2.1 Parent-Entity Net Investment in the Carve-Out Entity
In some cases, carve-out financial statements may reflect a single
legal entity. Such carve-out financial statements will reflect the historical equity
structure of that legal entity, including typical equity line items such as common
stock, additional paid-in capital, and retained earnings.
However, in many cases, carve-out financial statements reflect the
combination of multiple legal entities or portions of one or more legal entities
and, as a result, the typical equity line items may not be meaningful. In these
circumstances, entities will often combine the net equity attributable to the parent
(excluding accumulated other comprehensive income [AOCI], which is presented as a
separate line) into a single line item. This line item, often referred to as the
“parent’s net investment,” reflects the parent company’s investment in the
carved-out business.
In allocating assets and liabilities and items of income and expense to carve-out financial statements, preparers of carve-out financial statements should be cognizant of the possible disconnect between balance sheet and income statement allocations. Income statement allocations to carve-out financial statements should usually reflect all costs of doing business (see Chapter 3 for additional guidance), whereas the balance sheet of a carve-out entity should generally include the assets currently or formerly owned by the carve-out entity and those liabilities for which the carve-out entity was or is legally responsible. Differences between income statement and balance sheet allocations are typically reflected in equity in the carve-out financial statements as part of the parent’s net investment in the carve-out entity (as contributions to the carve-out entity or distributions from the carve-out entity) unless an arrangement between the parent and the carve-out entity requires cash settlement (in which case, differences would be reflected as a net payable to, or net receivable from, the parent). See Sections 3.2 and 4.1.1 for further discussion of intercompany balances.
In addition to the impact of allocations, the parent’s net
investment would include contributions to fund the operations of the carve-out
entity that do not represent liabilities to the parent as well as the accumulated
earnings or losses of the carve-out business(es).
Example 2-1
Statement of Stockholders’ Equity in Carve-Out Financial
Statements
Registrant A decides to spin off Business B,
which comprises the assets, liabilities, and operations of
several entities. Immediately before the spin-off, A forms
Company C, a new legal entity, and contributes B to C for
all of C's outstanding common stock.
As of December 31, 20X1, the net parent
investment in B was $1,000 and AOCI was $50.
During the period from January 1, 20X2, to December 31, 20X2,
B had net income of $200, other comprehensive income of $20,
and contributions from A of $70.
On January 1, 20X3, A completed the spin-off
of B by distributing C's outstanding common stock with a par
value of $100. Company C had a net income and other
comprehensive income of $80 and $40, respectively, during
the period from January 1, 20X3, to December 31, 20X3.
The table below presents C’s statement of stockholders’
equity.