6.4 Attribution of Eliminated Income or Loss (Other Than VIEs)
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.
As discussed in Section
10.2.1 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial
Interest, ASC 810-10-45-1 and ASC 810-10- 45-18 require
intercompany balances and transactions to be eliminated in their entirety. The
amount of profit or loss eliminated is not affected by the existence of a
noncontrolling interest (e.g., intra-entity open accounts balances, security
holdings, sales and purchases, interest, or dividends). Since consolidated financial
statements are based on the assumption that they represent the financial position
and operating results of a single economic entity, the consolidated statements do
not include any gain or loss transactions between the entities in the consolidated
group.
Some companies record all intercompany transactions at cost. However, other
companies that operate each component entity as a profit center may measure
profitability for each entity and thus may record intercompany transactions at fair
value. This is likely to be the case if the subsidiary is not wholly owned. In any
event, intercompany profits not realized through transactions with third parties are
to be eliminated upon consolidation; that is, if products are sold between a parent
and a subsidiary at a price in excess of the cost to the transferor, the unrealized
intercompany profit in the transferee’s inventory should be eliminated upon
consolidation.8 Although full elimination of intercompany profit is required for all
subsidiaries, the elimination of intercompany profit may be allocated
proportionately between the parent and the noncontrolling interest.
If there are other charges between a parent and subsidiary (e.g., for management services or for interest on intercompany advances), those charges also should be eliminated in consolidation. However, an intercompany charge that is capitalized as part of fixed assets (e.g., direct labor costs incurred in preparing a piece of equipment for its intended use) or included as overhead in inventory should not be eliminated if the charge is simply a pass-through of the cost of an item incurred by the transferor or paid by an entity within the consolidated group to an outside third party that would have been considered an asset in the accounts of the originating company.
As summarized in the table below, attribution of the eliminating entry depends
on (1) the nature of the intercompany transaction (downstream vs. upstream) and (2)
the accounting policy elected by the parent (for upstream transactions only).
Acceptable Eliminating Entry Attribution Methods for Intercompany Transactions With Partially Owned Subsidiaries | |||
|---|---|---|---|
Transaction | Intercompany Profit (Loss) Elimination | Attribution of Eliminating Entry | Notes |
Downstream Transaction Sale from parent to partially owned subsidiary | Fully eliminate all intercompany profit (loss) | Eliminating entry is attributed to parent; 100 percent of eliminated income (loss) reduces (increases) net income attributed to controlling interests. | |
Upstream Transaction Sale from partially owned subsidiary to parent | Fully eliminate all intercompany profit (loss) | Policy Election Must be consistently applied to all consolidated, partially owned subsidiaries. | |
Parent-Only Attribution Method Eliminating entry is attributed to parent; 100 percent of eliminated income (loss) reduces (increases) net income attributable to controlling interests. | Consolidated net income will be the same as that under the parent/noncontrolling
interest attribution method. In periods in which net income on an upstream transaction is being deferred (eliminated), net income attributable to controlling interests will be lower than that under the parent/noncontrolling interest attribution method. In the same period, the noncontrolling interest holder’s ownership interest in net assets of subsidiary will be higher than that under the parent/noncontrolling interest attribution method. | ||
Parent/Noncontrolling Interest Attribution Method Eliminating entry is attributed to parent and noncontrolling interests; eliminated income (loss) attributed to noncontrolling interests increases (decreases) net income attributable to controlling interests. | Consolidated net income will be the same as that under the parent-only
attribution method. In periods in which net income on an upstream transaction is being deferred (eliminated), net income attributable to controlling interest will be higher than that under the parent-only attribution method. In the same period, the noncontrolling interest holder’s ownership interest in net assets of the subsidiary will be lower than that under the parent-only attribution method. | ||
6.4.1 Eliminating Profit (Loss) on Downstream Transactions
In a downstream transaction, a parent sells goods (or services) to a subsidiary.
To the extent that the goods are sold for more (less) than the parent’s cost
basis in such goods, a profit (loss) will be recorded in the parent-only
financial statements. In a manner consistent with the single economic entity
concept articulated in ASC 810-10-45-1 and ASC 810-10-45-18, this type of
transaction must be eliminated in the consolidated financial statements. Any
associated profit or loss is deferred until the goods are ultimately sold to a
third party. We believe that 100 percent of the eliminating entry arising from
downstream transactions should be attributed to the parent’s controlling
interest regardless of the parent’s ultimate ownership interest in the
subsidiary because in the absence of any contractual arrangements identified in
step 1 of the three-step process described in Section 6.2, holders of noncontrolling
interests in the subsidiary will never participate economically in the profit or
loss associated with downstream intercompany transactions. Consequently,
attributing any portion of the deferral (or recognition in subsequent periods)
of such profit or loss to the noncontrolling interest holders would ignore the
substance of the transactions. However, because all of the subsidiary’s
shareholders (which include the parent) will participate in any subsequent
profit (loss) arising from the subsidiary’s ultimate sale of the goods to
third parties for amounts greater (less) than the purchase price the subsidiary
paid to the parent, incremental profits or losses arising from the subsidiary’s
ultimate sale of the goods to third parties are attributed to controlling and
noncontrolling interests in accordance with steps 2 and 3.
Some reporting entities apply the equity method of accounting in their
parent-only financial statements when accounting for the parent’s investment in
a subsidiary. Others use the cost method, under which the parent-only financial
statements include subsidiary income only to the extent that a dividend has been
declared by the parent’s subsidiary. While the financial results reported in the
consolidated financial statements will be the same under either approach, the
consolidation process will vary depending on the approach selected for preparing
the parent-only financial statements. The example below illustrates the impact
of a downstream transaction in the consolidated financial statements of a parent
that has elected to apply the equity method to its investment in its subsidiary
when preparing its parent-only financial statements.
Example 6-7
Company A has a 75 percent controlling interest in Subsidiary B. The remaining 25 percent of B’s common stock is owned by an unrelated third party, Entity C. Company A and Entity C split all earnings of B in a manner proportionate to their ownership interests. There are no contractual or other provisions that would make it necessary to allocate B’s earnings between A and C on other than a proportionate basis.
During 20X2, in addition to third-party transactions conducted by A and B, A has $125,000 of sales to B. As illustrated in the diagram below, the inventory sold to B has a cost basis of $60,000.
As of December 31, 20X2, the inventory that B has purchased from A is not yet resold to third parties.
In 20X3, B sells to third parties all inventory purchased from A in 20X2. There are no changes to B’s ownership structure, and no additional intercompany transactions are executed between A and B in 20X3.
Illustrated below are the following:
- The financial statements of A and B, respectively, for the year ended December 31, 20X2, together with the consolidating entries that would be recorded as of December 31, 20X2.
- The financial statements of A and B, respectively, for the year ended December 31, 20X3, together with the consolidating entries that would be recorded as of December 31, 20X3.
- The eliminating entries related to the downstream sale of inventory for the years ended December 31 of 20X2 and 20X3, respectively.
Note that in A’s stand-alone financial statements, A accounts for its investment in B under the equity method.
For simplicity:
- Tax implications have been ignored.
- Each of the transactions (including intercompany sales) is presumed to have been cash settled in the year it occurred.
- Intercompany sales have been presented separately from third-party sales to highlight the consolidation and elimination impact of intercompany transactions.
- Investments in B and noncontrolling interest accounts have been broken down by their contributed capital and retained earnings components.
Note that in the year ended December 31, 20X3, the
consolidating entry of $222,000 represents the
consolidating entry from the prior year.
6.4.2 Eliminating Profit (Loss) on Upstream Transactions
In an upstream transaction, a subsidiary sells goods (or services) to its
parent. To the extent that the intercompany sales price is greater (less) than
the subsidiary’s cost basis in such goods, a profit (loss) will be recorded in
the subsidiary’s financial statements. Thus, unlike a downstream transaction, in
which there is no gain or loss on the subsidiary’s books to ultimately
attribute, an upstream transaction typically gives rise to a gain or loss on the
subsidiary’s books that needs to be deferred, with the effect of such deferral
being allocated to the controlling and (depending on the parent’s policy
election) noncontrolling interests. The eliminating entry itself highlights the
competing requirements of ASC 810-10.
As previously noted, the ASC master glossary defines a noncontrolling interest as the “portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent.” The single economic entity concept articulated in ASC 810-10-45-1 and ASC 810-10-45-18 requires a reporting entity to eliminate intercompany transactions (including any associated gain or loss) in the consolidated financial statements. While ASC 810-10 also requires the reporting entity to allocate a subsidiary’s income and comprehensive income between the controlling and noncontrolling interests, it stops short of prescribing a specific means for doing so. Further clouding the picture, the last sentence of ASC 810-10-45-18 states that the “elimination of the intra-entity income or loss may be allocated between the parent and noncontrolling interests” (emphasis added), leaving open the possibility of attributing the effect of the eliminating entry to noncontrolling interests while stopping short of requiring such attribution outright.
In light of the competing requirements summarized above, we believe that there are two acceptable methods for attributing to controlling and noncontrolling interests the effect of the eliminating entry on an upstream transaction:
- Parent-only attribution method — Under the parent-only attribution method, 100 percent of the deferred income (loss) reduces (increases) net income attributable to the controlling interests on the basis that from the perspective of a single economic entity, until the parent resells the inventory to third parties (as addressed below), no transaction has occurred with an external party, and therefore no profit should flow through to the consolidated entity’s bottom line (i.e., net income attributable to the parent). While this method results in reported net income attributable to controlling interests that is lower (higher) than that under the parent/noncontrolling interest attribution method in the period of profit (loss) deferral, amounts reported as noncontrolling interests in the consolidated balance sheet in the same period will equal the noncontrolling interest holders’ portion of the subsidiary’s net assets after the upstream sale. That is, under the parent-only attribution method, the carrying amount of the noncontrolling interests in the consolidated balance sheet reflects the noncontrolling interest holders’ increased (decreased) claim on the subsidiary’s net assets in recognition that the subsidiary’s net assets increase (decrease) as a result of the upstream transaction even though 100 percent of the income (loss) on the upstream sale is deferred in consolidation.
- Parent/noncontrolling interest attribution method — Under the parent/noncontrolling interest attribution method, a reporting entity attributes the eliminating entry necessary to defer income (loss) on the upstream transaction to the parent and noncontrolling interest holders in proportion to their ownership interests (in the absence of any identified contractual arrangements in step 1 of the three-step process described in Section 6.2). Thus, although reported net income (loss) will be the same under this method as under the parent-only attribution method, reported net income (loss) attributable to the parent’s controlling interest will be higher (lower) in the period of profit (loss) deferral. Essentially, this method immediately affects the consolidated reporting entity’s bottom line (through the attribution of income as opposed to net income) for the portion of income (loss) on the upstream transaction that is related to noncontrolling interests in the subsidiary. Consequently, under the parent/noncontrolling interest attribution method, until the parent resells the inventory to third parties, the consolidated financial statements reflect higher net income (loss) attributable to the controlling interests but a lower (higher) overall balance sheet amount associated with the noncontrolling interest holders’ claim on the subsidiary’s net assets.
Connecting the Dots
The existence of two attribution methods allows for reporting entities with similar transactions to temporarily report different amounts for net income attributable to the controlling and noncontrolling interest holders, as well as different carrying amounts for noncontrolling interests, on their individual consolidated balance sheets. However, as illustrated in the example below, these differences reverse themselves upon the parent’s ultimate sale of the inventory to third parties. Notwithstanding the temporary nature of the differences that result from a reporting entity’s decision to choose one attribution method over the other, we believe that the selection of an attribution method is an accounting policy election that a reporting entity should apply consistently when consolidating all of its partially owned subsidiaries.
The example below illustrates the impact of applying both attribution methods to
an upstream transaction in the consolidated financial statements of a parent
that has elected to apply the equity method to its investment in its subsidiary
when preparing its parent-only financial statements.
Example 6-8
Company A has a 75 percent controlling interest in Subsidiary B. The remaining 25 percent of B’s common stock is owned by an unrelated third party, Entity C. Company A and Entity C split all earnings of B in a manner proportionate to their ownership interests. There are no contractual or other provisions that would make it necessary to allocate B’s earnings between A and C on other than a proportionate basis.
During 20X2, in addition to third-party transactions conducted by A and B, B has $125,000 of sales to A. As illustrated in the diagram below, the inventory sold to A has a cost basis of $60,000.
As of December 31, 20X2, the inventory that A has purchased from B is not yet resold to third parties.
In 20X3, A sells to third parties all inventory purchased from B in 20X2. There are no changes to B’s ownership structure, and no additional intercompany transactions are executed between A and B in 20X3.
Illustrated below are the following:
- The financial statements of A and B, respectively, for the years ended December 31, 20X2, and December 31, 20X3, together with the consolidating entries that would be recorded as of the end of each of those years under the parent-only attribution method.
- The eliminating entries related to the upstream sale of inventory for the years ended December 31 of 20X2 and 20X3, respectively, under each alternative attribution method.
- The financial statements of A and B, respectively, for the years ended December 31, 20X2, and December 31, 20X3, together with the consolidating entries that would be recorded as of the end of each of those years under the parent/noncontrolling interest attribution method.
Note that in A’s stand-alone financial statements, A accounts for its investment in B under the equity method.
For simplicity:
- Tax implications have been ignored.
- Each of the transactions (including intercompany sales) is presumed to have been cash settled in the year it occurred.
- Intercompany sales have been presented separately from third-party sales to highlight the consolidation and elimination impact of intercompany transactions.
- Investments in B (A) and noncontrolling interest (consolidated) accounts have been broken down by their contributed capital and retained earnings components.
Footnotes
8
ASC 980-810-45-1 provides an exception under which profit on
sales to regulated affiliates would not be eliminated when specific criteria
are met.