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

6.8 Presentation of Preferred Dividends of a Subsidiary

ASC 810-10

40-2 Section 480-10-25 does not require mandatorily redeemable preferred stock to be accounted for as a liability under certain conditions. If such conditions apply and the mandatorily redeemable preferred stock is not accounted for as a liability, then the entity’s acquisition of a subsidiary’s mandatorily redeemable preferred stock shall be accounted for as a capital stock transaction. Accordingly, the consolidated entity would not recognize in its income statement any gain or loss from the acquisition of the subsidiary’s preferred stock. In the consolidated financial statements, the dividends on a subsidiary’s preferred stock, whether mandatorily redeemable or not, would be included in noncontrolling interest as a charge against income.

While ASC 810-10-40-2 highlights that distributions to equity holders (including noncontrolling interest holders) acting in their capacity as owners should be excluded from the determination of the consolidated entity’s net income, ASC 810-10 does not specifically address whether dividends on a subsidiary’s preferred stock should be treated as an attribution of the subsidiary’s income to the noncontrolling interest or a direct adjustment to retained earnings. Further, the last sentence of ASC 810-10-40-2 has been subject to multiple interpretations because ASC 810-10 does not allow the parent to present noncontrolling interest expense as a deduction in arriving at consolidated net income.

On the basis of the ambiguities in ASC 810-10-40-2 and informal discussions with the FASB staff, we believe that the following two alternatives are acceptable for presenting preferred dividends of a subsidiary in a parent’s consolidated financial statements:

Alternative 1 — The parent presents the subsidiary’s preferred dividends as a component of the attribution of net income (loss) to the noncontrolling interest on the face of the consolidated statement of income. The preferred dividends result in a decrease (increase) in consolidated net income (loss) attributable to the parent.
We believe that Alternative 1 is acceptable in all situations and is the preferable approach.
Alternative 2 — The preferred dividends do not affect the reported amount of consolidated net income (loss) attributable to the parent. However, the parent (if public) treats the subsidiary’s preferred dividends as a direct adjustment when calculating income available to common stockholders of the parent. This outcome is consistent with the accounting for dividends on preferred stock issued by the parent. It is also consistent with the discussion in ASC 480-10-S99-3A(22)(a) regarding the accounting in the consolidated financial statements of the parent for remeasurement adjustments arising from redeemable preferred stock issued by a consolidated subsidiary.
Under certain facts and circumstances, Alternative 2 may yield a presentation that could be considered misleading. Preparers should consider consulting with professional accounting advisers if Alternative 2 is applied.
We believe that when Alternative 2 is applied by an entity that does not report EPS, the entity should provide transparent disclosure of the preferred dividends’ impact on income available to common stockholders9 when that amount differs materially from net income attributable to the controlling interest because of dividends paid on the noncontrolling interest. Such supplemental disclosure may be made on the face of the income statement (e.g., by using the format in the “Alternative 2” column of the table in Example 6-13) or in the notes.

The parent should consistently apply either Alternative 1 or Alternative 2 and consider disclosing its accounting policy in accordance with ASC 235-10-50. Further, if the subsidiary’s preferred stock is a redeemable equity security subject to the accounting requirements of ASC 480-10-S99-3A, any remeasurement adjustments are considered akin to dividends and should be presented in the manner prescribed by either of those alternatives. See Chapter 9 for additional considerations related to redeemable securities of a subsidiary.

Example 6-13

Assume the following facts:

Company A owns 100 percent of the common equity securities of its subsidiary, B.
Subsidiary B has issued preferred equity securities that are held by an unrelated third party, Entity C (the noncontrolling interest).
The preferred equity securities are neither cumulative nor participating securities (i.e., they do not participate in undistributed earnings of B).
For the year ended December 31, 20X9, A’s consolidated net income was $700,000 (including B’s net income), and B declared and paid dividends totaling $200,000 on the preferred equity securities.

Under each alternative, the dividends on the preferred stock of B would be included as follows in A’s consolidated statement of income for the year ended December 31, 20X9:

6.8.1 Noncontrolling Interests Held by Preferred Shareholders

A reporting entity should consider how to attribute its subsidiary’s net income or loss to the controlling and noncontrolling interests held in the subsidiary when the subsidiary is funded with classes of equity that have different rights and preferences (e.g., common equity and various classes of equity-classified preferred shares). While the terms of preferred shares may vary significantly, preferred shares commonly have a combination of some, or all, of the following rights that the reporting entity may need to consider when attributing its subsidiary’s net income or loss to the noncontrolling interests:

Rights to the subsidiary’s assets and earnings that have priority over the rights of common shareholders.
Entitlement to a share of the subsidiary’s earnings up to a stated dividend.
Entitlement to a liquidation preference in the subsidiary.
Stated dividend rights that are not affected by losses incurred by the subsidiary (i.e., the preferred shares receive dividends even if the subsidiary experiences losses).

We believe that depending on the terms of the share and the specific facts and circumstances, when the net income or loss of a reporting entity’s subsidiary is allocated between the controlling and noncontrolling interests held in the subsidiary, the reporting entity should allocate earnings or losses in a manner consistent with the three-step model described in Section 6.2 that reflects the substance of the rights and preferences of the subsidiary’s share classes.

Example 6-14

Assume the following facts:

Company C, Company H, and Company I form Entity CHI. The purpose and design of CHI is to buy and manage pizzerias.
Company C contributes $100 million in exchange for 25 percent of the common shares of CHI, and H contributes $300 million in exchange for 75 percent of the common shares of CHI.
Company H has a controlling financial interest in, and consolidates, CHI.
Company I contributes $200 million to CHI in exchange for preferred shares in CHI that receive a 2 percent cumulative stated dividend per year; unpaid dividends are added to I’s liquidation preference, which is initially equal to its investment.

Further assume that H has no other activities other than its investment in CHI. The results of operations for CHI for two years are as follows (dollar amounts in millions):

Because I, the preferred shareholder, is entitled to a 2 percent stated dividend per year on its preferred shares, H would attribute the net income (loss) of CHI to the controlling and noncontrolling interest holders as follows (dollar amounts in millions):

Footnotes

For entities that present EPS, the alternatives will not affect income available to common stockholders, which is the numerator in the calculation of EPS.

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.