Measuring the fair value of consideration received and any retained

When determining the gain or loss upon deconsolidation, the fair value of any consideration received and the fair value of any retained noncontrolling investment in the former subsidiary or groups of assets must be determined. When the consideration received is cash or when the retained noncontrolling investment in the former subsidiary or group of assets is a publicly traded equity interest, this

determination may be relatively straightforward. However, in other circumstances, the determination may prove more challenging. The facts and circumstances of a deconsolidating event should be evaluated carefully before recording a gain or loss. Consistent with the disclosure provisions included within ASC 810-10-50-1B and discussed further in Chapter 9, we believe that it is appropriate to disclose the details of the computation of any material gain or loss.

Consideration received may take many forms, including cash, tangible and intangible assets, financial instruments and contingent consideration. Because ASC 810-10-40-5 indicates that the consideration received is to be measured at fair value, we generally believe that it is appropriate to measure

consideration received at its fair value regardless of its form (see Section 6.1.4.1 below for further discussion of contingent consideration). In evaluating the nature and amount of consideration received, it may be helpful to consider the guidance in ASC 805 regarding consideration transferred. Refer to our

6 Loss of control over a subsidiary or a group of assets

market executory contracts (e.g., leases). To illustrate, if upon deconsolidation, a favorable lease contract (from the reporting entity’s perspective) exists between the reporting entity and its former subsidiary, we believe that an intangible asset should be recorded by the reporting entity for the off-market component of the lease contract. The effect of this accounting is to increase the gain (or reduce the loss) recorded upon deconsolidation, as presumably the consideration received was reduced by the favorable lease contract.

A retained noncontrolling investment may take many forms, including common stock investments, preferred stock investments, and debt interests (see Section 6.1.4.2). We also generally believe that it is appropriate to measure any noncontrolling investment at its fair value regardless of its form.

6.1.4.1 Accounting for contingent consideration in deconsolidation

In certain instances, a transfer of a controlling interest in a subsidiary involves contingent consideration.

For example, when an entity sells a controlling interest in a subsidiary, the acquirer may promise to deliver cash, additional equity interests or other assets to the seller after the sale date if certain specified events occur or conditions are met in the future. These contingencies frequently are based on future earnings or changes in the market price of the subsidiary’s stock over specified periods after the date of the sale; however, they might be based on other factors (e.g., components of earnings, product development milestones, cash flow levels or the successful completion of third-party contract

negotiations).

The basis for recognition and measurement of contingent consideration in deconsolidation is not

addressed in ASC 810 and therefore it is necessary to look to other guidance. If contingent consideration meets the definition of a derivative, it should be accounted for pursuant to ASC 815. When contingent consideration does not meet the definition of a derivative, the ASC does not provide detailed guidance. In this circumstance, we believe the basis for recognition and measurement of contingent consideration receivable by the seller is an accounting policy choice that should be applied on a consistent basis.

Discussed below are two policy alternatives that are applied in practice.

Alternative 1: Fair value approach

ASC 810-10-40-5 requires that the measurement of any gain or loss on deconsolidation of a subsidiary include the fair value of ―any consideration received.‖ We believe the reference to ―any consideration received‖ in ASC 810-10-40-5 could be interpreted to include contingent consideration. Thus, we believe that the seller may initially recognize an asset from the buyer equal to the fair value of any contingent consideration received upon deconsolidation. We note that this view is consistent with ASC 805’s

requirement that an acquirer recognize contingent consideration obligations as of the acquisition date as part of consideration transferred in exchange for an acquired business.

If a seller follows an accounting policy to initially recognize an asset equal to the fair value of the contingent consideration, we believe the seller also must elect an accounting policy to subsequently measure the contingent consideration under either of the following approaches:

a. Subsequent remeasurement at fair value by electing the fair value option provided in ASC 825-10-25 (assuming the gain contingency is a financial instrument eligible for the fair value option).

b. Recognize increases in the carrying value of the asset using the gain contingency guidance in ASC 450-30 and recognize impairments based on the guidance in ASC 450-20-25-2.

6 Loss of control over a subsidiary or a group of assets

Alternative 2: Loss recovery approach

We also believe it is reasonable to conclude that contingent consideration is not required to be measured at fair value. In that circumstance, we believe it is acceptable to apply a loss recovery approach by analogizing to the accounting for insurance recoveries on property and casualty losses.

Property and casualty losses are accounted for in accordance with ASC 605-40. Pursuant to that guidance, when a nonmonetary asset (e.g., property or equipment) is involuntarily converted to a monetary asset (e.g., receipt of insurance proceeds upon the occurrence of an insured event), the loss on the derecognition of the nonmonetary asset must be recognized, even when an entity reinvests, or is obligated to reinvest, the monetary assets in a replacement asset. Anticipated insurance proceeds up to the amount of the loss recognized are called insurance recoveries and may be recognized when it is probable²⁰ that they will be received. Some or all of the anticipated insurance recoveries therefore may be recognized. Specifically, anticipated insurance recoveries may be recognized at the lesser of the amount of: a) the proceeds that are probable of receipt or b) the total loss recognized. Insurance proceeds in excess of the amount of the loss recognized are subject to the gain contingency guidance in ASC 450-30, and are not recognized until all contingencies related to the insurance claim are resolved.

When analogizing insurance recovery accounting to the initial recognition of contingent consideration in deconsolidation, an entity would compare the fair value of the consideration received, excluding the contingent consideration, to the carrying amount of the assets that are deconsolidated pursuant to ASC 810. If the fair value of the consideration received, excluding the contingent consideration, is less than the carrying amount of the deconsolidated assets, the initial measurement of the contingent consideration asset would be limited to the difference between those amounts. That is, if it is probable that contingent consideration will be received, an asset would be recognized and measured initially at the lesser of the amount of probable future proceeds or the difference between the fair value of the

consideration received, excluding the contingent consideration, and the carrying amount of the

deconsolidated assets. Subsequent recognition and measurement would be based on the gain contingency guidance in ASC 450-30-25-1 (i.e., a contingency that might result in a gain usually should not be reflected in the financial statements because to do so might be to recognize revenue before its realization).

Any subsequent impairments would be recognized based on the guidance in ASC 450-20-25-2.

If the fair value of the consideration received, excluding the contingent consideration, is greater than the carrying amount of the deconsolidated assets, no contingent consideration asset would be recognized initially. Subsequent recognition and measurement of the contingent consideration would be based on the gain contingency model pursuant to ASC 450-30 and any subsequent impairment would be recognized based on the guidance in ASC 450-20-25-2.

Illustration 6-2 demonstrates these two alternatives.

Illustration 6-2

Assume Company A has a 100% controlling interest in Company B, a public retailer of athletic wear.

On 31 December 20X6, the carrying amount of Company B’s net assets is $150 million. On 1 January 20X7, Company A sells 100% of Company B to a third party for cash proceeds of $75 million and a promise by the third party to deliver additional cash annually over the next five years, determined based on a percentage of Company B’s annual earnings above an agreed upon target. The fair value of the contingent consideration is determined to be $175 million on 1 January 20x7. Company A determines it is probable that $225 million²¹ in total contingent consideration will be received over the life of this arrangement.

6 Loss of control over a subsidiary or a group of assets

Fair value approach

The gain on sale of the 100% interest in Company B is calculated as follows (in millions):

Cash proceeds $ 75

Fair value of the contingent consideration 175

250 Less:

Carrying amount of Company B’s net assets 150

Gain $ 100

The journal entry to record Company B’s deconsolidation follows:

Cash $ 75

Contingent consideration receivable 175

Net assets of Company B $ 150

Gain on sale 100

If Company A applies the fair value accounting policy, we believe Company A also must elect an accounting policy to subsequently measure the contingent consideration under either of the following approaches:

(a) Subsequent remeasurement at fair value by electing the fair value option provided in ASC 825-10-25

(b) Recognize increases in the carrying amount of the asset using the gain contingency guidance in ASC 450-30 and recognize impairments based on the guidance in ASC 450-20-25-2.

Loss recovery approach

Company A would compare the fair value of the consideration received, excluding the contingent consideration, to the carrying amount of the assets that are deconsolidated pursuant to ASC 810.

Cash proceeds $ 75

Less:

Carrying amount of Company B’s net assets 150

Difference $ (75)

Because the fair value of the consideration received, excluding the contingent consideration, is less than the carrying amount of the deconsolidated assets, an asset would be recognized and measured initially at the lesser of the amount of probable future proceeds or the difference between those amounts.

In this example, the difference of $75 calculated above is less than the probable future proceeds of

$225. Therefore, the contingent consideration asset would be recognized and measured initially at

$75. In this way, no gain would be recognized when initially recording this transaction.

The journal entry to record Company B’s deconsolidation would be as follows:

Cash $ 75

Contingent consideration receivable 75

Net assets of Company B $ 150

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6.1.4.2 Accounting for a retained creditor interest in deconsolidation

The FASB concluded that the loss of control and the related deconsolidation of a subsidiary or

derecognition of a group of assets specified in ASC 810-10-40-3A is a significant economic event that changes the nature of the investment held in the subsidiary or group of assets. Upon deconsolidation, an entity therefore is required to record any remaining noncontrolling investment in the subsidiary or a group of assets specified in ASC 810-10-40-3A at fair value. Consistent with this approach, we believe that a loan to the former subsidiary also should be measured at fair value at the deconsolidation date.

Thus, any difference between the carrying amount of the loan to the subsidiary and the fair value should be included in the gain/loss calculation upon deconsolidation of the subsidiary.