2.6 Consolidation and the Equity Method

2.6.1 Contracts on the Stock of Consolidated Subsidiaries

ASC 810-10

45-17A An equity-classified instrument (including an embedded feature that is separately recorded in equity under applicable GAAP) within the scope of the guidance in paragraph 815-40-15-5C shall be presented as a component of noncontrolling interest in the consolidated financial statements whether the instrument was entered into by the parent or the subsidiary. However, if such an equity-classified instrument was entered into by the parent and expires unexercised, the carrying amount of the instrument shall be reclassified from the noncontrolling interest to the controlling interest.

ASC 815-40

15-5C Freestanding financial instruments (and embedded features) for which the payoff to the counterparty is based, in whole or in part, on the stock of a consolidated subsidiary are not precluded from being considered indexed to the entity’s own stock in the consolidated financial statements of the parent if the subsidiary is a substantive entity. If the subsidiary is not a substantive entity, the instrument or embedded feature shall not be considered indexed to the entity’s own stock. If the subsidiary is considered to be a substantive entity, the guidance beginning in paragraph 815-40-15-5 shall be applied to determine whether the freestanding financial instrument (or an embedded feature) is indexed to the entity’s own stock and shall be considered in conjunction with other applicable GAAP (for example, this Subtopic) in determining the classification of the freestanding financial instrument (or an embedded feature) in the financial statements of the entity. The guidance in this paragraph applies to those instruments (and embedded features) in the consolidated financial statements of the parent, whether the instrument was entered into by the parent or the subsidiary. The guidance in this paragraph does not affect the accounting for instruments (or embedded features) that would not otherwise qualify for the scope exception in paragraph 815-10-15-74(a). For example, freestanding instruments that are classified as liabilities (or assets) under Topic 480 and put and call options embedded in a noncontrolling interest that is accounted for as a financing arrangement under Topic 480 are not affected by this guidance. For guidance on presentation of an equity-classified instrument (including an embedded feature that is separately recorded in equity under applicable GAAP) within the scope of the guidance in this paragraph, see paragraph 810-10-45-17A.

In consolidated financial statements, contracts potentially indexed to, and potentially settled in, the equity shares of a consolidated subsidiary are analyzed in a manner similar to contracts on the parent entity’s own stock unless the subsidiary is not a substantive entity. Thus, a contract on subsidiary stock could be within the scope of ASC 815-40 and qualify for equity classification in the consolidated financial statements even though it is not on the parent entity’s own stock. This is the case irrespective of whether the parent or the subsidiary entered into the contract. An equity-classified contract on the stock of a consolidated subsidiary is presented as a component of noncontrolling interest in the consolidated financial statements.

If the subsidiary is not a substantive entity, a contract on that subsidiary’s stock is outside the scope of ASC 815-40 and does not qualify for equity classification regardless of whether the contract otherwise meets the conditions for equity classification in ASC 815-40. However, since ASC 815-40 does not define “substantive entity,” judgment must be used in the determination of whether an entity is substantive. For example, a shell entity that holds commodities or stocks might not be a substantive entity.

2.6.2 Contracts on the Stock of a Parent or Other Entity That Is Not Consolidated

In the subsidiary’s separate financial statements, the equity of its parent would not be considered part of the subsidiary’s equity. Therefore, a contract potentially indexed to, and potentially settled in, the parent’s stock would be outside the scope of ASC 815-40 and could not be classified within equity in the subsidiary’s separate financial statements. For the same reason, a contract on the stock of an affiliated entity that is not consolidated by the reporting entity (e.g., a sister company within a group) would be outside the scope of ASC 815-40. Such a contract would not qualify as equity in the reporting entity’s financial statements, although it might qualify as equity in the reporting entity’s parent’s financial statements if the parent consolidates the affiliated entity. See Section 5.2.7 for further discussion about the analysis under ASC 815-40-25 of contracts indexed to an entity’s own equity that can be settled in the shares of another entity within a consolidated group.

Connecting the Dots

The discussion above focuses on a subsidiary’s accounting for an equity-linked instrument that is indexed to the stock of its parent or to the stock of an affiliate that is not consolidated by the subsidiary. As noted previously, in the application of ASC 815-40, the stock of a subsidiary’s parent or its affiliate is not considered equity of the subsidiary; therefore, an equity-linked instrument on the stock of the subsidiary’s parent or its affiliate may not be classified in equity. However, this does not mean that a subsidiary should classify an ownership interest in the stock of its parent or its affiliate as an asset. Rather, it is presumed that such ownership is established to facilitate a treasury stock transaction on behalf of the subsidiary’s parent or its affiliate and that the ownership interest should therefore be classified in equity within the subsidiary’s separate financial statements. See further discussion in Section 4.3.2.1 of Deloitte’s Roadmap Noncontrolling Interests.

2.6.3 Contracts on the Stock of an Equity Method Investee

Equity shares issued by an equity method investee are not considered part of the entity’s own equity. Therefore, contracts potentially indexed to, and potentially settled in, the equity shares of an equity method investee would be outside the scope of ASC 815-40.

2.6.4 Certain Option Combinations Involving Noncontrolling Interests

ASC 815-40

15-3 The guidance in this Subtopic does not apply to any of the following: . . .

d. A written put option and a purchased call option embedded in the shares of a noncontrolling interest of a consolidated subsidiary if the arrangement is accounted for as a financing under the guidance beginning in paragraph 480-10-55-53 . . . .

ASC 480-10

55-53 A controlling majority owner (parent) holds 80 percent of a subsidiary’s equity shares. The remaining 20 percent (the noncontrolling interest) is owned by an unrelated entity (the noncontrolling interest holder). Simultaneous with the acquisition of the noncontrolling interest, the noncontrolling interest holder and the parent enter into a derivative instrument that is indexed to the subsidiary’s equity shares. The terms of the derivative instrument may be any of the following: . . .

b. The parent has a call option to buy the other 20 percent at a fixed price at a stated future date, and the noncontrolling interest holder has a put option to sell the other 20 percent to the parent under those same terms, that is, the fixed price of the call is equal to the fixed price of the put option. (Derivative 2) . . .

55-55 Depending on how Derivative 2 was issued, one of three different accounting methods applies. If Derivative 2 was issued as a single freestanding instrument, under this Subtopic it would be accounted for in its entirety as a liability (or an asset in some circumstances), initially and subsequently measured at fair value. If the written put option and the purchased call option in Derivative 2 were issued as freestanding instruments, the written put option would be accounted for under this Subtopic as a liability measured at fair value, and the purchased call option would be accounted for under Subtopic 815-40. Under both of those situations, the noncontrolling interest is accounted for separately from the derivative instrument under applicable guidance. However, if the written put option and purchased call option are embedded in the shares (noncontrolling interest) and the shares are not otherwise classified as liabilities under the guidance in this Subtopic, the instrument shall be accounted for as discussed in paragraph 480-10-55-59 with the parent consolidating 100 percent of the subsidiary.

55-57 In applying paragraphs 480-10-25-4 through 25-14 to determine classification, a freestanding financial instrument within this Subtopic’s scope is precluded from being combined with another freestanding financial instrument, unless combination is required under the provisions of Topic 815; therefore, unless under the particular facts and circumstances that Topic provides otherwise, freestanding derivative instruments in the scope of this Subtopic would not be combined with the noncontrolling interest.

55-58 This guidance is limited to circumstances in which the parent owns a majority of the subsidiary’s outstanding common stock and consolidates that subsidiary at inception of the derivative instrument. This guidance is limited to the specific derivative instruments described.

Written Put Option and Purchased Call Option Embedded in Noncontrolling Interest

55-59 If the derivative instrument in Derivative 2 is embedded in the shares (noncontrolling interest) and the shares are not otherwise classified as liabilities under the guidance in this Subtopic, the combination of options should be viewed on a combined basis with the noncontrolling interest and accounted for as a financing of the parent’s purchase of the noncontrolling interest.

55-60 Under that approach, the parent would consolidate 100 percent of the subsidiary and would attribute the stated yield earned under the combined derivative instrument and noncontrolling interest position to interest expense (that is, the financing would be accreted to the strike price of the forward or option over the period until settlement). No gain or loss would be recognized on the sale of the noncontrolling interest by the parent to the noncontrolling interest holder at the inception of the derivative instrument.

55-61 The risks and rewards of owning the noncontrolling interest have been retained by the parent during the period of the derivative instrument, notwithstanding the legal ownership of the noncontrolling interest by the counterparty. Combining the two transactions in this circumstance reflects the substance of the transactions; that the counterparty is financing the noncontrolling interest. Upon such combination, the resulting instrument is not a derivative instrument subject to Subtopic 815-10.

55-62 This accounting applies even if the exercise prices of the put and call options are not equal, as long as those exercise prices are not significantly different.

ASC 480-10-55-53 through 55-62 require certain embedded option combinations involving a noncontrolling interest of a consolidated subsidiary to be accounted for on a combined basis with the noncontrolling interest as a financing of the parent’s purchase of the noncontrolling interest. Such option combinations are exempt from the scope of ASC 815-40. This accounting treatment applies when:

The parent holds 80 percent of the subsidiary’s equity shares and consolidates the subsidiary.
The remaining 20 percent of the subsidiary’s equity shares (the noncontrolling interest) are held by a third party.
Simultaneously with the acquisition of the noncontrolling interest, the parent and the holder of the noncontrolling interest enter into the following option combination:
- The parent has a call option to purchase the noncontrolling interest at a fixed price on a stated future date.
- The noncontrolling interest holder has a put option to sell the noncontrolling interest to the parent under the same terms. (ASC 480-10-55-62 suggests that the exercise prices do not need to be equal as long as they are not significantly different.)
The options are embedded in the shares representing the noncontrolling interest (i.e., they are not considered freestanding instruments).
The noncontrolling interest shares do not meet the definition of a mandatorily redeemable financial instrument (see Chapter 4 of Deloitte’s Roadmap Distinguishing Liabilities From Equity).

This guidance applies irrespective of whether the noncontrolling interest is in the form of common stock or preferred stock. Further, the guidance applies even if the relative ownership interests of the parent and the holder of the noncontrolling interest differ from the levels assumed in the fact pattern described in ASC 480 (i.e., 80 percent and 20 percent), provided that the parent owns a majority of the subsidiary’s outstanding common stock and consolidates the subsidiary at the inception of the arrangement (ASC 480-10-55-58). The guidance does not apply, however, if the option strike prices are based on a formula (e.g., EBITDA) that is not simply an indexation to interest rates rather than being fixed or if the options are contingent on the satisfaction of certain conditions (for further discussion, see Section 7.1 of Deloitte’s Roadmap Distinguishing Liabilities From Equity).

If a parent and the holder of a noncontrolling interest enter into put and call options on the noncontrolling interest and either the option combination or each option is considered to be a freestanding financial instrument (see Section 3.2.1) that is separate from the noncontrolling interest, the noncontrolling interest and the options would not be accounted for on a combined basis as a financing of the parent’s purchase of the noncontrolling interest. Instead, the accounting for the options depends on whether they represent a single freestanding financial instrument (in which case the option combination is accounted for as an asset or a liability under ASC 480-10-25-8) or two separate freestanding financial instruments (in which case the put option is accounted for as a liability under ASC 480-10-25-8, and the call option is evaluated under ASC 815-40). Either way, the accounting differs from that specified for noncontrolling interests with embedded options in ASC 480-10-55-59 through 55-62, because the noncontrolling interest would be reflected in equity by the parent.

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.