Chapter 6 — Attribution of Income, Other Comprehensive Income, and Cumulative Translation Adjustment Balances

6.3 Attribution of Losses in Excess of Carrying Amount

ASC 810-10

45-21 Losses attributable to the parent and the noncontrolling interest in a subsidiary may exceed their interests in the subsidiary’s equity. The excess, and any further losses attributable to the parent and the noncontrolling interest, shall be attributed to those interests. That is, the noncontrolling interest shall continue to be attributed its share of losses even if that attribution results in a deficit noncontrolling interest balance.

Before FASB Statement 160 was issued, reporting entities were required under ARB 51 to attribute losses solely to the parent once losses allocated to the noncontrolling interest equaled the noncontrolling interest’s equity. The reasoning behind this requirement was that the noncontrolling interest could not be compelled to provide additional capital to the subsidiary, whereas the parent would most likely have an implicit obligation to keep the subsidiary a going concern. After adoption of FASB Statement 160, noncontrolling interests are considered equity of the consolidated group that participate fully in the risks and rewards of the subsidiary. Accordingly, with limited exception (described after the example below), losses generally continue to be attributed to noncontrolling interests regardless of whether a deficit would be recorded. As explained in paragraphs B41 through B43 of the Background Information and Basis for Conclusions of FASB Statement 160, the FASB based its decision to change historical practice on the observation that although a controlling interest holder may be more likely to provide additional support to a subsidiary than a noncontrolling interest holder, it cannot be forced to do so. Given that observation, the Board was uncomfortable with requiring the allocation of losses between the controlling and noncontrolling interest holders to be predicated on probability.

Example 6-4

On January 1, 20X9, Company A acquired 80 percent of Subsidiary C in a transaction accounted for as a business combination under ASC 805-10. As of the acquisition date, the equity attributable to A (the parent) is $80 million, and the equity attributable to Entity B (the noncontrolling interest holder) is $20 million. Subsidiary C has only one class of common stock outstanding, and no shareholders have an explicit obligation to support the ongoing operations of C. During 20X9, C incurred net losses of $150 million.

The net earnings (losses) of C are attributed to A and B on the basis of their relative ownership interests (i.e., 80 percent/20 percent).

Of C’s 20X9 net losses, $30 million (20 percent of $150 million) would be attributed to the noncontrolling interest. As a result, the carrying amount of the noncontrolling interest will reflect a deficit balance of $10 million at the end of 20X9 ($20 million beginning balance reduced by $30 million of current-period losses). The remaining $120 million (80 percent of $150 million) of C’s 20X9 net losses would be attributed to A’s controlling interest, resulting in a 20X9 ending deficit balance for A’s controlling interest of $40 million.

The equity interests at acquisition and after the attribution of 20X9 losses are illustrated below.

Equity interests as of January 1, 20X9:

Equity interests as of December 31, 20X9 (after the attribution of losses):

Note that ASC 810-10-45-21 states that losses allocated to noncontrolling interests may exceed their interest in subsidiary equity. Thus, while ASC 810-10 acknowledges that a reporting entity may report noncontrolling interest balances as a negative amount in some situations, there are also circumstances in which it may not be appropriate to do so. Given that the FASB’s decision to permit the attribution of losses in excess of the noncontrolling interests’ equity balance was based on the Board’s belief that holders of controlling and noncontrolling interests in a typical entity could not be compelled to provide additional support to the entity, it remains appropriate to attribute losses in a manner disproportionate to ownership interests when a contractual arrangement does compel one investor to absorb more losses than another. For example, contractual arrangements outside of the shareholder agreement itself (e.g., debt guarantees), coupled with the perennial need to consider substance over form, may require attribution of losses on a basis different from proportionate ownership interests or loss-sharing percentages specified in the shareholder agreement. Similarly, in subsequent periods of net income, disproportionate attribution of income may be required until losses that have been disproportionately attributed are fully recovered.

We believe that a subsidiary’s losses in excess of each party’s investment in the subsidiary’s equity should be allocated between the parent and noncontrolling interest holders in accordance with the three-step allocation process described in Section 6.2. That is, as illustrated in the example below, a reporting entity with a controlling financial interest in a legal entity should consider the impact of its other interests in the legal entity (e.g., debt and other forms of financial support) when determining the attribution of current-period losses, especially when the amount of losses attributed in prior periods exceeds the ownership interests of the parent and noncontrolling interest holders. A reporting entity should also use this three-step process when attributing income generated in subsequent reporting periods.

Example 6-5

In 20X1, Company A and Entity B enter into a partnership agreement under which Subsidiary C is formed. Company A has invested $75 million for a 75 percent equity controlling interest in C, and B has invested $25 million for the remaining 25 percent noncontrolling interest in C. Company A consolidates C accordingly.

In addition to the equity interests that C has issued, C has obtained the following forms of financing:

$110 million of senior bank financing, fully guaranteed for repayment by A.
$50 million of unsecured debt financing provided by third parties. This debt is not guaranteed by A or B.

The equity interests and financing at formation are illustrated in the diagram below.

In its first five years of operations, C had no intercompany transactions with A or B. During this time, C generated annual net income (loss) as follows:

Year 1 — $(90 million).
Year 2 — $(100 million).
Year 3 — $(40 million).
Year 4 — $50 million.
Year 5 — $200 million.

Subsidiary C’s partnership agreement requires income to be distributed on a pro rata basis in accordance with the respective ownership percentages of A and B, but it is silent on attribution of losses and does not impose on A or B any explicit obligation to support the continued operations of C. Although the partnership agreement does not explicitly specify a formula for attributing losses, A would apply the three-step process described in Section 6.2 as follows:

Step 1 — Identify all contractual arrangements between the parent, noncontrolling interest holders, subsidiary, and third parties (or financial reporting requirements of other Codification topics) that have the potential to shift income or loss between the parties on a basis other than their relative equity ownership percentages.

Company A’s full (and sole) guarantee of C’s $110 million of senior bank financing serves to shift to A the responsibility for absorbing C’s cumulative losses that are in excess of $100 million (C’s initial equity balance) but less than or equal to $210 million.
Step 2 — Allocate the economic results of the subsidiary between the controlling and noncontrolling interests to reflect the contractual arrangements (or financial reporting requirements of other Codification topics) identified in step 1.

In consolidating C’s financial results, A would (1) allocate the first $100 million of C’s cumulative losses (years 1 and 2) proportionately between its controlling interest and B’s noncontrolling interest and (2) attribute the next $110 million of C’s cumulative losses (years 2 and 3) solely to A’s controlling financial interest.
Step 3 — Allocate residual items of income and loss (which may differ from net income [loss] because of the adjustments made in step 2) between the controlling and noncontrolling interest holders in accordance with each party’s pro rata equity ownership interest in the subsidiary.

In consolidating C’s financial results, A would allocate the remaining $20 million of C’s cumulative losses (year 3) proportionately between A’s controlling interest and B’s noncontrolling interest.

Attributions of the first $130 million of net income in years 4 and 5 would essentially unwind (in reverse chronological order) the attributions made in steps 3 and 2 above, with the remaining $120 million of net income occurring in year 5 being allocated proportionately between A’s equity interests in C and those of B.

The following table details the attribution of C’s income (loss) and its associated impact on A’s equity interests in C and those of B for each reporting period (dollar amounts in millions):7

Similarly, as illustrated in the example below, a reporting entity with a controlling financial interest in a legal entity should also consider the impact of liquidation preferences associated with investments in the legal entity when determining the attribution of current-period losses, especially when the amount of losses attributed in prior periods exceeds the ownership interests of the parent and noncontrolling interest holders. A reporting entity should also use this three-step process when attributing income generated in subsequent reporting periods.

Example 6-6

Company A has a controlling financial interest in Company C and made an $80 million investment in C's preferred stock that represents 80 percent of C’s equity capitalization. Company B made a $20 million investment in C's common stock that represents the remaining 20 percent noncontrolling interest in C. The preferred stock held by A has a substantive liquidation preference.

The equity interests in C as of January 1, 20X1, are illustrated in the diagram below.

In its first three years of operations, C had no intercompany transactions with A or B. During this time, C generated annual net income (loss) as follows:

Year 1 — $(90 million).
Year 2 — $(100 million).
Year 3 — $(40 million).

Assume the above facts for both scenarios below (Case A and Case B).

Case A — No Obligation to Fund Subsidiary Losses

Company C’s articles of incorporation require income to be distributed on a pro rata basis in accordance with the respective ownership percentages of A and B, but they are silent on attribution of losses and do not impose any explicit obligation to support the continued operations of C.

Although the articles of incorporation do not explicitly specify a formula for attributing losses, A would apply the three-step process described in Section 6.2 as follows:

Step 1 — Identify all contractual arrangements between the parent, noncontrolling interest holders, subsidiary, and third parties (or financial reporting requirements of other Codification topics) that have the potential to shift income or loss between the parties on a basis other than their relative equity ownership percentages.

Company A’s substantive liquidation preference serves to protect A from absorbing C’s cumulative losses before B’s equity balance is entirely depleted.
Step 2 — Allocate the economic results of the subsidiary between the controlling and noncontrolling interests to reflect the contractual arrangements (or financial reporting requirements of other Codification topics) identified in step 1.

In consolidating C’s financial results, A would (1) allocate the first $20 million of C’s cumulative losses (year 1) to B’s noncontrolling interest and (2) attribute the next $80 million of C’s cumulative losses (years 1 and 2) solely to A’s controlling financial interest.
Step 3 — Allocate residual items of income and loss (which may differ from net income [loss] because of the adjustments made in step 2) between the controlling and noncontrolling interest holders in accordance with each party’s pro rata equity ownership interest in the subsidiary.

In consolidating C’s financial results, A would allocate the remaining $130 million of C’s cumulative losses (years 2 and 3) proportionately between A’s controlling interest and B’s noncontrolling interest.

The following table details the attribution of C’s income (loss) and its associated impact on A’s equity interests in C and those of B for each reporting period (dollar amounts in millions):

Case B — Explicit Obligation to Fund Subsidiary Losses

Company C’s articles of incorporation require income to be distributed on a pro rata basis in accordance with the respective ownership percentages of A and B, and they explicitly require A to support the continued operations of C. Therefore, A is required to fund the operating losses of C. Accordingly, A would again apply the three-step process described in Section 6.2 as follows:

Step 1 — Identify all contractual arrangements between the parent, noncontrolling interest holders, subsidiary, and third parties (or financial reporting requirements of other Codification topics) that have the potential to shift income or loss between the parties on a basis other than their relative equity ownership percentages.

Company A’s substantive liquidation preference serves to protect A from absorbing C’s cumulative losses before B’s equity balance is entirely depleted.
Step 2 — Allocate the economic results of the subsidiary between the controlling and noncontrolling interests to reflect the contractual arrangements (or financial reporting requirements of other Codification topics) identified in step 1.

In consolidating C’s financial results, A would (1) allocate the first $20 million of C’s cumulative losses (year 1) to B’s noncontrolling interest.
Step 3 — Allocate residual items of income and loss (which may differ from net income [loss] because of the adjustments made in step 2) between the controlling and noncontrolling interest holders in accordance with each party’s pro rata equity ownership interest in the subsidiary.

In consolidating C’s financial results, A would allocate the remaining $210 million of C’s cumulative losses (years 1, 2 and 3) solely to A’s controlling financial interest as a result of A’s explicit obligation to support C’s losses.

The following table details the attribution of C’s income (loss) and its associated impact on A’s equity interests in C and those of B for each reporting period (dollar amounts in millions):

Connecting the Dots

As demonstrated above, it remains appropriate to attribute losses in a manner disproportionate to ownership interests when a contractual arrangement compels one investor to absorb more losses than another. Case B illustrates a fact pattern in which one investor is explicitly required to absorb such losses. However, careful consideration is warranted when the obligation is implicit rather than explicit. For example, a parent company may have a historical practice of funding its subsidiary’s losses that would support a conclusion that the parent company is implicitly obligated to keep the subsidiary a going concern. To the extent that a reporting entity believes that an implicit obligation to fund subsidiary losses is present and substantive, the reporting entity should consider consulting with its professional accounting advisers.

Footnotes

For purposes of this example, tax implications have been ignored.

Confidential and Proprietary — for Use Solely by Authorized Personnel

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.