Chapter 7 — Changes in a Parent’s Ownership Interest

7.1 Changes in a Parent’s Ownership Interest Without an Accompanying Change in Control

ASC 810-10

45-22 A parent’s ownership interest in a subsidiary might change while the parent retains its controlling financial interest in the subsidiary. For example, a parent’s ownership interest in a subsidiary might change if any of the following occur:

The parent purchases additional ownership interests in its subsidiary.
The parent sells some of its ownership interests in its subsidiary.
The subsidiary reacquires some of its ownership interests.
The subsidiary issues additional ownership interests.

45-23 Changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary shall be accounted for as equity transactions (investments by owners and distributions to owners acting in their capacity as owners). Therefore, no gain or loss shall be recognized in consolidated net income or comprehensive income. The carrying amount of the noncontrolling interest shall be adjusted to reflect the change in its ownership interest in the subsidiary. Any difference between the fair value of the consideration received or paid and the amount by which the noncontrolling interest is adjusted shall be recognized in equity attributable to the parent. Example 1 (paragraph 810-10-55-4B) illustrates the application of this guidance.

45-24 A change in a parent’s ownership interest might occur in a subsidiary that has accumulated other comprehensive income. If that is the case, the carrying amount of accumulated other comprehensive income shall be adjusted to reflect the change in the ownership interest in the subsidiary through a corresponding charge or credit to equity attributable to the parent. Example 1, Case C (paragraph 810-10-55-4F) illustrates the application of this guidance.

An entity’s ownership structure is often fluid. A parent may directly purchase additional ownership interests in its subsidiary from a third party, or it may sell some or all of its current ownership interests in the subsidiary to a third party. Alternatively, a subsidiary may issue (purchase) additional ownership interests to (from) third parties, thereby diluting (concentrating) the parent’s ownership interest. Irrespective of the events that lead to changes in ownership interests in the subsidiary, if control has not changed, a parent accounts for such changes in ownership as equity transactions. Generally, the parent should neither recognize a gain or loss on sales or issuances of subsidiary shares nor step up to fair value the portion of the subsidiary’s net assets that corresponds to the additional interests acquired. Rather, any difference between consideration paid or received and the change in noncontrolling interest is typically recorded in equity. As part of equity transaction accounting, the reporting entity must also reallocate the subsidiary’s AOCI between the parent and the noncontrolling interest.

As explained in the next section, there is an exception to this overall “equity transaction” principle for certain decreases in ownership specified in ASC 810-10-45-21A(b).

7.1.1 Scope Limitations for Certain Decreases in Ownership Without an Accompanying Change in Control

ASC 810-10

45-21A The guidance in paragraphs 810-10-45-22 through 45-24 applies to the following:

Transactions that result in an increase in ownership of a subsidiary
Transactions that result in a decrease in ownership of either of the following while the parent retains a controlling financial interest in the subsidiary:
1. A subsidiary that is a business or a nonprofit activity, except for either of the following:
  1. Subparagraph superseded by Accounting Standards Update No. 2017-05.
  2. A conveyance of oil and gas mineral rights (for guidance on conveyances of oil and gas mineral rights and related transactions, see Subtopic 932-360).
  3. A transfer of a good or service in a contract with a customer within the scope of Topic 606.
2. A subsidiary that is not a business or a nonprofit activity if the substance of the transaction is not addressed directly by guidance in other Topics that include, but are not limited to, all of the following:
  1. Topic 606 on revenue from contracts with customers
  2. Topic 845 on exchanges of nonmonetary assets
  3. Topic 860 on transferring and servicing financial assets
  4. Topic 932 on conveyances of mineral rights and related transactions
  5. Subtopic 610-20 on gains and losses from the derecognition of nonfinancial assets.

ASC 810-10-45-21A provides separate scope guidance on the applicability of ASC 810-10-45-22 through 45-24 to decreases in ownership (without an accompanying change in control) of (1) certain subsidiaries that are businesses or nonprofit activities and (2) certain other subsidiaries that are not businesses or nonprofit activities.

The guidance in ASC 810-10 on decreases in ownership without an accompanying change in control applies to all decreases in ownership (without an accompanying change in control) of subsidiaries that are businesses or nonprofit activities except for decreases that result from the types of transactions listed below, for which the guidance cited in the right column of the table would generally be considered.

Types of Transactions	Guidance to Be Considered
Conveyances of oil and gas mineral rights	ASC 932-360
Transfers of goods or services in contracts with customers	ASC 606

The guidance in ASC 810-10 on decreases in ownership without an accompanying change in control also applies to all decreases in ownership (without an accompanying change in control) in subsidiaries that are not businesses or nonprofit activities except for decreases that result from transactions whose substance is addressed by other U.S. GAAP, including, but not limited to, the types of transactions listed below, for which the guidance cited in the right column of the table would generally be considered.

Types of Transactions	Guidance to Be Considered
Revenue transactions	ASC 606
Exchanges of nonmonetary assets	ASC 845
Transfers and servicing of financial assets1	ASC 860
Conveyances of mineral rights and related transactions	ASC 932
Gains and losses from derecognition of nonfinancial assets	ASC 610-20

Essentially, ASC 810-10-45-21A(b) precludes a reporting entity from ignoring other U.S. GAAP simply because, for example, it transfers an equity interest in a subsidiary to effect the transaction.

The scope guidance in ASC 810-10-45-21A is symmetrical with that in ASC 810-10-40-3A, which addresses the scope of the deconsolidation and derecognition guidance in ASC 810-10. Note that because the scope limitations in ASC 810-10-45-21A(b) focus on avoiding premature derecognition of assets that could not otherwise be derecognized under U.S. GAAP, transactions that increase a parent’s ownership while retaining control are not subject to these limitations.

The decision tree below depicts the determination of scope for decreases in ownership interests without an accompanying change in control.

Since ASC 810-10’s scope guidance on transactions that lead to decreases in ownership (without an accompanying change in control) is symmetrical to its guidance on transactions that lead to deconsolidation and derecognition of a subsidiary, it may be helpful to refer to Appendix F of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest, which discusses considerations related to transactions in the latter category.

7.1.1.1 Transfer of Equity Interests in a Subsidiary Holding Financial Assets

A reporting entity should apply ASC 860 in lieu of ASC 810 when it issues an equity interest in a subsidiary whose only assets are financial assets.2 Paragraph BC9 of ASU 2010-02 explains, in part, as follows:

[T]he Board reasoned that limiting the decrease in ownership provisions of Subtopic 810-10 to businesses or nonprofit activities would remove the potential conflict in asset derecognition or gain or loss guidance that may exist in other U.S. GAAP and should limit the ability to use a legal entity to avoid the accounting consequences of other U.S. GAAP. For example, some Board members were concerned that an entity may place financial assets into a subsidiary and apply Subtopic 810-10 to sales of equity interests in that subsidiary in an effort to circumvent the guidance in Topic 860 on transfers of interests in financial assets (including the guidance on whether such transfers represent sales or secured borrowings).

Although the FASB was concerned with circumvention of ASC 860 through structuring, it is important to note that this scope limitation is not isolated to attempted circumvention of ASC 860. Rather, we believe that the scope guidance establishes a principle that transfers of equity interests in a subsidiary holding financial assets while the parent retains control should be accounted for under ASC 860. Since the entire financial asset is not transferred outside the consolidated group in this scenario, the proceeds from issuing the equity interest should be classified as a liability unless the issuance meets the definition of a participating interest and the derecognition criteria in ASC 860 are met.

In a speech at the 2009 AICPA Conference on Current SEC and PCAOB Developments, an SEC staff member, Professional Accounting Fellow Brian Fields, illustrated this concept by presenting an example in which a reporting entity transfers financial assets to a newly created subsidiary (e.g., a special-purpose entity) in exchange for all senior and subordinated interests in the subsidiary. All interests are in legal-form equity and do not contain a maturity date. The reporting entity then sells the senior interests to outside investors. The activities of the subsidiary are significantly limited and do not have the breadth and scope of activities of a business.

After presenting the example, Mr. Fields described how the SEC has previously evaluated transactions of this nature:

While these [newly created subsidiaries] contain only financial assets and do not have the breadth and scope of activities of a business, some believe that by describing the beneficial interests sold as legal form equity and not including an explicit maturity date they can classify securitization proceeds received as noncontrolling equity interests in the consolidated financial statements of the parent sponsor. We have reached a different view in these circumstances. Beneficial interests in such entities are essentially transfers of interests in financial asset cash flows dressed up in legal entity form, and we believe the proceeds received on such transfers should be presented as collateralized borrowings pursuant to transfer accounting requirements to the extent the underlying financial assets themselves do not qualify for derecognition.

To say it again in another way, when a subsidiary is created simply to issue beneficial interests backed by financial assets rather than to engage in substantive business activities, we’ve concluded that sales of interests in the subsidiary should be viewed as transfers of interests in the financial assets themselves. The objective of an asset-backed financing is to provide the beneficial interest holders with rights to a portion of financial asset cash flows and the guiding literature is contained in Codification Topic 860 on transfers of financial assets. That literature requires a transfer to be reflected either as a sale or collateralized borrowing, depending on its specific characteristics — presentation as an equity interest in the reporting entity is not a possible outcome. [Emphasis added and footnote omitted]

7.1.2 Model of Accounting for Changes in a Parent’s Ownership Interest in a Subsidiary While the Parent Maintains Control

ASC 810-10

ASC 220-10

45-14 The total of other comprehensive income for a period shall be transferred to a component of equity that is presented separately from retained earnings and additional paid-in capital in a statement of financial position at the end of an accounting period. A descriptive title such as accumulated other comprehensive income shall be used for that component of equity.

As previously stated, there are several transactions that may result in a change in a parent’s ownership interest in a subsidiary (e.g., the parent purchases [sells] outstanding shares of the subsidiary from [to] a noncontrolling interest holder, or the subsidiary purchases [issues] its own shares from [to] holders of noncontrolling interests). A transaction that gives rise to a change in a parent’s ownership interest in a subsidiary while the parent maintains control of the subsidiary is within the scope of ASC 810-10 and thus represents an equity transaction.

To determine the adjustment(s) to equity and noncontrolling interest accounts that must be recorded in the consolidated financial statements, a reporting entity must compare the consideration paid (received) in the transaction with the noncontrolling interest’s claim on net assets after the transaction. Although seemingly straightforward, this analysis requires the entity to consider two nuances in practice:

The structure of the transaction (the parent’s acquiring [selling] subsidiary shares directly from [to] a noncontrolling interest holder vs. the subsidiary’s reacquiring [issuing] its own shares from [to] holders of noncontrolling interests) may directly affect the absolute amount of the subsidiary’s net assets and thus indirectly affect each party’s claim on the subsidiary’s net assets.
Whereas ASC 220-10-45-14 requires a parent to separately present its portion of a subsidiary’s AOCI as a separate component of equity, ASC 220 and ASC 810 do not require separate presentation of the noncontrolling interest holder’s portion of the subsidiary’s AOCI. Consequently, ASC 810-10-45-24 requires that when a parent’s ownership interest in a consolidated subsidiary changes and the subsidiary has AOCI reported in its stand-alone balance sheet, the parent must adjust the consolidated AOCI balance to reflect the parent’s new interest in the subsidiary’s AOCI balance. The offset to this journal entry is to the parent’s equity balance (typically, additional paid-in capital [APIC]).

To properly reflect these principles when accounting for changes in ownership interest (within the scope of ASC 810-10) without an accompanying change in control, a reporting entity should perform the following five steps:

The table below summarizes how various forms of transactions involving changes in ownership of common shares in a subsidiary affect (1) the subsidiary’s net assets, (2) the controlling and noncontrolling interest holders’ respective ownership percentages, and (3) the consolidated reporting entity’s AOCI balance. (Refer to Section 7.1.2.8 for special considerations related to transactions involving changes in ownership of preferred shares in a subsidiary.)

Effect of Transactions Involving Changes in Ownership of Common Shares in a Subsidiary
Transaction	Effect on Subsidiary’s Net Assets	Effect on Controlling Interest Holder’s Ownership Percentage	Effect on Noncontrolling Interest Holders’ Ownership Percentage	Effect on Consolidated Reporting Entity’s AOCI Balance Related to Subsidiary3
Parent purchases equity interests in its subsidiary from a noncontrolling interest holder (see Section 7.1.2.1)	None	Increased	Decreased	Increased
Subsidiary purchases equity interests in itself from third parties (see Section 7.1.2.2)	Decreased	Increased	Decreased	Increased
Parent sells to a third party a portion of its investment in its subsidiary (see Section 7.1.2.6)	None	Decreased	Increased	Decreased
Subsidiary issues equity interests to third parties (see Section 7.1.2.7)	Increased	Decreased	Increased	Decreased

7.1.2.1 Parent’s Acquisition of Interests in Subsidiary Directly From Third Party

A parent may acquire interests in its subsidiary directly from a noncontrolling interest holder. By acquiring those interests, the parent increases its relative ownership interest in the subsidiary. The example below illustrates the accounting for such an acquisition.

Example 7-1

Subsidiary XYZ is capitalized as follows:

Company A (the parent) purchases 100 shares of XYZ common stock from B (the noncontrolling interest holder) for $10,000. As a result, A should perform the following steps to reflect in A’s consolidated financial statements the increase in A’s ownership:

Step 1: Adjust the subsidiary’s net assets — This step is not applicable to transactions performed directly between shareholders. Net assets remain at $80,000.
Step 2: Determine the new ownership percentages — The new ownership percentages held by A and B, respectively, are calculated as follows:
- Company A’s new ownership percentage = (750 shares + 100 shares) ÷ 1,000 shares = 85%.
- Entity B’s new ownership percentage = (250 shares – 100 shares) ÷ 1,000 shares = 15%.
Step 3: Determine the new carrying amount of the noncontrolling interest — Entity B’s new carrying amount is$80,000 × 15% = $12,000.
Step 4: Recognize the consideration paid, the change in the noncontrolling interest, and the adjustment to APIC — The following entry should be recorded:
Step 5: Adjust the consolidated reporting entity’s AOCI balance — The following entry should be recorded:

7.1.2.2 Subsidiary’s Direct Acquisition of Its Equity Interests

Although the parent may not be a direct party to the transaction, a subsidiary’s acquisition of its own shares from third parties also serves to increase the parent’s controlling interest in the subsidiary. As illustrated below, a reporting entity would recognize such a transaction by performing the same five steps described in Section 7.1.2.

Example 7-2

Subsidiary XYZ is capitalized as follows:

Subsidiary XYZ purchases 100 shares of its common stock (par value equals $1 per share) from B (the noncontrolling interest holder) for $10,000. As a result, A should perform the following steps to reflect in A’s consolidated financial statements the increase in A’s ownership:

Step 1: Adjust the subsidiary’s net assets — Subsidiary XYZ’s net assets after the transaction are as follows:
Step 2: Determine the new ownership percentages — The new ownership percentages held by A and B, respectively, are calculated as follows:
- Company A’s new ownership percentage = 750 shares ÷ (1,000 shares –100 shares) = 83.33%.
- Entity B’s new ownership percentage = (250 shares – 100 shares) ÷ (1,000 shares – 100 shares) = 16.67%.
Step 3: Determine the new carrying amount of the noncontrolling interest — Entity B’s new carrying amount is $70,000 × 16.67% = $11,669.
Step 4: Recognize the consideration paid, the change in the noncontrolling interest, and the adjustment to APIC — The following entry should be recorded:
Step 5: Adjust the consolidated reporting entity’s AOCI balance — The following entry should be recorded:

Connecting the Dots

When an entity repurchases its common shares, it should consider the guidance in ASC 505-30. In some circumstances, the price paid to repurchase common shares includes other elements (stated or unstated) for which separate accounting is required. ASC 505-30 provides guidance on allocating the repurchase price to these other elements. The accounting for the other elements is subject to the requirements of other U.S. GAAP. However, in some circumstances, an entity may conclude that the requirements of other U.S. GAAP do not address the accounting for the excess of the repurchase price over fair value and that this excess therefore represents an expense. In reaching such a conclusion, an entity must use judgment and evaluate the specific facts and circumstances associated with the repurchase transaction. Refer to Deloitte’s Roadmap Earnings per Share for more information. While ASC 505-30 is written in the context of a reporting entity’s acquisition of its common stock, we generally believe that the concepts of ASC 505-30 should be applied to a reporting entity’s acquisition of a common-share noncontrolling interest.

7.1.2.3 Downstream Transactions

A partially owned subsidiary may obtain control of its parent (e.g., by exchanging its common shares for the outstanding voting common shares of its parent) in a type of transaction known as a downstream merger. As a result of the transaction, the consolidated net assets are owned by both the former shareholders of the parent and the former shareholders of the noncontrolling interest in the subsidiary. Regardless of its legal form, a downstream merger is accounted for as if the parent acquired the noncontrolling interest in its subsidiary. Therefore, the reporting for a downstream merger is similar to that for a reverse acquisition without a change in basis for the assets and liabilities. The parent is treated as the ongoing reporting entity from an accounting perspective. The consolidated financial statements of the surviving entity are those of the parent even though the subsidiary is the surviving legal entity. The surviving entity’s stockholders’ equity is adjusted to reflect the former parent’s stockholders’ equity after effect is given to the acquisition of the noncontrolling interest, which is accounted for as an equity transaction in accordance with ASC 810-10-45-23. See Deloitte’s Roadmap Business Combinations for more information about downstream mergers.

7.1.2.4 Additional Ownership Interest Obtained Through a Business Combination

In a business combination, an acquirer (parent) may obtain an additional ownership interest in an existing consolidated subsidiary if the target has a noncontrolling interest in that acquirer’s (parent’s) subsidiary before the business combination.

Under the acquisition accounting model in ASC 805, total consideration transferred to the seller by the acquirer must be attributed to all assets acquired and liabilities assumed in the business combination. Such attribution is based on the fair value of the individual assets acquired and liabilities assumed. When the target entity holds a noncontrolling interest in a subsidiary of the acquirer, one of the “assets” acquired by the acquirer is an increased ownership interest in the acquirer’s previously consolidated subsidiary. Consequently, and in a manner consistent with the guidance in ASC 810-10, an equity transaction has also taken place. To record this equity transaction, the acquirer should treat the amount attributed to the acquired noncontrolling interest under the acquisition accounting model in ASC 805 as the consideration “paid” to acquire the noncontrolling interest. Once the consideration “paid” has been determined, the acquirer should perform the five steps outlined in Section 7.1.2 to recognize its increased ownership interest in its subsidiary.

7.1.2.5 Acquisition of Additional Ownership Interests in a Subsidiary When the Parent Obtained Control Before Adopting FASB Statement 160

As discussed in Section 7.1.2, a parent’s acquisition of additional ownership interests in a partially owned subsidiary is generally accounted for as an equity transaction. Before the adoption of FASB Statement 160, a parent would apply the guidance in paragraph 14 of FASB Statement 141 to account for increases in its ownership interest in a consolidated subsidiary. Paragraph 14 required the parent to apply purchase accounting and step up a portion of the target’s net assets related to the additional ownership percentage acquired. Often, the parent recorded additional goodwill associated with the purchase of this additional ownership interest.

When a parent has a controlling financial interest in a partially owned subsidiary that was acquired before the adoption of FASB Statement 160, a question often arises about whether the parent can step up the subsidiary’s net assets to fair value when the parent subsequently acquires additional ownership interests in the subsidiary.

Because FASB Statement 160 required prospective application of its amendments to the accounting requirements later codified in ASC 810-10, the parent can neither further step up the subsidiary’s net assets to fair value for the additional interest acquired nor record additional goodwill (as it previously did under FASB Statement 141). As a result, the parent will never fully step up to fair value a partial controlling interest in its subsidiary if that subsidiary was acquired before the adoption of FASB Statement 160.

Example 7-3

Before adopting FASB Statement 160, Company X purchased an 80 percent controlling interest in Subsidiary Y. In accordance with FASB Statement 141, X recorded Y’s net assets acquired at 80 percent fair value and 20 percent carrying value. Company X adopted FASB Statement 160 on January 1, 2009. In March 2016, X purchased an additional 20 percent interest in Y. Accordingly, in the manner described in Section 7.1.2, X accounts for its increase in ownership interest as an equity transaction between the parent and the noncontrolling interest. That is, X neither applies additional acquisition accounting nor steps up Y’s net assets to fair value for the additional 20 percent interest it acquired. Instead, X records the difference between the cash consideration paid and the carrying amount of the noncontrolling interest as an adjustment to X’s APIC.

7.1.2.6 Parent’s Selling of Interests in a Subsidiary Directly to a Noncontrolling Interest Holder

A parent should use the same five-step approach described in Section 7.1.2 to recognize decreases in its ownership interest in its subsidiary while control is maintained.

Example 7-4

Subsidiary XYZ is capitalized as follows:

Company A (the parent) sells 100 shares of XYZ common stock to Entity B (the newly established noncontrolling interest holder) for $10,000. As a result, A should perform the following steps to reflect in A’s consolidated financial statements the decrease in A’s ownership:

Step 1: Adjust the net assets of the subsidiary — This step is not applicable to transactions performed directly between shareholders. Net assets remain at $80,000.
Step 2: Determine the new ownership percentages — The new ownership percentages held by A and B, respectively, are calculated as follows:
- Company A’s new ownership percentage = (1,000 shares – 100 shares) ÷ 1,000 shares = 90%.
- Entity B’s new ownership percentage = (0 shares + 100 shares) ÷ 1,000 shares = 10%.
Step 3: Determine the new carrying amount of the noncontrolling interest — Entity B’s new carrying amount is $80,000 × 10% = $8,000.
Step 4: Recognize the consideration received, the change in the noncontrolling interest, and the adjustment to APIC — The following entry should be recorded:
Step 5: Adjust the consolidated reporting entity’s AOCI balance — The following entry should be recorded:

7.1.2.7 Subsidiary’s Direct Issuance of Its Equity Interests to Third Parties

Although the parent may not be a direct party to the transaction, a subsidiary’s issuance of its own shares to third parties also serves to dilute the parent’s controlling interest in the subsidiary. As illustrated below, a parent would recognize such a transaction by performing the same five steps described in Section 7.1.2.

Example 7-5

Subsidiary XYZ is capitalized as follows:

Subsidiary XYZ issues 100 shares of its common stock (par value equals $1 per share) to Entity B (the newly established noncontrolling interest holder) for $10,000. As a result, A should perform the following steps to reflect in A’s consolidated financial statements the decrease in A’s ownership:

Step 1: Adjust the net assets of the subsidiary — Subsidiary XYZ’s net assets after the transaction are as follows:
Step 2: Determine the new ownership percentages — The new ownership percentages held by A and B, respectively, are calculated as follows:
- Company A’s new ownership percentage = 1,000 shares ÷ (1,000 shares + 100 shares) = 90.91%.
- Entity B’s new ownership percentage = (0 shares + 100 shares) ÷ (1,000 shares + 100 shares) = 9.09%.
Step 3: Determine the new carrying amount of the noncontrolling interest — Entity B’s new carrying amount is $90,000 × 9.09% = $8,181.
Step 4: Recognize the consideration received, the change in the noncontrolling interest, and the adjustment to APIC — The following entry should be recorded:
Step 5: Adjust the consolidated reporting entity’s AOCI balance — The following entry should be recorded:

7.1.2.7.1 Parent’s Accounting for Subsidiary’s Issuance of Share-Based Payment Awards

A subsidiary may issue share-based payment awards of its own stock to its employees. ASC 718-10-35-2 states, in part:

The compensation cost for an award of share-based employee compensation classified as equity shall be recognized over the requisite service period, with a corresponding credit to equity (generally, paid-in capital). [Emphasis added]

The guidance in ASC 718 indicates that when an entity issues share-based payment awards, a corresponding increase in equity or a liability should be recorded to offset the share-based payment expense. However, a subsidiary’s issuance of equity-classified share-based payment awards to its employees may decrease the parent’s ownership interest in the subsidiary. We believe that in such cases, it would be appropriate for the parent to (1) recognize a share-based payment expense as the awards vest over time at the subsidiary and (2) record a corresponding credit to the noncontrolling interests. Other alternatives may also be acceptable.

The example below illustrates an entity’s accounting for the issuance of share-based payment awards in the form of stock options that, once fully vested, are either exercised or forfeited. If the options are forfeited, the amount previously credited to noncontrolling interests for the vested portion would be reclassified into equity (i.e., the parent’s APIC). This example can be applied to other forms of share-based payment award arrangements, including restricted stock units.

Example 7-6

Parent Company A has an 80 percent ownership interest in Subsidiary B. The remaining 20 percent is owned by a third-party noncontrolling interest holder.

On January 1, 20X6, B grants to its employee, Employee C, 100 at-the-money stock options that are exchangeable into common shares of B once they are exercised. The options vest annually over the next three years. Each option has a grant date fair-value-based measure of $6 and an exercise price of $10. The options have a term of three years. Assume that A recognizes forfeitures when they occur.

The entries below outline the vesting of the options in the following scenarios:

Scenario 1 — Fully vested options are exercised on January 1, 20X9, when C’s 100 shares in B have a proportionate ownership interest in B of $800.
Scenario 2 — Employee C forfeits its vested options on January 1, 20X9.

7.1.2.7.2 Reorganization Through an UP-C Structure

The use of umbrella partnership C corporation (“UP-C”) structures by private equity investors and other owners of private operating entities that seek liquidity through public equity offerings is common. To facilitate an UP-C reorganization, the owners of a private operating entity first convert the entity to a partnership or limited liability company (LLC) if it is not one already. They then form a new holding company — a C corporation — and transfer to the holding company their controlling interest in the operating entity (thereby becoming the operating entity’s “legacy owners”). The legacy owners retain a direct noncontrolling interest in the operating entity, and shares of the holding company’s stock are sold in an initial public offering (IPO).

The UP-C structure enables private owners to access the public markets while retaining partnership or LLC interests as well as the pass-through and other tax benefits that come from those interests. The structure and transactions may generate additional tax attributes for the holding company (e.g., goodwill and other intangible asset basis adjustments), the benefits of which are often shared with the operating entity’s legacy owners (e.g., through tax receivable agreements).

Example 7-7

Company J, a private operating company, is an LLC that is 100 percent owned by two members who each own 5,000 units of the LLC. As of 20X1, J has accumulated a deficit of $100 million in equity.

Company J’s ownership structure is illustrated below.

In 20X2, J’s owners create an UP-C structure as follows:

First, J’s owners form Company K, a holding company organized as a C corporation. They plan for K to publicly sell shares of its stock in an IPO.
In contemplation of K’s IPO, J’s owners amend J’s operating agreement. Specifically, they modify J’s capital structure by reclassifying the interests in J as voting (“Class A”) and nonvoting (“Class B”) LLC units.
Before or contemporaneously with the launch of K’s IPO, J issues 7,000 Class B units to the two LLC members who originally owned 100 percent of J (the “pre-IPO LLC members,” who are now J’s legacy owners) and 3,000 Class A units to K. That is, all of the previous 10,000 units of J were converted to 7,000 Class B units and 3,000 Class A units.
In K’s IPO, K issues 3,000 Class A common shares of its stock to the public.
Company K is the managing member of J.

The 20X2 UP-C reorganization is illustrated below.

Each Class B LLC unit can be exchanged on a one-for-one basis for a Class A share of K’s common stock. The UP-C reorganization represents a transaction between entities under common control followed by an IPO and does not result in a change in accounting basis of K’s net assets, which include J’s net assets.

After the UP-C reorganization, K owns 30 percent of J’s LLC member interests, and the pre-IPO LLC members own 70 percent. Company K’s sole assets are its member interests in J, and those interests represent a controlling interest in J (because the pre-IPO LLC members’ interests in J are nonvoting). The pre-IPO LLC members’ interests in J represent noncontrolling interests in K’s consolidated financial statements.

We believe that it is appropriate for K to view the initial recognition of the noncontrolling interests related to the outstanding LLC units of J as being akin to a change in a parent’s ownership interest without a change in control. This transaction, therefore, is accounted for as an equity transaction in accordance with ASC 810-10-45-23.

Company K should account for the UP-C reorganization as a transaction with a less than wholly owned subsidiary that results in a change in ownership percentage. Company K should ratably allocate the accumulated deficit of $100 million that existed immediately before the reorganization between K and the noncontrolling interests.

Company K should reflect 30 percent (3,000 Class A units owned out of 10,000 LLC units outstanding) or $30 million of the total pre-IPO accumulated deficit (30% ownership × $100 million accumulated deficit) in its consolidated financial statements. The remaining portion (a $70 million deficit) should be allocated in K’s financial statements to the noncontrolling interest holders.

Note that any subsequent change in K’s ownership of J, such as the issuance of additional LLC units, would require a rebalancing between the noncontrolling interests and the parent in accordance with the five-step process described in Section 7.1.2.

Further note that in this example, the noncontrolling interests are not redeemable. Facts and circumstances may vary in an UP-C transaction, and the noncontrolling interests may be redeemable depending on the transaction’s terms. The classification of equity instruments in the asset, liability, or equity section of a reporting entity’s balance sheet is outside the scope of this publication. See Deloitte’s Roadmap Distinguishing Liabilities From Equity, which provides extensive interpretive guidance on the appropriate classification of equity instruments within or outside of the equity section of a reporting entity’s balance sheet. In addition, see Chapter 9 of this Roadmap, which provides interpretive guidance on how an entity should account for a redeemable noncontrolling interest, including initial measurement guidance, once it has been determined that equity classification of the redeemable noncontrolling interest is appropriate.

7.1.2.8 Special Considerations Related to Transactions Involving Changes in Ownership of Preferred Shares in a Subsidiary

Preferred shares typically convey to their holder rights that differ significantly from those conveyed by common shares. For example, whereas common shares typically provide their holder with the upside and downside potential associated with residual interests in an entity, preferred shares typically limit the holder’s upside to a stated dividend amount and provide their holder with downside protection through the combination of a substantive stated liquidation preference and seniority to common shareholders. While preferred shares also typically lack creditor rights, the combination of rights conveyed by preferred shares typically provide their holder with certain risks and rewards that are more akin to those of a debt instrument than to those of an equity instrument.

Recognizing that the objective of noncontrolling interest presentation and measurement is to provide investors in a reporting entity with a depiction of claims held by others on the net assets of a subsidiary, we believe that preferred shares in a subsidiary that are held by third parties should be classified as noncontrolling interests in the reporting entity’s consolidated balance sheet. However, to the extent that the preferred shares provide their holder with a substantive preference to common shareholders in liquidation while limiting the holder’s participation in profits (beyond a stated dividend), we believe that just as an issuance of debt does not cause a rebalancing of equity accounts, the amounts received from the fair value issuance of subsidiary preferred shares can be excluded from the five-step process outlined in Section 7.1.2. That is, we expect that the issuance of such preferred shares would not make it necessary to reallocate existing equity balances (including AOCI) between the controlling and noncontrolling interest holders.

Subsidiary preferred shares with more complex features may have a risk return profile that differs from that of the preferred shares described in this section. Preparers discussing such scenarios should consider consulting with professional accounting advisers.

The interpretive guidance above is provided in the context of a subsidiary’s issuances, as opposed to repurchases, of preferred shares. The reporting entity’s accounting for a subsidiary’s repurchase of preferred shares depends on whether the reporting entity is within the scope of ASC 480-10-S99-3A and whether the shares are redeemable or nonredeemable:

Redeemable preferred shares — As discussed in Section 9.4.1, preferred-share redeemable noncontrolling interests in a subsidiary are classified in the temporary equity section of the reporting entity’s consolidated balance sheet. After issuance of a subsidiary’s redeemable preferred shares, the carrying amount of a preferred-share redeemable noncontrolling interest is adjusted in accordance with one of the two methods described in Section 9.4.3.2. The objective of this measurement adjustment is to ultimately recognize the preferred-share redeemable noncontrolling interest at its redemption price on its redemption date. Therefore, if the redeemable preferred shares in the subsidiary are redeemed at their carrying amount, no rebalancing should be required since there will be no difference between the shares’ book value and their redemption value at the time of redemption. However, if the preferred-share redeemable noncontrolling interest is redeemed at a price other than its carrying amount (e.g., a reporting entity that applies the accretion method has a subsidiary that voluntarily acquires the preferred-share redeemable noncontrolling interest before the shares’ stated redemption date), a rebalancing will be necessary to account for the difference between the consideration paid to acquire the preferred-share redeemable noncontrolling interest and the interest’s carrying amount. See Section 9.4.5.2 for additional considerations related to the EPS implications of redemptions of preferred-share noncontrolling interests.
Nonredeemable preferred shares — Unlike the carrying amount of preferred-share redeemable noncontrolling interests, the carrying amount of preferred-share noncontrolling interests that are not redeemable is not adjusted after issuance of the shares. As a result, the repurchase of preferred-share noncontrolling interests that are not redeemable will generally result in a rebalancing of the equity accounts since the book value of the nonredeemable preferred shares will most likely not equal the redemption price. In rebalancing the equity accounts, an entity should perform the five-step process outlined in Section 7.1.2. Further, the difference between the net carrying amount of the preferred shares and the redemption price will increase or reduce net income attributable to the parent in the parent’s calculation of income available to common stockholders. See Deloitte’s Roadmap Earnings per Share for further discussion.

7.1.2.9 Accounting for Costs Related to Equity Transactions With Noncontrolling Interest Holders

ASC 810-10-45-23 indicates that “[c]hanges in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary shall be accounted for as equity transactions (investments by owners and distributions to owners acting in their capacity as owners).”

SAB Topic 5.A provides guidance on accounting for costs related to the issuance of equity securities, stating that “[s]pecific incremental costs directly attributable to a proposed or actual offering of securities may properly be deferred and charged against the gross proceeds of the offering.” Therefore, direct costs of issuing equity securities are generally reflected as a reduction of the amount that would have otherwise been recorded in APIC. SAB Topic 5.A further states that “management salaries or other general and administrative expenses may not be allocated as costs of the offering and deferred costs of an aborted offering may not be deferred and charged against proceeds of a subsequent offering.” These indirect costs are generally reflected as an expense in the income statement.

In addition, AICPA Technical Q&As Section 4110.09 states that although there is no authoritative literature on costs entities incur to acquire their own stock, some “believe that costs associated with the acquisition of treasury stock should be treated in a manner similar to stock issue costs.” Under SAB Topic 5.A, direct costs associated with the acquisition of treasury stock may be added to the cost of the treasury stock.

On the basis of the above, direct costs of purchasing or selling noncontrolling interests in a subsidiary when control is maintained may be recorded as an adjustment to APIC. However, indirect costs of purchasing or selling noncontrolling interests in a subsidiary when control is maintained are generally reflected as an expense in the income statement. These conclusions are supported by analogies to ASC 810, SAB Topic 5.A, and AICPA Technical Q&As Section 4110.09.

While these conclusions are supported by analogies to the aforementioned guidance, we are also aware of others analogizing to the treatment of transaction costs in a business combination. Companies using this approach may elect an accounting policy to record all transaction costs as an expense in the income statement.

Although both approaches above are acceptable, a reporting entity should elect and consistently apply an accounting policy for such transaction costs.

7.1.2.10 Establishment of Noncontrolling Interests in Conjunction With an Asset Acquisition or Business Combination

As stated in ASC 810-10-45-23, changes in a parent’s ownership interest while the parent retains control in a partially owned subsidiary are accounted for as equity transactions, with no gain or loss recognized in consolidated net income or comprehensive income. If a difference exists at initial acquisition between noncontrolling interests’ claims on net assets based on terms and conditions from contractual arrangements and either their fair value (for noncontrolling interests recognized in a business combination or in an asset acquisition that results from the consolidation of a VIE) or their proportionate share of relative fair value (for noncontrolling interests recognized in an asset acquisition that results from the consolidation of a subsidiary that is not a VIE), a subsequent equity transaction that changes a parent’s ownership interest in a subsidiary while the parent maintains control of the subsidiary should not trigger recognition of a gain or loss resulting from this difference. We believe that it is not appropriate to recognize this difference subsequently as a gain or loss until the noncontrolling interests are derecognized upon the occurrence of one of the following events:

Liquidation of the legal entity — The partially owned subsidiary is legally dissolved (i.e., it no longer exists as a legal entity).
Parent’s loss of control — The reporting entity loses control of the partially owned subsidiary under ASC 810 (see Section 7.2).
Acquisition of the noncontrolling interests in existence on the acquisition date — The equity interests present as of the acquisition date as noncontrolling interests in the partially owned subsidiary are acquired by the reporting entity.

See Sections 5.2.4 and 6.12 for additional considerations.

7.1.3 Accounting for the Tax Effects of Transactions With Noncontrolling Shareholders

ASC 740-20

45-11 The tax effects of the following items occurring during the year shall be charged or credited directly to other comprehensive income or to related components of shareholders’ equity: . . .

c. An increase or decrease in contributed capital (for example, deductible expenditures reported as a reduction of the proceeds from issuing capital stock). . . .

g. All changes in the tax bases of assets and liabilities caused by transactions among or with shareholders shall be included in equity including the effect of valuation allowances initially required upon recognition of any related deferred tax assets. Changes in valuation allowances occurring in subsequent periods shall be included in the income statement.

As discussed in Section 7.1.2, a parent accounts for changes in its ownership interest in a subsidiary over which it maintains control as equity transactions. The parent cannot recognize a gain or loss in consolidated net income or comprehensive income for such transactions and is not permitted to step up a portion of the subsidiary’s net assets to fair value to the extent of any additional interests acquired (i.e., no additional acquisition method accounting). As part of the equity transaction accounting, the parent must also generally reallocate the subsidiary’s AOCI between the parent and the noncontrolling interest.

The direct tax effect of a change in ownership interest in a subsidiary when the parent maintains control is generally recorded in stockholders’ equity. Some transactions with noncontrolling shareholders may create both a direct and an indirect tax effect. It is important to properly distinguish between the direct and indirect tax effects of a transaction since their accounting may differ. For example, the indirect tax effect of a parent’s change in its assumptions associated with undistributed earnings of a foreign subsidiary resulting from a sale of its ownership interest in that subsidiary is recorded as income tax expense rather than as an adjustment to stockholders’ equity.

Example 7-8

Parent Entity A owns 80 percent of its foreign subsidiary, which operates in a zero-rate tax jurisdiction. The foreign subsidiary has a net book value of $100 million as of December 31, 20X9. Entity A’s tax basis of its 80 percent investment is $70 million. Assume that the carrying amounts of the interest of the parent (A) and noncontrolling interest holder (Entity B) in the foreign subsidiary are $80 million and $20 million, respectively. The $10 million difference between A’s book basis and tax basis in the foreign subsidiary is attributable to undistributed earnings of the foreign subsidiary. In accordance with ASC 740-30-25-17, A has not historically recorded a deferred tax liability (DTL) for the taxable temporary difference associated with undistributed earnings of the foreign subsidiary because A has specific plans to reinvest such earnings in the foreign subsidiary indefinitely and the reversal of the temporary difference is therefore indefinite.

On January 1, 20Y0, A sells 12.5 percent of its interest in the foreign subsidiary to a nonaffiliated entity, Entity C, for total proceeds of $20 million. As summarized in the table below, this transaction (1) decreases A's carrying amount in the foreign subsidiary by $10 million (12.5% × $80 million) to $70 million and reduces A's interest in the foreign subsidiary to 70 percent ($70 million of $100 million total net book value), and (2) increases the total carrying amount of the noncontrolling interest holders (B and C) by $10 million to $30 million.

Assume that A is subject to a 25 percent tax rate.

Below is A’s journal entry on January 1, 20Y0, before consideration of income tax accounting:

Entity A’s tax consequence from the tax gain on the sale of its investment in the foreign subsidiary is approximately $2.8 million, or [$20 million selling price – ($70 million tax basis × 12.5% portion sold)] × 25% tax rate. The amount comprises the following direct and indirect tax effects:

The direct tax effect of the sale is $2.5 million. This amount, which is associated with the difference between the selling price and book basis of the interest sold by A (i.e., the gain on the sale), is calculated as [$20 million selling price – ($80 million book basis × 12.5% portion sold)] × 25% tax rate. The gain on the sale of A’s interest is recorded in shareholders’ equity; therefore, the direct tax effect is also recorded in shareholders’ equity.
The indirect tax effect of the sale is $312,500. This amount, which is associated with the preexisting taxable temporary difference (i.e., the undistributed earnings of the subsidiary) of the interest sold, is calculated as [($80 million book basis – $70 million tax basis) × 12.5% portion sold] × 25% tax rate. The partial sale of the foreign subsidiary results in a change in A’s assertion regarding the indefinite reinvestment of the subsidiary’s earnings associated with the interest sold by A. This is considered an indirect tax effect and recognized as income tax expense.

Below is A’s journal entry on January 1, 20Y0, to account for the income tax effects of the sale of its interest in the foreign subsidiary:

As a result of the sale, A should reassess its intent and ability to indefinitely reinvest the earnings of the foreign subsidiary associated with its remaining 70 percent ownership interest. A DTL should be recognized if circumstances have changed and A concludes that the temporary difference is now expected to reverse in the foreseeable future. This reassessment and the recording of any DTL may occur in a period preceding the actual sale of its ownership interest, since a liability should be recorded when A’s assertion regarding indefinite reinvestment changes.

For a discussion of the tax effects of contributions to pass-through entities in control-to-control transactions, see Section 3.4.16 of Deloitte’s Roadmap Income Taxes.

Footnotes

Refer to Section 7.1.1.1 for further discussion.

We do not believe that the accounting model should change by virtue of a clearly inconsequential amount of nonfinancial assets in the subsidiary.

All increases and decreases reflected in this column are in absolute terms.

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.