8.9 Master Limited Partnerships

8.9.1 Background

ASC 260-10

Master Limited Partnerships

05-2 The Master Limited Partnerships Subsections clarify the application of the General Subsection of the Other Presentation Matters Subtopic to master limited partnerships.

05-3 Publicly traded master limited partnerships often issue multiple classes of securities that may participate in partnership distributions according to a formula specified in the partnership agreement. A typical master limited partnership consists of publicly traded common units held by limited partners, a general partner interest, and incentive distribution rights. Depending on the structure of the master limited partnership, the incentive distribution rights may be a separate class of nonvoting limited partner interest that the general partner initially holds but generally may transfer or sell apart from its overall interest. Alternatively, the incentive distribution rights may be embedded in the general partner interest such that they cannot be detached and transferred apart from the general partner’s overall interest.

05-4 Generally, the partnership agreement obligates the general partner to distribute 100 percent of the partnership's available cash (as defined in the partnership agreement) at the end of each reporting period to the general partner and limited partners via a distribution waterfall (that is, a schedule that prescribes distributions to the general partner and limited partners at each threshold) within a contractually determined period of time following the end of a reporting period. When certain thresholds are met, the distribution waterfall further allocates available cash to the holder of the separate class of nonvoting limited partner interest (the incentive distribution right holder) or, when the incentive distribution right is embedded in the general partner interest, to the general partner. The net income (or loss) of the partnership is allocated to the capital accounts of the general partner and limited partners based on their respective sharing of income or losses specified in the partnership agreement, but only after taking into account any priority income allocations resulting from incentive distributions.

05-5 Paragraphs 260-10-45-59A through 45–70 address the use of the two-class method to calculate earnings per unit for capital structures that are not convertible into a class of common stock.

An MLP is a publicly traded limited partnership that typically issues multiple classes of securities that participate in partnership distributions in accordance with distribution formulas stated in the partnership agreement. An MLP combines the tax benefits of a limited partnership with the liquidity of publicly traded securities.25 MLPs are often found in the energy industry but also exist in other industries. A typical MLP consists of (1) publicly traded common units owned by limited partners (LPs) (“common units”), (2) a general partner (GP) interest, and (3) incentive distribution rights (IDRs). The common units generally represent substantially all of the capital of the MLP. IDRs are not ownership interests in the MLP, but they contain rights to share in the MLP’s distributions. IDRs may be a separate class of nonvoting limited partnership interests or may be embedded in the GP Interest. The GP is responsible for managing the business operations of the MLP and receives a return for services provided through management fees earned through the GP interest and distributions received on IDRs.

The partnership agreement for an MLP obligates the GP to distribute 100 percent of the partnership’s available cash, as defined in the partnership agreement, at the end of each quarter to the LPs holding common units; to the GP; and when certain thresholds are met, to the IDRs. These distributions are made via a distribution waterfall (i.e., a schedule that prescribes distributions to the LPs, GP, and IDRs at each threshold). The partnership agreement states that holders of IDRs are not entitled to distributions other than as provided in the distribution waterfall for available cash. The net income (or loss) of the partnership is allocated to the capital accounts of the GP and LPs on the basis of their ownership percentages, but only after taking into account any priority income allocations to IDRs26 and losses previously allocated to the partners. Therefore, an investor’s participation in the partnership’s distributions often does not mirror the partnership’s allocation of the MLP’s income or losses to the investor’s capital accounts.

Given the uniqueness of an MLP’s structure, ASC 260 contains specific guidance on the calculation of EPU by MLPs.

8.9.2 Scope

ASC 260-10

Master Limited Partnerships

15-4 The Master Limited Partnership Subsections follow the same Scope and Scope Exceptions as outlined in the General Subsection of this Subtopic. See paragraphs 260-10-15-1 through 15-3, with specific qualifications noted in the following paragraph.

Entities

15-5 A master limited partnership may issue incentive distribution rights that are a separate class of nonvoting limited partner interest that the general partner initially holds or incentive distribution rights that are embedded in the general partner interest and therefore cannot be detached or transferred apart from the general partner’s overall interest. Incentive distribution rights that are a separate class of non-voting limited partner interest generally may be transferred or sold apart from the general partner interest. The Master Limited Partnership Subsections apply to all master limited partnerships that meet both of the following criteria:

The partnership is required to make incentive distributions when certain thresholds have been met (regardless of whether the incentive distribution rights are a separate limited partner interest or embedded in the general partner interest)
The partnership accounts for the incentive distributions as equity distributions (as opposed to compensation costs).

The determination of whether the incentive distribution is an equity distribution or compensation cost is outside the scope of the Master Limited Partnership Subsection.

ASC 260-10-15-4 and 15-5 address the scope of the specific EPU guidance applicable to MLPs. The general scope requirements of ASC 260 regarding the entities required to present EPS apply to MLPs. MLPs are subject to the requirement to present basic and diluted EPU in their financial statements because the common units issued to LPs meet the definition of common stock that trades in a public market.

SEC Considerations

The requirement for MLPs to present basic and diluted earnings per common unit is consistent with SAB Topic 4.F, which requires public limited partnerships to report the results of operations on a per-unit basis.

The specific EPU guidance in ASC 260 for MLPs focuses on how IDRs affect the EPU calculations. As discussed above, IDRs may be (1) a separate class of nonvoting limited partnership interest that is initially held by the GP but may be transferred or sold apart from the GP interest or (2) embedded in the GP interest in such a way that they may not be transferred or sold apart from this interest. As discussed in Section 8.9.3, this distinction affects whether the IDRs are considered participating securities and how the MLP applies the two-class method.

Connecting the Dots

The MLP subsection of ASC 260 only applies when distributions on IDRs are considered equity distributions. In developing the original pronouncement that was codified in the MLP subsection, the EITF decided not to provide any EPU guidance related to situations in which distributions on IDRs are considered compensation cost. The determination of whether distributions on IDRs represent equity distributions or compensation cost is a matter of professional judgment. When distributions on IDRs are considered equity distributions, the two-class method must be applied in the MLP’s calculation of EPU. When distributions on IDRs are considered compensation cost, the IDRs are not considered participating securities to which the two-class method must be applied.

8.9.3 EPS Accounting

8.9.3.1 Guidance on Applying Two-Class Method to MLPs

ASC 260-10

Master Limited Partnerships

45-71 This Subsection provides guidance pertaining to the presentation of earnings per unit for master limited partnerships.

Incentive Distribution Rights That Are a Separate Class of Limited Partnership Interest

45-72 Incentive distribution rights that are a separate class of limited partner interest are participating securities because they have a right to participate in earnings with common equity holders. Therefore, current-period earnings shall be allocated to the general partner, limited partner, and incentive distribution right holder using the two-class method to calculate earnings per unit.

Incentive Distribution Rights That Are Embedded in the General Partner Interest

45-73 Incentive distribution rights that are embedded in the general partner interest are not separate participating securities. However, because the general partner and limited partner interests are separate classes of equity, the two-class method shall be applied in computing earnings per unit for the general partner and limited partner interests.

ASC 260 specifies that MLPs must apply the two-class method in calculating EPU, regardless of whether the IDRs are in the form of a separate class of limited partnership interest or are embedded in the GP interest. IDRs that represent a separate limited partnership interest are participating securities; therefore, the MLP should use the two-class method to allocate current-period earnings to the common units, GP interest, and IDRs in accordance with ASC 260-10-45-72. In contrast, IDRs that are embedded in the GP interest do not represent separate participating securities. Nevertheless, in such cases, the MLP would still use the two-class method to allocate current-period earnings to the common units and GP interest (including the IDRs) in accordance with ASC 260-10-45-73. The amount of current-period earnings allocated to the IDRs would be included in the amount of earnings allocated to the GP interest.

The following implementation guidance from ASC 260 helps explain the application of the two-class method of calculating EPU for MLPs and includes separate discussion of IDRs that are participating securities and those that are not:

ASC 260-10

Participating Securities and Undistributed Earnings

55-30 If a participating security provides the holder with the ability to participate in all dividends up to a specified threshold (for example, the security participates in dividends per common share up to 5 percent of the current market price of the stock), then undistributed earnings would be allocated to common stock and the participating security based on the assumption that all of the earnings for the period are distributed. In this example, undistributed earnings would be allocated to common stock and to the participating security up to 5 percent of the current market price of the common stock, as the amount of the threshold for participation by the participating security is objectively determinable. The remaining undistributed earnings for the period would be allocated to common stock.

Master Limited Partnerships

55-102 This Subsection, which is an integral part of the requirements of this Subtopic, provides general guidance used to compute earnings per unit for master limited partnerships.

Incentive Distribution Rights That Are a Separate Class of Limited Partner Interest

Distributions

55-103 When calculating earnings per unit under the two-class method for a master limited partnership, net income (or loss) for the current reporting period shall be reduced (or increased) by the amount of available cash that has been or will be distributed to the general partner, limited partners, and incentive distribution right holder for that reporting period. For example, assume a partnership agreement requires the general partner to distribute available cash within 60 days following the end of each fiscal quarter. The master limited partnership is required to file financial statements with a regulatory agency within 45 days following the end of each fiscal quarter. In order to compute earnings per unit for the first quarter, the general partner determines the amount of available cash that will be distributed to the general partner, limited partners, and incentive distribution right holder for that first quarter. The master limited partnership would reduce (or increase) net income (or loss) by that amount in computing undistributed earnings that are allocated to the general partner, limited partners, and incentive distribution right holder in calculating earnings per unit for the first quarter.

Earnings in Excess of Cash Distributions

55-104 Undistributed earnings shall be allocated to the general partner, limited partners, and incentive distribution right holder utilizing the contractual terms of the partnership agreement. The distribution waterfall (that is, a schedule that prescribes distributions to the various interest holders at each threshold) for available cash specified in the partnership agreement contractually mandates the way in which earnings are distributed for the period presented. The undistributed earnings shall be allocated to the incentive distribution right holder based on the contractual participation rights of the incentive distribution right to share in current period earnings. Therefore, if the partnership agreement includes a specified threshold as described in paragraph 260-10-55-30, a master limited partnership shall not allocate undistributed earnings to the incentive distribution right holder once the specified threshold has been met.

55-105 In determining whether a specified threshold exists, a master limited partnership shall evaluate whether distributions to the incentive distribution right holder would be contractually limited to available cash as defined in the partnership agreement if all earnings for the period were distributed. For example, if the partnership agreement contractually limits distributions to the incentive distribution right holder to the holder’s share of available cash as defined in the partnership agreement, then the specified threshold for the current reporting period would be the holder’s share of available cash that has been or will be distributed for that reporting period. The master limited partnership would not allocate undistributed earnings to the incentive distribution right holder because the holder’s share of available cash is the maximum amount that the incentive distribution right holder would be contractually entitled to receive if all earnings for the current reporting period were distributed. However, if the partnership agreement is silent or does not explicitly limit distributions to the incentive distribution right holder to available cash, then the master limited partnership would allocate undistributed earnings to the incentive distribution right holder utilizing the distribution waterfall for available cash specified in the partnership agreement.

Cash Distributions in Excess of Earnings

55-106 Any excess of distributions over earnings shall be allocated to the general partner and limited partners based on their respective sharing of losses specified in the partnership agreement (that is, the provisions for allocation of losses to the partners’ capital accounts for the period presented). If the incentive distribution right holders do not share in losses, the excess of distribution over earnings amount would not be allocated to the incentive distribution right holders. However, if the incentive distribution right holders have a contractual obligation to share in the losses of the master limited partnership on a basis that is objectively determinable (as described in paragraph 260-10-45-68), the excess of distributions over earnings shall be allocated to the general partner, limited partners, and incentive distribution right holders based on their respective sharing of losses specified in the partnership agreement for the period presented.

Incentive Distribution Rights That Are Embedded in the General Partner Interest

Distributions

55-107 When calculating earnings per unit under the two-class method for a master limited partnership, net income (or loss) for the current reporting period shall be reduced (or increased) by the amount of available cash that has been or will be distributed to the general partner (including the distribution rights of the embedded incentive distribution rights) and limited partners for that reporting period. For example, assume that a partnership agreement requires the general partner to distribute available cash within 60 days following the end of each fiscal quarter. The master limited partnership is required to file financial statements with a regulatory agency within 45 days following the end of each fiscal quarter. In order to compute earnings per unit for the first quarter, the general partner determines the amount of available cash that will be distributed to the general partner and limited partners for that first quarter. The master limited partnership would reduce (or increase) net income (or loss) by that amount in computing undistributed earnings that are allocated to the general partner (including the distribution rights of the embedded incentive distribution rights) and limited partners in calculating earnings per unit for the first quarter.

Earnings in Excess of Cash Distributions

55-108 Undistributed earnings shall be allocated to the general partner (including the distribution rights of the embedded incentive distribution rights) and limited partners utilizing the contractual terms of the partnership agreement. The distribution waterfall for available cash specified in the partnership agreement contractually mandates the way in which earnings are distributed for the period presented. The undistributed earnings shall be allocated to the general partner (with respect to the distribution rights of an embedded incentive distribution right) based on the contractual participation rights of the incentive distribution right to share in current period earnings. Therefore, if the partnership agreement includes a specified threshold as described in paragraph 260-10-55-30, a master limited partnership shall not allocate undistributed earnings to the general partner (with respect to the distribution rights of an embedded incentive distribution right) once the specified threshold has been met.

55-109 In determining whether a specified threshold exists, a master limited partnership shall evaluate whether distributions to the general partner (with respect to the distribution rights of an embedded incentive distribution right) would be contractually limited to available cash as defined in the partnership agreement if all earnings for the period were distributed. For example, if the partnership agreement contractually limits distributions to the general partner (with respect to the distribution rights of an embedded incentive distribution right) to the holder’s share of available cash as defined in the partnership agreement, then the specified threshold for the current reporting period would be the general partner’s share (with respect to the distribution rights of an embedded incentive distribution right) of available cash that has been or will be distributed for that reporting period. The master limited partnership would not allocate undistributed earnings to the general partner (with respect to the distribution rights of an embedded incentive distribution right) because the general partner’s share (with respect to the distribution rights of an embedded incentive distribution right) of available cash is the maximum amount that the general partner (with respect to the distribution rights of an embedded incentive distribution right) would be contractually entitled to receive if all earnings for the current reporting period were distributed. However, if the partnership agreement is silent or does not explicitly limit distributions to the general partner (with respect to the distribution rights of an embedded incentive distribution right) to available cash, then the master limited partnership would allocate undistributed earnings to the general partner (with respect to the distribution rights of an embedded incentive distribution right) utilizing the distribution waterfall for available cash specified in the partnership agreement.

Cash Distributions in Excess of Earnings

55-110 Any excess of distributions over earnings shall be allocated to the general partner and limited partners based on their respective sharing of losses specified in the partnership agreement for the period presented.

The following is a summary of the guidance in ASC 260-10-55-102 through 55-110 on an MLP’s calculation of EPU under the two-class method:

IDR is separate class of limited partnership interest — The MLP’s earnings are allocated among the common units, GP interest, and IDRs by using the two-class method, and the IDRs are considered a participating security. Distributed earnings for each quarterly financial reporting period will equal available cash (as defined in the MLP’s partnership agreement) for that specific period, even though the actual distributions do not occur until the following quarterly financial reporting period. That is, the amount of available cash that is considered to represent distributed earnings must be based on the portion of the respective financial reporting period’s earnings that must be distributed in the following period. Undistributed earnings for each quarterly financial reporting period, which represent net income of the MLP less distributed earnings, should be allocated to the common units, GP interest, and IDRs on the basis of the contractual terms of the partnership agreement. If the MLP contains a specified threshold, as described in ASC 260-10-55-30, the MLP would not allocate undistributed earnings to the IDRs once the specified threshold is met. As a result, the undistributed earnings would be allocated only to the common units and the GP interest. Any excess of cash distributed over earnings would be allocated to the IDRs (along with the common units and GP interest) only if the IDRs contain a contractual obligation to share in losses, which will typically not be the case. Therefore, cash distributions that exceed earnings, or undistributed losses, will typically not be allocated to IDRs.
IDR is embedded in the GP interest — The MLP’s earnings are allocated among the common units and GP interest (including the distribution rights of the IDRs) by using the two-class method. Distributed earnings for each quarterly financial reporting period will equal available cash (as defined in the MLP’s partnership agreement) for that specific period, even though the actual distributions do not occur until the following quarterly financial reporting period. That is, the amount of available cash that is considered as representing distributed earnings must be based on the portion of the respective financial reporting period’s earnings that must be distributed in the following period. Undistributed earnings for each quarterly financial reporting period, which represent net income of the MLP less distributed earnings, should be allocated to the common units and GP interest (including the distribution rights of the IDRs) on the basis of the contractual terms of the partnership agreement. If the MLP contains a specified threshold, as described in ASC 260-10-55-30, the MLP would not allocate undistributed earnings to the GP interest with respect to distribution rights of the IDRs once the specified threshold is met. As a result, the undistributed earnings would be allocated only to the common units and GP interest (excluding the distribution rights of the IDRs). Any excess of cash distributed over earnings would be allocated to common units and GP interest on the basis of their respective sharing of losses in the partnership agreement for the MLP.

Connecting the Dots

Under the MLP subsection of ASC 260, the calculation of EPU by an MLP critically depends on whether the partnership agreement contains a specified threshold under ASC 260-10-55-30. ASC 260 indicates that the partnership agreement for an MLP contains a specified threshold if distributions on IDRs (or the GP interest with respect to distribution rights of embedded IDRs) are contractually limited to the IDR’s allocable portion of available cash, as defined in the partnership agreement. Thus, the determination of whether undistributed earnings are allocated to IDRs is not based on an assumption that cash available for distribution equals net earnings for the period (or that all earnings for the period are distributed). Rather, the focus is on whether a specified threshold exists, as discussed in ASC 260. Since this guidance is specific to MLPs, it should not be applied by analogy.

In practice, most MLP partnership agreements will contractually limit distributions to available cash and a specified threshold therefore will exist. As a result, the MLP should not allocate undistributed earnings to the IDRs (or the GP interest with respect to the distribution rights of an embedded IDR). Rather, undistributed earnings are allocated only to the common units and GP interest (excluding any distribution rights of an embedded IDR). ASC 260 does not provide any specific guidance on how to allocate undistributed earnings (or losses) to common units and the GP interest. The allocation based on the waterfall in the allocation of available cash is not appropriate unless it is modified to exclude the waterfall provisions associated with allocations to IDRs. Therefore, the MLP would need to apply an allocation based on (1) the waterfall for the allocation of available cash as modified to exclude IDRs (i.e., as if the IDRs did not exist), (2) a capital allocation approach, (3) a relative percentage ownership approach, or (4) another systematic and rational method. The objective of the allocation approach selected should be to mirror how undistributed earnings (losses) would be allocated if undistributed earnings (or losses) were distributed. The method of allocation selected should be applied consistently.

In the unusual circumstance in which a partnership agreement for an MLP does not contain a specified threshold, the two-class method should be applied under an assumption that all earnings for the period are distributed, which will result in an allocation of undistributed earnings to IDRs (or the GP interest with respect to the distribution rights of an embedded IDR). The allocation of undistributed earnings should be based on the contractual waterfall of distributions of the partnership under the assumption that distributions pertaining to the period equaled net earnings for the period. Because IDRs typically do not contractually share in losses, undistributed losses would typically not be allocated to IDRs.

8.9.3.2 Examples of Application of Two-Class Method to MLPs

8.9.3.2.1 IDR Is Separate Class of Limited Partnership Interest and Earnings Exceed Available Cash

The example below illustrates the calculation of the two-class method for calculating EPU for an MLP when the IDRs are a separate class of limited partnership interest and the earnings of the MLP for the period exceed available cash.

Example 8-29

Assume the following:

Partnership A has net income of $50,000 for the quarter ended March 31, 20X1.
Partnership A has 9,800 common units held by the LPs (the “common units”), 200 GP units, and IDRs.
On March 31, 20X1, A has available cash, as defined in the partnership agreement, of $20,000.
The waterfall requires that available cash be distributed as follows:
- First, 98 percent to the LPs and 2 percent to the GP until each LP has received a total of $0.40 per LP common unit (the “first threshold”), with 98 percent and 2 percent representing the ownership percentages of the LPs and GP, respectively.
- Second, 85 percent to the LPs, 2 percent to the GP, and 13 percent to the IDRs until each LP has received a total of $0.50 per LP common unit (the “second threshold”).
- Third, 75 percent to the LPs, 2 percent to the GP, and 23 percent to the IDRs until each LP has received a total of $0.60 per LP common unit (the “third threshold”).
- Thereafter, 50 percent to the LPs, 2 percent to the GP, and 48 percent to the IDRs.
The following table illustrates the cumulative amount of available cash that would be distributed to the LPs, the GP, and the IDRs at each threshold.

Partnership A would apply the two-class method of calculating EPU. The application would depend on whether the partnership agreement contractually limits distributions to IDRs to the allocable portion of available cash and, as a result, contains a “specified threshold,” as described in ASC 260-10-55-30. Whether the partnership agreement contains a specified threshold is a matter of professional judgment. However, if the partnership agreement is silent on this matter or does not explicitly limit distributions to the IDR holders of available cash, the partnership agreement would not be considered to have a specified threshold.

Calculation of EPU — Specified Threshold Exists

If the partnership agreement is considered to have a “specified threshold,” the partnership would allocate available cash to the LP common units, the GP units, and the IDRs by using the distribution waterfall specified in the partnership agreement. The undistributed earnings are allocated to the LP common units and the GP units only according to the contractual terms of the partnership agreement (which, for this example, is assumed to be based on the LPs’ and the GP’s ownership percentages).

Calculation of EPU — Specified Threshold Does Not Exist

If the partnership agreement is not considered to have a “specified threshold,” the partnership would allocate current-period earnings to the LP common units, the GP units, and the IDRs by using the distribution waterfall specified in the partnership agreement. That is, because the two-class method requires that current-period earnings be allocated as though all the earnings have been distributed, current-period earnings would be viewed as the amount of cash available for distribution. Therefore, in this example, an entity would use the distribution waterfall to allocate the undistributed earnings of $30,000 to the LP common units, the GP units, and the IDRs.

8.9.3.2.2 IDR Is Separate Class of Limited Partnership Interest and Available Cash Exceeds Earnings

The example below illustrates the use of the two-class method to calculate EPU for an MLP when the IDRs are a separate class of limited partnership interest and the available cash of the MLP for the period exceeds earnings.

Example 8-30

Assume the same facts as in Example 8-29 except that on March 31, 20X1, Partnership A has available cash of $70,000.

Calculation of EPU — IDRs Do Not Have Contractual Obligation to Share in Losses

Partnership A must determine whether, under the partnership agreement, the IDR holders have a contractual obligation to share in the losses of the partnership on a basis that is objectively determinable. If the IDR holders do not have a contractual obligation to share in losses, the excess of distributions over earnings is allocated to the LP common units and the GP units on the basis of their respective sharing of losses specified in the partnership agreement (which, in this example, are assumed to be shared between the LPs and the GP on the basis of their contractual ownership percentages).

The following are the calculations of the IDR, GP unit, and LP common unit distribution amounts (as described in the first table footnote above) by using the waterfall table from Example 8-29, updated for $70,000 in cash available (versus $20,000 in Example 8-29).

GP units: ($70,000 available cash – $6,459.61 total third threshold amount) × 2% + $129.19 GP third threshold amount = $1,400.
IDRs: ($70,000 available cash – $6,459.61 total third threshold amount) × 48% + $450.42 IDR third threshold amount = $30,949.80.
LP common units: ($70,000 available cash – $6,459.61 total third threshold amount) × 50% + $5,880 LP third threshold amount = $37,650.20.

Calculation of EPU — IDRs Do Have a Contractual Obligation to Share in Losses

If the IDR holders do have a contractual obligation to share in losses, the excess of distributions over earnings is allocated to the LP common units, the GP units, and the IDRs on the basis of their respective sharing of losses specified in the partnership agreement. Assume that the IDRs share in losses in the same manner as they share in earnings (i.e., via the distribution waterfall, which, for this example, is equal to the undistributed losses).

8.9.4 Drop-Down Transaction

ASC 260-10

Prior-Period Adjustments

55-16A See paragraph 260-10-55-111 for guidance on the presentation of prior-period earnings per unit for entities within the scope of the Master Limited Partnerships Subsections that retrospectively adjust their financial statements and financial information for prior periods as a result of a dropdown transaction accounted for under the Transactions Between Entities Under Common Control Subsections of Subtopic 805-50.

Presentation of Historical Earnings per Unit After a Dropdown Transaction Accounted for as a Transaction Between Entities Under Common Control

55-111 A general partner may transfer net assets to a master limited partnership as part of a dropdown transaction that occurs after formation of the master limited partnership. If the master limited partnership accounts for the dropdown transaction under the Transactions Between Entities Under Common Control Subsections of Subtopic 805-50, in calculating the historical earnings per unit under the two-class method, the earnings (losses) of the transferred net assets before the date of the dropdown transaction should be allocated entirely to the general partner. In that circumstance, the previously reported earnings per unit of the limited partners for periods before the date of the dropdown transaction should not change as a result of the dropdown transaction.

The following example helps illustrate the accounting for a drop-down transaction:

Example 8-31

Accounting for Drop-Down Transaction

Assume the following:

Partnership A, an MLP, originally reported net income of $200,000 for the years ended December 31, 20X2, and 20X1.
On January 1, 20X3, A’s GP enters into a drop-down transaction between entities under common control by transferring certain net assets to A in exchange for cash. The net income of the transferred net assets was $20,000 for the years ended December 31, 20X2, and 20X1.
According to the partnership agreement for A, net income is allocated to the GP and LPs on the basis of their ownership percentages (2 percent to GP, 98 percent to LPs).
For simplicity, there are no equity interests outstanding for A other than the GP and LP interests.

Partnership A originally reported income and EPU for the years ended December 31, 20X2, and 20X1 as follows:

After the drop-down transaction, A must retrospectively adjust its financial statements for prior reporting periods in accordance with ASC 260-10-55-16A. Under ASC 260-10-55-111, the previously reported EPU of the LPs should not change as a result of the drop-down transaction. Therefore, the retrospectively adjusted net income must be allocated to the GP and the previously reported income attributable to the LPs is not adjusted. The income and EPU for the years ended December 31, 20X2, and 20X1 would be adjusted as follows.

In accordance with ASC 260-10-50-3, A should disclose that the GP was entitled to 100 percent of the income of the transferred assets before the date of the drop-down transaction and that the GP and LPs had the right to 2 percent and 98 percent, respectively, of income after the drop-down transaction for the purpose of subsequent calculations of EPU under the two-class method going forward. See Section 9.2.1.2 for information about the disclosure requirements related to drop-down transactions.

Footnotes

A major advantage of investing in an MLP is that distributions are typically classified as pass-through income and the partnership itself is not subject to corporate taxation on income. Income is taxed on the individual investor on the basis of the distributions received from the MLP.

These priority allocations equal the cash distributions on IDRs, so the capital account for the IDRs maintains a zero balance over the life of the MLP.

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.