Decreases in a parent’s ownership interest in a subsidiary without loss of control

A parent may decrease its ownership interest in a subsidiary by (1) selling a portion of the subsidiary’s shares it holds or (2) causing the subsidiary to issue shares. In accounting for such transactions under ASC 810, assuming they meet the scope of ASC 810-10-45-21A(b), the carrying amount of the noncontrolling interest should be increased to reflect the change in the noncontrolling interest’s ownership in the subsidiary’s net assets (that is, the amount attributed to the additional noncontrolling interests should reflect its proportionate ownership percentage in the subsidiary’s net assets acquired).

Any difference between the consideration received (whether by the parent or the subsidiary) and the adjustment made to the carrying amount of the noncontrolling interest should be recognized directly in equity attributable to the controlling interest (that is, as an adjustment to additional paid-in capital).

4 Changes in a parent’s ownership interest in a subsidiary while control is retained

Illustration 4-2: Decrease in a parent’s ownership throughparent selling shares

Assume Subsidiary A, a widget manufacturer, has 10,000 shares of common stock outstanding, all of which are owned by its parent, ABC Co. The carrying amount of Subsidiary A’s equity is $200,000.

ABC Co. sells 2,000 of its shares in Subsidiary A to an unrelated entity for $50,000 of cash, reducing its ownership interest from 100% to 80%.

Under ASC 810, a noncontrolling interest of $40,000 is recognized ($200,000 x 20%). The $10,000 excess of the cash received ($50,000) over the adjustment to the carrying amount of the

noncontrolling interest ($40,000) is recognized as an increase in additional paid-in capital attributable to ABC Co. as follows:

Cash $ 50,000

Additional paid-in capital $ 10,000

Stockholders’ equity — noncontrolling interest 40,000

Illustration 4-3: Decrease in a parent’s ownership through a subsidiary issuing new shares Assume Subsidiary A, a widget manufacturer, has 10,000 shares of common stock outstanding. ABC Co. (the parent) owns 9,000 of the outstanding shares and other shareholders own the remaining 1,000 shares. The carrying amount of Subsidiary A’s equity is $300,000, with $270,000 attributable to ABC Co. (the parent) and $30,000 attributable to the noncontrolling interest holders.

Assume Subsidiary A sells 2,000 previously unissued shares to an unrelated entity for $120,000 cash, increasing the carrying amount of Subsidiary A’s equity to $420,000 ($300,000 + $120,000).

The transaction would reduce ABC Co.’s ownership interest from 90% to 75% (9,000/12,000).

However, the transaction would increase ABC Co.’s Investment in Subsidiary A to $315,000 (75% of

$420,000), an increase of $45,000 ($315,000 - $270,000). Therefore, the entry recorded by ABC Co. would be:

Investment in Subsidiary A $ 45,000

Additional paid-in capital $ 45,000

In addition, the carrying amount of the noncontrolling interest would increase to $105,000 (25% of

$420,000). This increase of $75,000 ($105,000 - $30,000) would be recorded by Subsidiary A as:

Cash $ 120,000

Additional paid-in capital $ 45,000

Stockholders’ equity — noncontrolling interest 75,000

In consolidation, the increase to Investment in Subsidiary A recorded on ABC Co.’s balance sheet would eliminate against the increase in additional paid-in capital recorded on Subsidiary A’s balance sheet. Refer to Chapter 5, Intercompany eliminations, for further discussion of elimination entries.

4 Changes in a parent’s ownership interest in a subsidiary while control is retained

Question 4.1 For business combinations effected before Statement 160 and Statement 141(R) were adopted, how should companies account for subsequent acquisitions or dispositions of the noncontrolling interest by the parent while it maintains its controlling financial interest?

We believe that all subsequent acquisitions or dispositions of ownership interests in subsidiaries meeting the scope of ASC 810-10-45-21A while the parent maintains control — including those related to

business combinations effected prior to the adoption of Statement 160 — should be accounted for pursuant to Statement 160’s provisions.

Pursuant to ASC 805, as amended by Statement No. 141(R), assets and liabilities that arose from business combinations whose acquisition dates preceded Statement 141(R)’s effective date are not to be adjusted upon application of Statement 141(R). Accordingly, acquisitions of the noncontrolling interest by the parent while it maintains its controlling financial interest should not be accounted for as step acquisitions. Similarly, a parent’s sales of its ownership interests in a subsidiary meeting the scope of ASC 810-10-45-21A over which it continues to maintain control should be accounted for as equity transactions.

4.1.2.1 Accounting for a stock option of subsidiary stock

A subsidiary may grant a share-based payment award of its own stock to its employees that would result in a decrease in ownership and a noncontrolling interest when exercised. Questions arise as to whether these awards should be classified in the consolidated financial statements as a noncontrolling interest or as additional paid-in capital prior to exercise.

Awards of this nature may arise in a business combination when the acquirer is not obligated to replace acquiree’s awards and the awards remain in existence after the transaction. The accounting for these awards is addressed in Section 6.3 of our FRD, Business combinations. We believe this accounting would also apply to awards of subsidiary stock that do not arise in a business combination.

4.1.2.2 Scope exception for in-substance real estate transactions

The decrease in ownership guidance in ASC 810-10 does not apply if a transaction is a sale of in-substance real estate, even if that real estate is considered a business. Entities should apply the sale of real estate guidance in ASC 360-20 and ASC 976-605 to such transactions. However, guidance on noncontrolling interests in consolidated financial statements within ASC 810-10 will continue to apply to increases in ownership of an entity that is in-substance real estate.

4.1.2.3 Scope exception for oil and gas conveyances

Any conveyance of an oil and gas mineral right that is accounted for under the guidance in ASC 932-360-40 is outside the scope of ASC 810’s derecognition provisions as well as ASC 810’s provisions regarding decrease in ownership in circumstances in which a controlling interest is retained. Therefore, if a company is conveying a mineral interest, the transaction would be accounted for under ASC 932.

However, in a transaction in which a company sells all or a portion of a subsidiary or a group of assets that include oil and gas mineral rights (or contributes it to another entity), such transaction may be more appropriately accounted for under the guidance in ASC 810. Consideration of the illustrations and guidance in ASC 932 is required to determine whether a transaction represents a conveyance of a mineral property. If a transaction does not fall within the guidance of ASC 932, it should be accounted

4 Changes in a parent’s ownership interest in a subsidiary while control is retained

The following example illustrates a transaction that is not in the scope of ASC 810:

Illustration 4-4 Facts

O&G Co. A owns a 100% gas mineral interest in a property in Colorado. O&G Co. A assigns an operating interest to Drilling Co. A and retains a non-operating interest in the property. The

transaction requires Drilling Co. A to drill, develop and operate the property. O&G Co. A will participate in the production profits after Drilling Co. A recoups its costs.

Analysis

The accounting for the transaction described above (a pooling of assets in a joint undertaking) is addressed in ASC 932-360-55-3. Therefore, the transaction should be accounted for in accordance with ASC 932, not ASC 810.

The following example illustrates a transaction that is in the scope of ASC 810:

Illustration 4-5 Facts

O&G Co. A owns an operating subsidiary, Foreign Sub X. Foreign Sub X has oil and gas mineral properties as well as other energy related operations. Subsequently, O&G Co. A sells a 55% interest in those operations to O&G Co. B and loses control.

Analysis

In this fact pattern, O&G Co. A is selling 55% of its equity in Foreign Sub X, which results in the loss of control.¹⁶ Because this transaction does not represent an oil or gas mineral property conveyance as contemplated in the guidance of ASC 932 or any of ASC 932’s implementation guidance illustrations, it should be accounted for under the derecognition guidance in ASC 810.

We believe, in this circumstance, ASC 810 is the most appropriate guidance because this transaction represents the sale of a business that happens to include oil and gas mineral properties. This type of transaction is not addressed in the mineral property conveyance guidance in ASC 932.

4.1.2.4 Decreases in ownership of a subsidiary that is not a business or nonprofit activity

If a decrease in ownership occurs in a subsidiary that is not a business or nonprofit activity, an entity first needs to evaluate the substance of the transaction and identify whether other applicable literature (e.g., transfers of financial assets as discussed in ASC 860, revenue recognition as discussed in ASC 605, etc.) may provide relevant guidance. If no such guidance exists, an entity should apply the guidance in ASC 810-10. For example, if an enterprise sells the equity securities of a subsidiary that is not a business and all of the assets in the subsidiary are financial assets, the substance of the transaction should be evaluated under ASC 860.

However, guidance on noncontrolling interests in consolidated financial statements within ASC 810-10 will continue to apply to increases in ownership of an entity that is not a business or nonprofit activity.

4 Changes in a parent’s ownership interest in a subsidiary while control is retained

4.1.2.5 Issuance of preferred stock by a subsidiary

Pursuant to ASC 810-10-45-23, changes in a parent’s ownership interest while the parent retains control of a subsidiary should be accounted for as equity transactions. We generally believe that the preferred stock issuance by a subsidiary to noncontrolling interest holders should be reflected as noncontrolling interest in the financial statements of the parent at the amount of the cash proceeds received (e.g., the par amount).

Unlike common stock, preferred stock of a subsidiary often does not represent a residual equity interest.

Oftentimes, the holders of preferred stock are entitled to a liquidation preference, which generally includes a par amount and, in some cases, cumulative unpaid dividends. Additionally, the preferred stock holders of a subsidiary typically are entitled to a share of the subsidiary’s earnings up to the stated dividend. Unlike an issuance of common stock by a subsidiary (which generally results in a change in the parent’s ownership interest), the issuance of preferred stock by a subsidiary does not change the parent’s ownership interest. When recording the issuance of preferred stock by a subsidiary that is not a residual interest, we would not expect to see an adjustment to the parent’s equity accounts. (See Section 3.1.3 for interpretive guidance on attributions to noncontrolling interests held by preferred shareholders).

4.1.2.6 Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences

Pursuant to ASC 810-10-45-23, changes in a parent’s ownership interest while the parent retains control of a subsidiary (e.g., partnership) should be accounted for as equity transactions.

Partnerships can take various forms. Frequently, there is a substantive profit sharing arrangement whereby the profits of the partnership are allocated to the partners based on a predetermined formula.

In some cases, the profit sharing arrangement may provide certain partners with preferences in profits from operations or in liquidation. In other cases, the substantive profit sharing arrangement may not provide for preferences in profits or in liquidation.

To the extent it is determined that the issuance of partnership units represents the issuance of

preferential units (e.g., such units have preference in operating or liquidating cash flows), we believe that the guidance on the issuance of preferred stock by a subsidiary should be followed (see Section 4.1.2.5).

That is, when recording the issuance of preferential units by a partnership subsidiary, there is generally no adjustment to the parent’s equity accounts. Alternatively, if partnership units are issued without preferences, we believe that a parent of a partnership would follow the guidance in ASC 810-10-45-23.

See Question 4-2 for discussion of the accounting upon expiration of a preference period.

We would expect a parent of a partnership to develop a reasonable policy with respect to this accounting and apply that policy consistently.

Question 4.2 How should the provisions of ASC 810-10 be applied to a consolidated Master Limited Partnership’s issuance of preferential limited partnership units?

A Master Limited Partnership (MLP) is a limited partnership whose units are available to investors and traded on public exchanges, just like corporate stock. MLPs usually involve (1) a general partner (GP), who typically holds a small percentage (commonly 2%) of the outstanding partnership units and manages the operations of the partnership, and (2) limited partners (LPs), who provide capital and hold most of the ownership but have limited influence over the operations. Enterprises that form MLPs typically do so to take advantage of the special tax treatment of the partnership structure (although MLPs may also

4 Changes in a parent’s ownership interest in a subsidiary while control is retained

The GP frequently consolidates the MLP. For the issuance of LP interests, all sales first should be evaluated to determine if they represent in-substance sales or partial sales of real estate under ASC 360-20-15-2 through 15-10 (refer to our FRD, Real estate sales, for further interpretive guidance). Assuming the sale is not in-substance a sale or partial sale of real estate, a consolidated subsidiary that issues shares while the parent maintains control of the subsidiary should be accounted for as a capital transaction pursuant to the decrease in ownership guidance.

However, the decrease in ownership guidance may not apply when an MLP issues limited partnership units that have a preference in distributions or liquidation rights (referred to as the common LP units). It is common for an MLP partnership agreement to provide that, during a subordination period, the common LP units will have the right to receive distributions of available cash each quarter based on a minimum

quarterly distribution, plus any arrearages, before any distributions of available cash may be made on the subordinated LP units. Furthermore, no arrearages will be paid on the subordinated units. The practical effect of the subordinated LP units is to increase the likelihood that during the subordination period there will be available cash to be distributed on the common LP units. When subordinated LP units are held by the parent/GP of an MLP, common LP units do not possess the characteristics of a residual equity interest given the common LP units’ preference over the subordinated LP units. As such, we believe that the accounting guidance related to changes in a parent’s ownership interest in a subsidiary would not apply.

Therefore, if the parent/GP owns subordinated LP units in the MLP, the parent/GP should reflect the proceeds from issuance of common LP units as noncontrolling interest in its financial statements with no adjustment to additional paid-in capital. We believe that if the class of security issued by the subsidiary has a preference in distribution or liquidation rights over any other class of equity security, then it is analogous to preferred stock. As such, we do not believe the guidance above would apply to such transactions. See 4.1.2.4 above for additional discussion.

MLP partnership agreements include provisions for the subordination period to expire after a specific period of time if the minimum quarterly distributions have been made to the holders of the common LP units. Upon the expiration of the subordination period, all subordinated LP units held by the parent/GP have the same distribution and liquidation rights as the other common LP units. Although the common LP units previously issued by the MLP to the holders of the noncontrolling interest no longer have a preference in distributions due to the expiration of the subordination period, we believe this loss of preference has no immediate accounting consequences. The accounting for changes in noncontrolling interests only applies to changes in a parent’s ownership interest in a subsidiary, which includes

circumstances in which, ―(a) the parent purchases additional ownership interests in its subsidiary, (b) the parent sells some of its ownership interests in its subsidiary, (c) the subsidiary reacquires some of its ownership interests, or (d) the subsidiary issues additional ownership interests‖ (ASC 810-10-45-22). We believe the expiration of the subordination period is not a change in the parent’s ownership interest in a subsidiary because the expiration does not result in a change in ownership interest in the MLP. As such, there is no adjustment to be recognized to the equity accounts of the parent (that is, no adjustment to additional paid-in capital) or noncontrolling interest as a result of the expiration of the preferences.