting entity should recognize a noncontrolling interest at fair value.

5.2.3 Initial Measurement of Noncontrolling Interests When an Acquired Subsidiary Has Retained Earnings or a Deficit

ASC 810-10

45-2 The retained earnings or deficit of a subsidiary at the date of acquisition by the parent shall not be included in consolidated retained earnings.

Because the initial measurement of a noncontrolling interest in a business combination or asset acquisition accompanies allocation of the consideration transferred by the reporting entity to all acquired or assumed elements (including the noncontrolling interest itself), it is inappropriate upon initial consolidation for the reporting entity to recognize any preacquisition retained earnings (deficit) of its newly acquired subsidiary or to attribute such items to controlling and noncontrolling interests.

5.2.4 Difference Between Noncontrolling Interests’ Fair Value and Their Claims on Net Assets on the Acquisition Date

As noted in Sections 5.2.1 and 5.2.2, the initial measurement of noncontrolling interests in a legal entity in which the reporting entity acquired a controlling financial interest depends on whether the legal entity meets the definition of a business. If the legal entity meets the definition of a business, the reporting entity should account for the transaction as a business combination under ASC 805 and recognize the noncontrolling interests at fair value.If the legal entity is not a VIE and does not meet the definition of a business, the reporting entity should account for the transaction as an asset acquisition under ASC 805-50 and recognize the noncontrolling interests at their proportionate share of the relative fair value of the assets (and liabilities) acquired. However, if the legal entity is a VIE and does not meet the definition of a business, the reporting entity should account for the transaction as an asset acquisition under ASC 810-10-30-4 and recognize the noncontrolling interests at fair value.

A reporting entity’s initial recognition of the noncontrolling interests at either fair value (for noncontrolling interests recognized either in a business combination or in an asset acquisition that results from the consolidation of a VIE) or the noncontrolling interests’ proportionate share of the relative fair value (for noncontrolling interests recognized in an asset acquisition that results from the consolidation of a subsidiary that is not a VIE) may result in a difference between the noncontrolling interest holders’ claims on net assets based on the terms and conditions of contractual arrangements on the acquisition date and the amounts initially recognized for the equity interests on the acquisition date.

We believe that the reporting entity should not recognize this difference at the initial recognition of the noncontrolling interests on the acquisition date. Rather, the reporting entity should measure the noncontrolling interests under ASC 805 (or, if applicable, ASC 810-10-30-4) at amounts that would be either fair value or relative fair value.

See Sections 6.1 and 7.1.2 for subsequent accounting considerations.

Footnotes

1

ASC 805 contains certain exceptions to the fair value measurement principle related to business combinations.

5.3 Noncontrolling Interests Recognized When the Reporting Entity Sells Shares in a Wholly Owned Subsidiary and Retains Control

While a noncontrolling interest may initially result from a business combination (see Section 5.2.1) or asset acquisition (see Section 5.2.2), it may also result from the dilution of a reporting entity’s equity interest in a wholly owned subsidiary over which the reporting entity retains control.

Example 5-1

On June 30, 20X7, Company A acquires Subsidiary B, a wholly owned subsidiary. Company A’s ownership interest in B as of the acquisition date is illustrated in the diagram below.

As of June 30, 20X7:

On July 15, 20X9, A seeks to raise capital and issues shares of common equity in B to an unrelated third party, Entity G. As a result, A’s ownership interest in B is diluted from 100 percent to 90 percent. The respective ownership interests of A and G are illustrated in the diagram below.

As of July 15, 20X9:

Upon the sale of the equity to G, A should initially recognize the noncontrolling interest (i.e., the 10 percent ownership interest that A no longer holds in B) in an amount equal to G’s new ownership interest of 10 percent multiplied by the net assets of B. See Section 7.1.2.6 for discussion of how to account for a parent’s selling of interests in a subsidiary directly to a noncontrolling interest holder.

In addition, the size of a noncontrolling interest can increase as a result of a parent’s sale of equity in its subsidiary. Such a sale remains an equity transaction, with no gain or loss recognized in the financial statements of the parent or subsidiary, as long as the parent retains control over the subsidiary both before and after the transaction. See Sections 7.1 through 7.1.2.8 for a discussion of changes in a parent’s ownership interest without an accompanying change in control.

Gain or loss recognition may be appropriate if the change in the reporting entity’s ownership interest is accompanied by a loss of control and therefore requires deconsolidation. See Appendix F of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest for a discussion of considerations related to such deconsolidation.

5.4 Other Considerations Related to the Initial Recognition of a Noncontrolling Interest

5.4.1 Accounting for the Issuance of a Noncontrolling Interest With Ownership Tax Benefits

Some consolidated entities are pass-through entities (e.g., partnerships). Often, the equity interests issued by pass-through entities entitle their holder to receive tax credits and other tax benefits (e.g., accelerated pass-through tax losses) that arise from the pass-through entities’ activities. Since only ownership interests that are “classified as equity” should be classified as noncontrolling interests, the first step is to consider whether the instrument should be classified outside of equity in accordance with ASC 480, which may be the case if the instrument is mandatorily redeemable.

In most instances, this form of equity interest will be appropriately classified in equity as a noncontrolling interest. Because of the complexity of attributing earnings to the noncontrolling interest, the parent will generally apply the HLBV method to subsequently attribute (comprehensive) income and loss to the noncontrolling interest (see Section 6.2.1).

This type of interest may have certain provisions that could result in the redemption of the equity interest outside the control of the parent. In such a case, the SEC requires classification of the instrument in temporary equity and a subsequent potential adjustment to the redemption amount (see Chapter 9 for additional information on accounting for redeemable noncontrolling interests).

5.4.1.1 Separating the Benefits of Tax Credits From the Substantive Noncontrolling Interest

The U.S. federal government encourages private capital investment in various projects (e.g., affordable housing or rehabilitation of historic buildings) by allowing investors in those projects to claim tax credits on their federal income tax returns. Projects that qualify for tax credits are usually undertaken by limited liability entities (typically, either limited partnerships or limited liability companies) to limit an investor’s financial risk exposure while still allowing the tax credits generated from the project to pass through to the investor.

In many limited partnership structures that generate tax credits, the general partner has an insignificant equity interest in the partnership but receives a fee for its decision-making responsibilities in the limited partnership. This fee is embedded in the general partnership interest and is a capital allocation of the general partner in the limited partnership. The limited partners typically hold essentially all of the equity interests; and in a tax equity structure, the price paid by the limited partners to acquire their equity interests is generally a function of the estimated tax benefits to be earned as well as any other rights to income and cash.

Sometimes, a limited partnership that generates tax credits is considered a VIE and, despite not having made a substantial equity investment in the partnership, the general partner will meet both of the characteristics of a controlling financial interest and thus will consolidate the limited partnership.2

If the general partner consolidates the legal entity that generates tax credits (i.e., the limited partnership), the parent (i.e., the general partner) recognizes the limited partner’s capital contributions on its balance sheet in accordance with the noncontrolling interest guidance. In general, such amounts are not mandatorily redeemable, in which case the general partner would not classify the noncontrolling interest entirely as a liability in its financial statements. However, questions have arisen about whether it would be appropriate for the parent to bifurcate the limited partner’s capital contribution (i.e., the noncontrolling interest) into separate liability (e.g., deferred revenue) and equity components. Some have asserted that as general partner of the limited partnership, the reporting entity has effectively “sold” the tax credits to the limited partner(s) in a manner akin to the transfer of goods or services in a revenue transaction.

However, in at least one instance, the SEC staff indicated that ownership interests in a low-income housing tax credit (LIHTC) partnership structure that provide limited partners with substantive and contractually specified rights to receive allocations of the partnership’s economic benefits should be classified as noncontrolling interests in the parent’s consolidated financial statements. In conjunction with this observation, the SEC staff objected to the bifurcation of limited partners’ noncontrolling interests into separate liability and equity components in the general partner’s consolidated balance sheet. While the SEC staff’s views were specific to tax credits for LIHTC partnership structures, this accounting framework should be applied to other forms of partnerships that generate tax credits.

Footnotes

2

For additional information about the analysis of a limited partnership structure as a VIE and the subsequent determination of its primary beneficiary, see Chapters 5 and 7 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest.