7.1 Certain Transactions Involving Noncontrolling Interests

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:

The parent has a fixed-price forward contract to buy the other 20 percent at a stated future date. (Derivative 1)
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)
The parent and the noncontrolling interest holder enter into a total return swap. The parent will pay to the counterparty (initially the noncontrolling interest holder) an amount computed based on the London Interbank Offered Rate (LIBOR), plus an agreed spread, plus, at the termination date, any net depreciation of the fair value of the 20 percent interest since inception of the swap. The counterparty will pay to the parent an amount equal to dividends paid on the 20 percent interest and, at the termination date, any net appreciation of the fair value of the 20 percent interest since inception of the swap. At the termination date, the net change in the fair value of the 20 percent interest may be determined through an appraisal or the sale of the stock. (Derivative 3)

55-54 If the terms correspond with Derivative 1, the forward purchase contract that requires physical settlement by repurchase of a fixed number of shares (the noncontrolling interest) in exchange for cash is recognized as a liability, initially measured at the present value of the contract amount; the noncontrolling interest is correspondingly reduced. Subsequently, accrual to the contract amount and any amounts paid or to be paid to holders of those contracts are reflected as interest cost. In effect, the parent accounts for the transaction as a financing of the noncontrolling interest and, consequently, consolidates 100 percent of the subsidiary.

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.

55-56 If the terms correspond with Derivative 3, the total return swap is indexed to an obligation to repurchase the issuer’s shares and may require the issuer to settle the obligation by transferring assets. Therefore it is in the scope of this Subtopic and is required to be accounted for as a liability (or asset in some circumstances), initially, and subsequently measured at fair value. The noncontrolling interest is accounted for separately from the total return swap.

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.

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.

7.1.1 Scenarios

ASC 480-10-55-53 through 55-62 contain multiple scenarios illustrating the accounting for certain transactions that involve noncontrolling interests. Other than in one scenario, ASC 480-10-55-53 through 55-62 merely illustrate how to apply ASC 480 and ASC 815-40. However, in the scenario in which an option combination is embedded in the noncontrolling interest, ASC 480-10-55 contains unique requirements that differ from other requirements in ASC 480 or ASC 815-40 (see Section 7.1.2).

The following table provides an overview of the scenarios in ASC 480-10-55-53 through 55-62. In each scenario, the parent holds 80 percent of the subsidiary’s equity shares and consolidates the subsidiary, and a third party holds the remaining 20 percent of the subsidiary’s equity shares (the noncontrolling interest). However, the parent is exposed to the risks and rewards associated with the noncontrolling interest through a forward, an option combination, or a total return swap on the noncontrolling interest that may require the issuer to pay cash.

Scenario	Parent’s Accounting
Derivative 1 — The parent has a fixed-price forward contract to buy the other 20 percent on a stated future date (ASC 480-10-55-53(a) and 55-54).	The forward is accounted for as a liability in accordance with the requirements for a physically settled forward purchase contract under ASC 480-10-25-8 (see Section 5.3.1). The subsidiary is 100 percent consolidated. No noncontrolling interest.
Derivative 2 — The parent has a call option to buy the other 20 percent at a fixed price on 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 (ASC 480-10-55-53(b) and ASC 480-10-55-55).	The accounting depends on how Derivative 2 was structured. (see Section 7.1.2)
Derivative 2 is issued as a single freestanding instrument (ASC 480-10-55-53(b) and ASC 480-10-55-55).	The option combination is accounted for as an asset or a liability at fair value under ASC 480-10-25-8 (see Section 5.3.2). The subsidiary is 80 percent consolidated. The noncontrolling interest is 20 percent. See also Section 7.1.2.2.
The written put option and the purchased call option in Derivative 2 are issued as separate freestanding instruments (ASC 480-10-55-53(b) and ASC 480-10-55-55).	The put option is accounted for as a liability at fair value under ASC 480-10-25-8 (see Section 5.3.2). The call option is evaluated under ASC 815-40 (i.e., it is accounted for as equity if it meets the equity classification conditions in ASC 815-40). The subsidiary is 80 percent consolidated. The noncontrolling interest is 20 percent. See also Section 7.1.2.2.
The written put option and the purchased call option in Derivative 2 are embedded in the shares, and the shares are not mandatorily redeemable (ASC 480-10-55-53(b), ASC 480-10-55-55, and ASC 480-10-55-59 through 55-62).	The transaction is accounted for as a financing (i.e., as if the parent had already purchased the 20 percent noncontrolling interest by using borrowed funds) under ASC 480-10-55-53(b), ASC 480-10-55-55, and ASC 480-10-55-59. The liability for the financing is accreted to the option strike price. The subsidiary is 100 percent consolidated. No noncontrolling interest. See Section 7.1.2.1 for further discussion.
Derivative 3 — The parent and the noncontrolling interest holder enter into a total return swap on the other 20 percent (ASC 480-10-55-53(b) and ASC 480-10-55-56).	The total return swap is accounted for as an asset or a liability at fair value under ASC 480-10-25-8 (see Section 5.3.2). The subsidiary is 80 percent consolidated. The noncontrolling interest is 20 percent.

7.1.2 “Derivative 2”

7.1.2.1 Options Embedded in Noncontrolling Interest

The scenario described in ASC 480-10-55-53(b), ASC 480-10-55-55, and ASC 480-10-55-59 through 55-62 is as follows:

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 third party’s acquisition of the noncontrolling interest, the parent and the holder of the noncontrolling interest enter into the following option combination, which is labelled “Derivative 2” in ASC 480-10-55-53(b):
- 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 separate freestanding instruments).
The noncontrolling interest shares do not meet the definition of a mandatorily redeemable financial instrument.

ASC 480-10-55-55 and ASC 480-10-55-59 through 55-62 require the embedded options and the noncontrolling interest in this scenario to be accounted for on a combined basis as a financing of the parent’s purchase of the noncontrolling interest. That is, the transaction is accounted for as a liability in a manner similar to a mandatorily redeemable financial instrument or a physically settled forward purchase contract on the issuer’s equity shares under ASC 480 even though redemption of the shares is conditional on the exercise of one or both of the options. Effectively, therefore, ASC 480-10-55-55 and ASC 480-10-55-59 through 55-62 override ASC 480-10-55-38 through 55-40 under which shares that embed a written put option and a purchased call option with the same terms are not considered mandatorily redeemable (see Section 4.2.1).

ASC 480-10-55-55 and ASC 480-10-55-59 through 55-62 apply irrespective of whether the noncontrolling interest is in the form of common stock or preferred stock. Further, such 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 scenario 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 (see ASC 480-10-55-58).

The liability accounting required by ASC 480-10-55-59 through 55-62 applies only to the combination of a call option and a put option on a noncontrolling interest when the options (1) are exercisable on the same future date and (2) have either the same fixed price or, as discussed in ASC 480-10-55-62, exercise prices that are not significantly different. Entities may be required to use significant judgment to determine whether the call and put options have the same fixed price. For example, if the call and put options each have an exercise price with the same fixed amount and the same adjustment for an interest component such as LIBOR, the call and put options would be considered to have the same fixed price.

However, the liability classification guidance in ASC 480-10-55-59 through 55-62 does not apply if (1) the option exercise prices are based on a formula (e.g., EBITDA) that is not simply an indexation to interest rates or (2) the options are contingent on the satisfaction of certain conditions.

For options that have an exercise price based on EBITDA, the substance of the transaction does not represent the parent’s financing of the purchase of the noncontrolling interest because the purchase price continues to vary on the basis of the subsidiary’s operating performance. Options that are contingent on the satisfaction of certain conditions also do not represent the parent’s financing of the purchase of the noncontrolling interest because such purchase will not occur if the specified conditions are not met.

If the liability classification in ASC 480-10-55-59 through 55-62 does not apply solely because the option exercise prices are based on a formula that is not simply an indexation to interest rates, the noncontrolling interest is not considered a mandatorily redeemable financial instrument under ASC 480-10-25-4 (see Chapter 4) and is not subject to liability classification under the other provisions of ASC 480. Accordingly, the parent would classify the noncontrolling interest as an equity instrument. However, if the parent is an SEC registrant, the noncontrolling interest would be subject to classification and measurement in temporary equity in accordance with ASC 480-10-S99-3A (see Chapter 9).

7.1.2.2 Freestanding Options

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 3.3) 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 on 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.

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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.