Consolidated and other financial statements

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Financial reporting

developments

A comprehensive guide

Consolidated and

other financial

statements

Noncontrolling interests, combined

financial statements, and parent company

financial statements

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To our clients and other friends

This Financial reporting developments (―FRD‖) publication is designed to help you understand financial reporting issues related to the accounting for noncontrolling interests. This publication also includes interpretive guidance on consolidation procedure and on the presentation of combined and parent-only financial statements. The publication reflects our current understanding of the provisions in ASC 810, Consolidations, based on our experience with financial statement preparers and related discussions with the FASB and SEC staffs.

The accounting for noncontrolling interests is based on the economic entity concept of consolidated financial statements. Under the economic entity concept, all residual economic interest holders in an entity have an equity interest in the consolidated entity, even if the residual interest is relative to only a portion of the entity (that is, a residual interest in a subsidiary). Therefore, a noncontrolling interest is required to be displayed in the consolidated statement of financial position as a separate component of equity. Likewise, the consolidated net income or loss and comprehensive income or loss attributable to both controlling and noncontrolling interests is separately presented on the consolidated statement of comprehensive income.

Consistent with the economic entity concept, after control is obtained, increases or decreases in

ownership interests that do not result in a loss of control should be accounted for as equity transactions. However, changes in ownership interests that result in a loss of control of a subsidiary or group of assets generally result in corresponding gain or loss recognition upon deconsolidation. The decrease in

ownership guidance generally does not apply to transactions involving non-businesses, in-substance real estate or oil and gas mineral rights conveyances.

The primary revisions made to this publication include the reorganization of certain content and the removal of the discussion of the transition guidance in FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (primarily codified in ASC 810). We also enhanced the interpretive guidance in Chapter 2 related to the presentation of noncontrolling interests when derivatives are issued with or as part of those interests. We also added certain other interpretive guidance (for example, to reflect the issuance of new guidance for deconsolidating in-substance real estate). These important changes are summarized in Appendix C.

Practice and authoritative guidance interpreting the provisions of ASC 810 continue to evolve and therefore readers should monitor developments in this area closely.

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1 Consolidated financial statements ... 1

1.1 Objectives and scope ... 1

1.2 Consolidation procedure — time of acquisition... 4

1.2.1 Acquisition through single step ... 4

1.2.2 Acquisition through multiple steps ... 4

1.3 Proportionate consolidation ... 5

1.4 Differing fiscal year-ends between parent and subsidiary ... 6

2 Nature and classification of the noncontrolling interest ... 8

2.1 Noncontrolling interests ... 8

2.2 Equity derivatives issued on the stock of a subsidiary ... 9

2.2.1 Is the equity derivative embedded in the noncontrolling interest or freestanding? ... 10

2.2.1.1 Equity derivatives considered embedded ... 11

2.2.1.2 Equity derivatives considered freestanding ... 11

2.2.2 Equity derivatives deemed to be financing arrangements ... 12

2.2.3 Application of the redeemable equity guidance ... 12

2.2.3.1 Measurement and reporting issues related to redeemable equity securities ... 13

2.2.4 Earnings per share considerations... 14

2.2.5 Examples of the presentation of noncontrolling interests with equity derivatives issued on those interests ... 14

2.2.6 Redeemable or convertible equity securities and UPREIT structures ... 19

2.2.7 Redeemable noncontrolling interest denominated in a foreign currency ... 20

3 Attribution of net income or loss and comprehensive income or loss ... 22

3.1 Attribution procedure ... 22

3.1.1 Substantive profit sharing arrangements ... 22

3.1.2 Attribution of losses ... 24

3.1.2.1 Distributions in excess of the noncontrolling interest’s carrying amount ... 24

3.1.3 Attribution to noncontrolling interests held by preferred shareholders ... 25

3.1.4 Attribution of goodwill impairment ... 25

3.1.5 Attributions related to business combinations effected before Statement 160 and Statement 141(R) were adopted ... 26

3.1.6 Effect on effective income tax rate ... 26

4 Changes in a parent’s ownership interest in a subsidiary while control is retained ... 28

4.1 Increases and decreases in a parent’s ownership of a subsidiary ... 28

4.1.1 Increases in a parent’s ownership interest in a subsidiary ... 29

4.1.1.1 Increases in a parent’s ownership interest in a consolidated VIE ... 30

4.1.2 Decreases in a parent’s ownership interest in a subsidiary without loss of control ... 30

4.1.2.1 Accounting for a stock option of subsidiary stock ... 32

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Contents

4.1.2.5 Issuance of preferred stock by a subsidiary ... 34

4.1.2.6 Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences ... 34

4.1.3 Accumulated other comprehensive income considerations ... 35

4.1.4 Accounting for foreign currency translation adjustments upon a change in parent’s ownership interest without loss of control ... 36

4.1.5 Allocating goodwill upon change in parent’s ownership interest ... 36

4.1.6 Accounting for transaction costs incurred in connection with changes in ownership... 37

4.1.7 Chart summarizing accounting for changes in ownership ... 37

4.2 Comprehensive example ... 38

4.2.1 Consolidation at the acquisition date ... 38

4.2.2 Consolidation in year of combination ... 40

4.2.3 Consolidation after purchasing an additional interest ... 42

4.2.4 Consolidation in year 2 ... 44

4.2.5 Consolidation after selling an interest without loss of control ... 46

4.2.6 Consolidation in year 3 ... 47

5 Intercompany eliminations ... 50

5.1 Procedures for eliminating intercompany balances and transactions ... 50

5.1.1 Effect of noncontrolling interest on elimination of intercompany amounts ... 51

6 Loss of control over a subsidiary or a group of assets ... 63

6.1 Deconsolidation of a subsidiary or derecognition of certain groups of assets ... 63

6.1.1 Loss of control ... 65

6.1.2 Nonreciprocal transfers to owners ... 65

6.1.3 Gain/loss recognition... 66

6.1.4 Measuring the fair value of consideration received and any retained noncontrolling investment ... 67

6.1.4.1 Accounting for contingent consideration in deconsolidation ... 68

6.1.4.2 Accounting for a retained creditor interest in deconsolidation ... 71

6.1.5 Accounting for accumulated other comprehensive income in deconsolidation ... 71

6.1.6 Deconsolidation through multiple arrangements ... 71

6.1.7 Deconsolidation through a bankruptcy proceeding ... 72

6.1.8 Gain/loss classification and presentation ... 73

6.1.9 Subsequent accounting for retained noncontrolling investment ... 73

6.2 Comprehensive example ... 74

6.2.1 Deconsolidation by selling entire interest ... 75

6.2.2 Deconsolidation by selling a partial interest ... 77

7 Combined financial statements ... 79

7.1 Purpose of and procedures for combined financial statements ... 79

7.1.1 Common management ... 79

7.1.2 Procedures applied in combining entities for financial reporting ... 80

8 Parent-company financial statements ... 81

8.1 Purpose of and procedures for parent-company financial statements ... 81

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Contents

9 Presentation and disclosures ... 83

9.1 Certain presentation and disclosure requirements related to consolidation ... 83

9.1.1 Consolidated statement of comprehensive income presentation ... 84

9.1.2 Reconciliation of equity presentation ... 84

9.1.2.1 Presentation of redeemable noncontrolling interests in equity reconciliation ... 85

9.1.2.2 Interim reporting period requirements ... 85

9.1.3 Consolidated statement of financial position presentation ... 86

9.1.4 Consolidated statement of cash flows presentation ... 86

9.1.4.1 Presentation of transaction costs in statement of cash flow ... 87

9.1.5 Disclosure ... 87

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Contents

Notice to readers:

This publication includes excerpts from and references to the FASB Accounting Standards Codification (the Codification or ASC). The Codification uses a hierarchy that includes Topics, Subtopics, Sections and Paragraphs. Each Topic includes an Overall Subtopic that generally includes pervasive guidance for the topic and additional Subtopics, as needed, with incremental or unique guidance. Each Subtopic includes Sections that in turn include numbered Paragraphs. Thus, a Codification reference includes the Topic (XXX), Subtopic (YY), Section (ZZ) and Paragraph (PP).

Throughout this publication references to guidance in the codification are shown using these reference numbers. References are also made to certain pre-codification standards (and specific sections or paragraphs of pre-Codification standards) in situations in which the content being discussed is excluded from the Codification.

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1 Consolidated financial statements

1.1 Objectives and scope

Excerpt from Accounting Standards Codification

Consolidation — Overall

Objectives General 810-10-10-1

The purpose of consolidated financial statements is to present, primarily for the benefit of the owners and creditors of the parent, the results of operations and the financial position of a parent and all its subsidiaries as if the consolidated group were a single economic entity. There is a presumption that consolidated financial statements are more meaningful than separate financial statements and that they are usually necessary for a fair presentation when one of the entities in the consolidated group directly or indirectly has a controlling financial interest in the other entities.

Scope and Scope Exceptions Entities

810-10-15-8

The usual condition for a controlling financial interest is ownership of a majority voting interest, and, therefore, as a general rule ownership by one reporting entity, directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity is a condition pointing toward consolidation. The power to control may also exist with a lesser percentage of ownership, for example, by contract, lease, agreement with other stockholders, or by court decree.

810-10-15-10

A reporting entity shall apply consolidation guidance for entities that are not in the scope of the Variable Interest Entities Subsections (see the Variable Interest Entities Subsection of this Section) as follows: a. All majority-owned subsidiaries — all entities in which a parent has a controlling financial interest —

shall be consolidated. However, there are exceptions to this general rule.

1. A majority-owned subsidiary shall not be consolidated if control does not rest with the majority owner — for instance, if any of the following are present:

i. The subsidiary is in legal reorganization ii. The subsidiary is in bankruptcy

iii. The subsidiary operates under foreign exchange restrictions, controls, or other

governmentally imposed uncertainties so severe that they cast significant doubt on the parent's ability to control the subsidiary.

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1 Consolidated financial statements

majority voting interest to control the investee's operations or assets, or, alternatively, those rights may be so restrictive as to call into question whether control rests with the majority owner.

v. Control exists through means other than through ownership of a majority voting interest, for example as described in (b) through (e).

2. A majority-owned subsidiary in which a parent has a controlling financial interest shall not be consolidated if the parent is a broker-dealer within the scope of Topic 940 and control is likely to be temporary.

3. Except as discussed in paragraph 946-810-45-3, consolidation by an investment company within the scope of Topic 946 of a non-investment-company investee is not appropriate. b. Subtopic 810-20 shall be applied to determine whether the rights of the limited partners in a

limited partnership overcome the presumption that the general partner controls, and therefore should consolidate, the partnership.

c. Subtopic 810-30 shall be applied to determine the consolidation status of a research and development arrangement.

d. The Consolidation of Entities Controlled by Contract Subsections of this Subtopic shall be applied to determine whether a contractual management relationship represents a controlling financial interest.

e. Paragraph 710-10-45-1 addresses the circumstances in which the accounts of a rabbi trust that is not a VIE (see the Variable Interest Entities Subsections for guidance on VIEs) shall be

consolidated with the accounts of the employer in the financial statements of the employer. ASC 810 defines a subsidiary as an entity in which a parent has a controlling financial interest, whether that controlling interest comes through voting interests or other means (for example, variable interests). While consolidation policy is not the subject of this publication, in general, the first step in determining whether an entity has a controlling financial interest in a subsidiary is to establish the basis on which the investee is to be evaluated for control (that is, whether the consolidation determination should be based on ownership of the investee’s outstanding voting interests or its variable interests). Accordingly, the provisions of ASC 810-10’s variable interest model1_{should first be applied to determine whether the}

investee is a variable interest entity (VIE). Only if the entity is determined not to be a VIE should the consolidation guidance for voting interest entities within ASC 810-10 be applied.

Once it is determined a parent has a controlling financial interest in an entity, the assets, liabilities and any noncontrolling interests of that entity are accounted for in the parent’s consolidated financial statements in accordance with the consolidation principles in ASC 810-10-45. These principles are generally the same for entities consolidated under the voting interest and variable interest models. Illustration 1-1 summarizes how ASC 810’s control framework should generally be applied to interests in an entity.

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Illustration 1-1: ASC 810, Consolidation Decision Tree

No Yes

Related party or de facto agent consolidates entity Does the enterprise,

including its related parties and de facto agents, collectively have power and benefits?

Yes

Variable Interest Model

Is the entity being evaluated for consolidation a legal entity?

No Yes No Yes Yes No

Does a scope exception to consolidation guidance (ASC 810) apply?

• Employee benefit plans

• Governmental organizations

• Certain investment companies

Does a scope exception to the Variable Interest Model apply?

• Not-for-profit organizations

• Separate accounts of life insurance companies

• Lack of information

• Certain businesses

Does the enterprise have a variable interest in a legal entity? Consider whether fees paid

to a decision maker or a service provider represent a variable interest

Apply other GAAP

Is the legal entity a variable interest entity?

• Does the entity have sufficient equity to finance its activities without additional subordinated financial support?

• Do the equity holders, as a group, lack the characteristics of a controlling financial interest?

• Is the legal entity structured with non-substantive voting rights (i.e., anti-abuse clause)?

Apply other GAAP

Consider whether silos exist or whether the interests or other contractual arrangements of the entity (excluding interests in silos) qualify as variable interests in the entity as a whole1

Yes No

Is the enterprise the primary beneficiary (i.e., Does the enterprise individually have both power and benefits)?

Variable Interest Model (cont.)

No Yes

Consolidate entity Does a related party or de facto agent

individually have power and benefits?

No

No Yes

Party most

Do the minority shareholders hold substantive participating rights or do certain other conditions exist (e.g., legal subsidiary is in bankruptcy)? No Yes Do not consolidate No Yes Do not consolidate Consolidate entity Voting model

The general partner (GP) is presumed to have control unless that presumption can be overcome by one the following conditions:

• Can a simple majority vote of limited partners remove a general partner without cause and there are no barriers to the exercise that removal right?

• Do limited partners have substantive participating rights?

Consolidation of partnerships and similar entities

Consolidation of corporations and other legal entities

Does a majority shareholder, directly or indirectly, have greater than 50% of the outstanding voting shares?

No Yes

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Note:

The FASB currently has a consolidation project on its agenda to amend ASC 810. The FASB’s tentative decisions would modify the provisions for evaluating an enterprise as a principal or an agent and the provisions for evaluating the substance of kick-out rights and participating rights, among other things. Additionally, the tentative decisions would modify the literature in ASC 810-20 used to reach

consolidation conclusions for limited partnerships and similar entities. Readers should monitor

developments in this area closely.

1.2 Consolidation procedure — time of acquisition

An entity may acquire a controlling financial interest in a subsidiary through a single step or through multiple steps over time.

1.2.1 Acquisition through single step

ASC 805 provides guidance when an acquirer obtains control of an acquiree through a single investment, often referred to as a ―single-step acquisition.‖ Single step acquisitions are perhaps the most

recognizable form of business combination. ASC 805 requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree, generally measured at their fair values as of the acquisition date. These concepts are discussed further in our FRD, Business combinations. The comprehensive example in Chapter 4 includes an example of the accounting for a single-step acquisition. See Section 4.2, Illustration 4-9; Section 4.2.1, Illustration 4-10; and Section 4.2.2, Illustration 4-11.

1.2.2 Acquisition through multiple steps

An acquirer may obtain control of an acquiree through a series of two or more investments, which is commonly referred to as a ―step acquisition.‖ or, in ASC 805, as a ―business combination achieved in stages.‖ Under ASC 805, if the acquirer holds a noncontrolling equity investment in the acquiree

immediately before obtaining control, the acquirer should first remeasure that investment to fair value as of the acquisition date and recognize any remeasurement gain or loss in earnings. If, before obtaining control, an acquirer recognized changes in the value of its noncontrolling investment in the target in other comprehensive income (that is, the investment was classified as available-for-sale in accordance with ASC 320), the amount recognized in other comprehensive income as of the acquisition date should be reclassified from other comprehensive income and included in the recognized remeasurement gain or loss as of the acquisition date. The acquirer then should apply ASC 805’s business combination guidance, as discussed in our FRD, Business combinations.

After taking control of a target company, further acquisitions of ownership interests (i.e., acquisitions of noncontrolling ownership interests with no changes in control) are accounted for as transactions among shareholders within equity pursuant to the guidance in ASC 810 (refer to Chapter 4).

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Illustration 1-2: Summary of guidance applied for acquisitions of an interest in an entity Acquisition of an

interest prior to obtaining control

Apply other GAAP (ASC 320, ASC 323 and ASC 815, among others).

Acquisition of an additional interest, which provides control

First, remeasure the previously held interest (i.e., the interest held before obtaining control, if any) at fair value, recognizing any gain or loss in earnings. Next, measure and consolidate (generally at fair value) the net assets acquired and any noncontrolling interests, in accordance with ASC 805. (Refer to our FRD, Business combinations, for further interpretive guidance).

Acquisition of an additional interest,

after control has already been obtained*

Reduce the carrying amount of the noncontrolling interest. Recognize any difference between the consideration paid and the reduction to the noncontrolling interest in equity attributable to the controlling interest. (See Chapter 4 for further interpretive guidance).

* See Section 4.1.2 for further discussion of this accounting.

1.3 Proportionate consolidation

Excerpt from Accounting Standards Codification

Other Presentation Matters 810-10-45-14

If the investor-venturer owns an undivided interest in each asset and is proportionately liable for its share of each liability, the provisions of paragraph 323-10-45-1 may not apply in some industries. For example, in certain industries the investor-venturer may account in its financial statements for its pro rata share of the assets, liabilities, revenues, and expenses of the venture. Specifically, a

proportionate gross financial statement presentation is not appropriate for an investment in an unincorporated legal entity accounted for by the equity method of accounting unless the investee is in either the construction industry (see paragraph 910-810-45-1) or an extractive industry (see

paragraphs 930-810-45-1 and 932-810-45-1). An entity is in an extractive industry only if its activities are limited to the extraction of mineral resources (such as oil and gas exploration and production) and not if its activities involve related activities such as refining, marketing, or transporting extracted mineral resources.

Real Estate — General — Investments — Equity Method and Joint Ventures

Recognition 970-323-25-12

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The use of the proportionate gross financial statement presentation method (that is, proportionate consolidation, as described in ASC 810-10-45-14) is permitted only in the following circumstances: a) investments in certain unincorporated legal entities in the extractive or construction industry that otherwise would be accounted for under the equity method of accounting (i.e., a controlling interest does not exist), and b) ownership of an undivided interest in real property when each owner is entitled only to its pro rata share of income and expenses and is proportionately (i.e., severally) liable for its share of each liability, and the real property owned is not subject to joint control by the owners.

1.4 Differing fiscal year-ends between parent and subsidiary

Excerpt from Accounting Standards Codification

Objectives General

Differing Fiscal Year-Ends Between Parent and Subsidiary 810-10-15-11

A difference in fiscal periods of a parent and a subsidiary does not justify the exclusion of the subsidiary from consolidation.

Other Presentation Matters

Differing Fiscal Year-Ends Between Parent and Subsidiary 810-10-45-12

It ordinarily is feasible for the subsidiary to prepare, for consolidation purposes, financial statements for a period that corresponds with or closely approaches the fiscal period of the parent. However, if the difference is not more than about three months, it usually is acceptable to use, for consolidation purposes, the subsidiary's financial statements for its fiscal period; if this is done, recognition should be given by disclosure or otherwise to the effect of intervening events that materially affect the financial position or results of operations

810-10-45-13

A parent or an investor should report a change to (or the elimination of) a previously existing

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Disclosure 810-10-50-2

An entity should make the disclosures required pursuant to Topic 250. This paragraph applies to all entities that change (or eliminate) a previously existing difference between the reporting periods of a parent and a consolidated entity or an investor and an equity method investee. This paragraph does not apply in situations in which a parent entity or an investor changes its fiscal year-end.

If there is a difference between a parent’s fiscal year end and a subsidiary’s fiscal year end, the parent may use the subsidiary’s financial statements for consolidation purposes, provided the difference is not more than about three months (i.e., 93 days per Rule 3A-02(b) of Regulation S-X). When the fiscal year ends do differ, a parent should disclose the effect of intervening events that, if recognized, would materially affect the consolidated financial position or results of operations.

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2 Nature and classification of the

noncontrolling interest

2.1 Noncontrolling interests

Excerpt from Accounting Standards Codification

Glossary 810-10-20

Noncontrolling Interest

The portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent. A noncontrolling interest is sometimes called a minority interest.

Nature and Classification of the Noncontrolling Interest in the Consolidated Statement of Financial Position

810-10-45-15

The ownership interests in the subsidiary that are held by owners other than the parent is a noncontrolling interest. The noncontrolling interest in a subsidiary is part of the equity of the consolidated group.

810-10-45-16

The noncontrolling interest shall be reported in the consolidated statement of financial position within equity, separately from the parent’s equity. That amount shall be clearly identified and labeled, for example, as noncontrolling interest in subsidiaries (see paragraph 810-10-55-41). An entity with noncontrolling interests in more than one subsidiary may present those interests in aggregate in the consolidated financial statements.

810-10-45-16A

Only either of the following can be a noncontrolling interest in the consolidated financial statements: a. A financial instrument (or an embedded feature) issued by a subsidiary that is classified as equity

in the subsidiary’s financial statements

b. A financial instrument (or an embedded feature) issued by a parent or a subsidiary for which the payoff to the counterparty is based, in whole or in part, on the stock of a consolidated subsidiary, that is considered indexed to the entity’s own stock in the consolidated financial statements of the parent and that is classified as equity.

810-10-45-17

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2 Nature and classification of the noncontrolling interest

810-10-45-17A

An equity-classified instrument (including an embedded feature that is separately recorded in equity under applicable GAAP) within the scope of the guidance in paragraph 815-40-15-5C shall be

presented as a component of noncontrolling interest in the consolidated financial statements whether the instrument was entered into by the parent or the subsidiary. However, if such an equity-classified instrument was entered into by the parent and expires unexercised, the carrying amount of the instrument shall be reclassified from the noncontrolling interest to the controlling interest.

Note:

This chapter introduces certain concepts related to the accounting for financial instruments that may have embedded features. Given the complexity of the relevant authoritative literature and the significant judgment required to apply that literature, it may be important to consult additional guidance when accounting for these instruments and their related features.

ASC 810-10 indicates that a noncontrolling interest in an entity is any equity interest in a consolidated entity that is not attributable to the parent. ASC 810-10 requires that the noncontrolling interest be classified as a separate component of consolidated equity.

In ASC 810-10, the FASB concluded that a noncontrolling interest in an entity meets the definition of equity in Concepts Statement 6, which defines equity (or net assets) as, ―the residual interest in the assets of an entity that remains after deducting its liabilities.‖ A noncontrolling interest represents a residual interest in the assets of a subsidiary within a consolidated group and is, therefore, consistent with the definition of equity in Concepts Statement 6. The noncontrolling interest is presented separately from the equity of the parent so that users of the consolidated financial statements can distinguish the parent’s equity from the equity attributable to the noncontrolling interest (that is, equity of the

subsidiary held by owners other than the parent).

To be classified as equity in the consolidated financial statements, the instrument issued by the

subsidiary should be classified as equity by the subsidiary based on other authoritative literature. If the instrument is classified as a liability in the subsidiary’s financial statements (e.g., under any of the guidance in ASC 480), it cannot be presented as noncontrolling interest in the consolidated entity’s financial statements because that instrument does not represent an ownership interest in the consolidated entity under US GAAP.

For example, mandatorily redeemable preferred shares issued by a subsidiary would be classified as a liability in the subsidiary’s financial statements pursuant to ASC 480. The preferred shares would not be classified as noncontrolling interest in the consolidated financial statements.

2.2 Equity derivatives issued on the stock of a subsidiary

It is common for a parent and the noncontrolling interest holders of a subsidiary to enter into arrangements whereby they may do one or more of the following:

• Grant the noncontrolling interest holders an option to sell their equity interests in the subsidiary to the parent

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Those arrangements can take the form of options (written or purchased, puts or calls), forwards (date-certain or contingent) or even swap-like contracts. In some cases, the arrangements may be papered between the parent and the noncontrolling interest holders, and in other cases between the subsidiary and the noncontrolling interest holders.

The various options and forwards described above are contracts on the shares (common or preferred) of a subsidiary. If the underlying share is classified in equity (as noncontrolling interest), the equity

derivatives2_{on the noncontrolling interest should be separately evaluated to determine their}

classification.

The accounting in this area can be complex because of the variety of authoritative guidance that should be considered and the terms of the transaction. For example, (1) the equity derivative may be entered into contemporaneously with the creation of the noncontrolling interest or subsequent to its creation, (2) the form of the equity derivative (that is, whether it is embedded or freestanding) can be determinative and (3) the strike price of the equity derivative may be set at either a fixed or variable (formulaic) price or at fair value. Each of those variations can affect the accounting.

The following summarizes, at a high level, the relevant accounting considerations applicable to equity derivatives associated with noncontrolling interest.

2.2.1 Is the equity derivative embedded in the noncontrolling interest or

freestanding?

The first step in accounting for an equity derivative associated with a noncontrolling interest is to determine whether the equity derivative is an embedded feature in the noncontrolling interest or a freestanding financial instrument, because the accounting can be significantly different. For example, the accounting for a freestanding written put on a subsidiary’s shares is different than that for puttable shares issued by the subsidiary. While ASC 480 provides little interpretive guidance on the definition of a ―freestanding‖ financial instrument, we believe that the substance of a transaction should be considered in making this determination.

The determination of whether an instrument is embedded or freestanding involves understanding both the form and substance of the transaction, and may involve substantial judgment. In this regard,

documenting an instrument in a separate contract is not necessarily determinative that it is freestanding, particularly when a contract is entered into in conjunction with another transaction. If the transactions are between the same parties and involve the same underlying (in this context, the issuer’s shares), it is important to assess whether the instruments are (1) legally detachable and (2) separately exercisable. Those concepts can be further described as follows:

• Legally detachable — Generally, whether two instruments can be legally separated and transferred such that the two components may be held by different parties.

• Separately exercisable — Generally, whether one instrument can be exercised without terminating the other instrument (e.g., through redemption, simultaneous exercise, or expiration).

If the exercise of one instrument must result in the termination of the other, the instruments would generally not be considered freestanding pursuant to ASC 480. On the other hand, if one instrument can be exercised while the other instrument continues to be outstanding, the instruments would be

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For example, if a parent enters into a contract with the only minority shareholder of its privately held subsidiary that permits the shareholder to put its shares in the subsidiary to the parent at a fixed price, that put option generally would be considered to be embedded in the related shares. In contrast, if the same parent enters into a put option on publicly traded common stock of a different subsidiary, and that put option permits the counterparty to put any common shares of the subsidiary to the parent at a fixed price (e.g., the counterparty could put shares of the subsidiary already owned or buy shares in the market), that written put option would be considered freestanding, provided that it is also legally detachable from the shares.

2.2.1.1 Equity derivatives considered embedded

If the equity derivative is considered a feature embedded in the subsidiary’s shares, that embedded feature should be analyzed to determine whether the shares should be a mandatorily redeemable financial instrument subject to ASC 480 or, if the shares are not a liability, whether the feature should be bifurcated. To determine whether the embedded feature should be bifurcated, the hybrid instrument (the

subsidiary’s shares and embedded feature) should be evaluated under ASC 815-15. In many cases, unless the subsidiary itself is a publicly traded entity, the feature will not meet the definition of a

derivative pursuant to ASC 815-10-15 because those features usually require gross physical settlement or the transfer of the full amount of consideration payable in exchange for the full number of underlying nonpublic subsidiary shares. As the underlying nonpublic shares are not readily convertible to cash, this gross physical settlement does not meet any of the forms of net settlement pursuant to ASC 815-10-15-99. However, if the instrument meets the definition of a derivative, it should be evaluated under

ASC 815-10-15-74(a) to determine if an exception from bifurcation is available.3

The exception in ASC 815-10-15-74(a) is applicable if the feature is considered indexed to the issuer’s own stock and would be classified in equity. ASC 815-40 includes guidance that should be considered in making this determination. There are special considerations as to whether the feature is considered indexed to the issuer’s own stock when subsidiary shares are involved, as discussed in ASC 815-40-15-5C. If an equity derivative is (1) deemed to be embedded and (2) the entire instrument is not a liability, the redeemable equity guidance should be considered (see Section 2.2.3 below).

2.2.1.2 Equity derivatives considered freestanding

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2.2.2 Equity derivatives deemed to be financing arrangements

In limited situations, a parent may enter into an equity derivative to acquire a subsidiary’s shares that should be accounted for as a financing of the parent’s purchase of the minority interest. In those situations, equity derivatives are entered into between the parent and minority interest holder at the inception of noncontrolling interest that require physical settlement. The contracts may be either (1) a fixed-priced forward to buy the remaining interest in the subsidiary at a stated future date and the forward is considered freestanding or (2) combination of a purchased call option and written put option with same (or not significantly different) fixed strike price and same fixed exercise date that are

embedded in the shares.4

Essentially, the parent consolidates 100% of the subsidiary and does not recognize the noncontrolling interest at the consolidated entity level, but rather a liability for the financing (i.e., the future purchase of the noncontrolling interest). In those circumstances, the risks and rewards of owning the noncontrolling interest have been obtained by the parent during the period of the equity derivative, even though the legal ownership of the noncontrolling interest is still retained by the noncontrolling interest holders. Essentially, combining the equity derivative and the noncontrolling interest reflects the substance of the transaction; that is, the noncontrolling interest holder is financing the noncontrolling interest.

ASC 480-10-55-54 states that the forward contract should be recognized as a liability, initially measured at the present value of the fixed forward price. Subsequently, the liability is accreted to the fixed forward price over the term of the forward contract with the resulting expense recognized as interest cost. Similar accounting and measurement would be applied to the combined noncontrolling interest and embedded options.

The initial measurement guidance in ASC 480-10-55-54 is not consistent with the general initial measurement requirement of ASC 480 for physically settled forward purchase contracts. The general measurement guidance in ASC 480-10-30-3 states that a freestanding physically settled forward contract should be measured initially at the fair value of the underlying shares at inception, adjusted for any consideration or unstated rights or privileges. While the methods are different, we generally believe that they should result in approximately the same initial measurement. Any significant differences would require additional analysis to determine if there are additional rights or privileges in the transaction.

2.2.3 Application of the redeemable equity guidance

Generally, an embedded feature, whether or not bifurcated, that permits or requires the noncontrolling interest holder to deliver the subsidiary’s interests in exchange for cash or other assets from the controlling entity (or the subsidiary itself) will result in the noncontrolling interest being considered redeemable equity. Public entities should consider the SEC staff’s guidance (included in codification at ASC 480-10-S99-3A) on redeemable equity securities when classifying redeemable noncontrolling interest. Those interests should first follow the accounting and measurement guidance in ASC 810-10 (including allocation of earnings, adjustments for dividends, etc.). The SEC’s guidance should then be considered, which could affect the classification (presented in the mezzanine rather than in equity), and if so, may also adjust the

measurement of any noncontrolling interest and the related earnings per share calculations.

4_{ASC 480-10-55-53 through 55-56 describe three different derivative instruments indexed to the stock of a consolidated}

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In certain instances, the issuer may be required, or may have a choice, to exchange the subsidiary’s interests by delivery of its own shares, rather than cash or other assets. In those instances, the SEC staff’s guidance requires the issuer to consider the guidance in ASC 815-40-25-7 through 25-35 to determine whether it can deliver the shares that could be required under the settlement of the exchange. If the issuer does not completely control settlement by delivery of its own shares (i.e., it cannot satisfy the settlement in shares), cash settlement would be presumed and temporary classification may be required for the noncontrolling interest.

2.2.3.1 Measurement and reporting issues related to redeemable equity securities

Redeemable noncontrolling interest is required to be initially measured at the initial carrying amount of the noncontrolling interest pursuant to the guidance in ASC 805-20-30. While that will generally be fair value, the guidance in ASC 805-20-30 should be considered.

For all companies, both public and nonpublic, noncontrolling interest is first accounted for pursuant to ASC 810. If the noncontrolling interest is considered redeemable pursuant to ASC 480-10-S99-3A, the redeemable noncontrolling interest is presented in temporary equity. The measurement guidance is not applied in lieu of the accounting for noncontrolling interest under ASC 810. Rather, it is an incremental measurement that starts with the carrying amount pursuant to ASC 810 and adjusts for any increase (but not decrease) to the carrying amount of temporary equity.

As a result, a parent should first attribute net income or loss of the subsidiary and related dividends to the noncontrolling interest pursuant to ASC 810. After that attribution, the issuer should consider the provisions of ASC 480-10-S99-3A to determine whether any further adjustments are necessary to increase the carrying value of redeemable noncontrolling interest. The amount presented in temporary equity should be the greater of the noncontrolling interest balance determined pursuant to ASC 810 or the amount determined pursuant to ASC 480-10-S99-3A.

Pursuant to ASC 480-10-S99-3A, a security (including noncontrolling interest) that is currently redeemable is measured at the current redemption amount. For a security that is not redeemable

currently, but will become redeemable in the future, the SEC guidance permits the following two methods of adjusting the carrying amount of the redeemable security:

• Method 1 — Adjust the carrying amount of the redeemable security to what would be the redemption amount assuming the security was redeemable at the balance sheet date.

• Method 2 — Accrete the carrying amount of the redeemable security to the redemption amount over time, to the date it is probable5_{it will become redeemable, using an appropriate method (e.g., the}

interest method).

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2.2.4 Earnings per share considerations

As noted in ASC 480-10-S99-3A paragraph 22, adjustments to the carrying amount of redeemable noncontrolling interest from the application of the SEC guidance do not affect net income or comprehensive income in the consolidated financial statements. However, the adjustments may affect earnings per share (EPS). The effect, if any, will depend on (1) whether the noncontrolling interest is represented by the subsidiary’s common shares or preferred shares and (2) if common shares, whether the redemption amount is at the then-current fair value or some other value (e.g., a formulaic value or fixed amount).

Refer to Section 3.2.2 of our FRD, Earnings per share, for further discussion of the EPS effects of redeemable equity instruments (including redeemable noncontrolling interest).

2.2.5 Examples of the presentation of noncontrolling interests with equity

derivatives issued on those interests

The following table summarizes the accounting for certain common equity derivatives used to acquire interests in a subsidiary. This table assumes the equity derivatives are issued on all of the outstanding noncontrolling interest (i.e., for the fixed number of shares not held by the parent) and are entered into by the controlling interest.

This table should be applied only after determining (1) when the equity derivative was entered into relative to the creation of the noncontrolling interest 6_{(2) whether its price is fixed, variable or at fair}

value and (3) whether the instrument is embedded or freestanding. It should be used as a starting point in applying the literature. Parenthetical references cite the relevant literature. Application of ASC 480-10-S99-3A is not specifically provided in the table, but references are made where the SEC staff’s guidance would be an additional consideration.

This table, necessarily, does not contemplate all possible instruments and assumes subsidiaries represent substantive entities as contemplated in ASC 815-40-15-5C. Careful consideration of the individual facts and circumstances will be necessary to determine the appropriate accounting for any instrument issued on noncontrolling interest.

Instrument Entered into Redemption amount Accounting

Written put option permitting the noncontrolling interest holder to put its interest to the controlling interest Contemporaneous with creation of noncontrolling interest

Fixed, fair value or variable

If embedded

If the embedded written put option does not require bifurcation pursuant to ASC 815-15, the put option is recognized as part of the noncontrolling interest. Changes in the fair value of the option over its life are not recognized. Earnings are generally attributed to the controlling interest and noncontrolling interests without considering the put option.

If the embedded put option is exercised, the noncontrolling interest is reduced and APIC is adjusted for any difference between the noncontrolling interest’s carrying value and the consideration paid.7

For SEC reporting, additional consideration of ASC 480-10-S99-3A is required for the noncontrolling interest.

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If freestanding

ASC 480 requires it to be classified as a liability and measured at fair value with the changes in value recognized in earnings. The exercise of the option results in the acquisition of

noncontrolling interest and any difference between the cash paid and the combined value of the freestanding instrument and noncontrolling interest’s carrying value would be recorded to APIC.

If embedded and bifurcated

The written put option is bifurcated and reported separately at fair value with changes in fair value recorded in earnings. The noncontrolling interest is recognized and measured pursuant to ASC 810.

For SEC reporting, additional consideration of ASC 480-10-S99-3A is required for the host equity derivative.

Subsequent to creation of noncontrolling interest

The written put option is recognized as a liability that is initially and subsequently measured at fair value pursuant to ASC 480. The noncontrolling interest is recognized and measured in accordance with ASC 810.

Purchased call option permitting the controlling interest to acquire the noncontrolling interest Contemporaneous with creation of noncontrolling interest

Fixed, fair value or

variable If embedded _{If the embedded purchased call option does not require bifurcation} pursuant to ASC 815-15, the call option is recognized as part of the noncontrolling interest. Changes in the fair value of the option over its life are not recognized. Earnings are generally attributed to the controlling interest and noncontrolling interests without considering the call option.

If the embedded call option is exercised, the noncontrolling interest is reduced and APIC is adjusted for any difference between the noncontrolling interest’s carrying value and the consideration paid.

If (1) freestanding and in the scope of ASC 815-10 or (2) bifurcated

The purchased call option is reported separately and measured at fair value with changes in value recognized in earnings. The noncontrolling interest is recognized and measured pursuant to ASC 810.

If freestanding and not in the scope of ASC 815-10

Follow ASC 815-40 to determine the appropriate classification and subsequent measurement of the instruments as an asset or equity. (ASC 815-40-25-1 through 25-43)

The noncontrolling interest continues to be recognized pursuant to ASC 810.

For a freestanding call option classified as equity pursuant to ASC 815-40, if the call option is not exercised and were entered into by the parent, the carrying amount of the instrument should be reclassified from the noncontrolling interest to the controlling interest. If it is not exercised and were entered into by the subsidiary, there is no reclassification to be made.

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Subsequent to creation of noncontrolling interest

If freestanding and in the scope of ASC 815-10

The freestanding purchased call option is reported separately and measured at fair value with changes in value recognized in earnings. The noncontrolling interest is recognized and measured pursuant to ASC 810.

If freestanding and not in the scope of ASC 815-10

Follow ASC 815-40 to determine the appropriate classification and subsequent measurement of the instruments as an asset or equity. (ASC 815-40-25-1 through 25-43 )

The noncontrolling interest continues to be recognized pursuant to ASC 810.

For a freestanding call option classified as equity pursuant to ASC 815-40, if the call option is not exercised and were entered into by the parent, the carrying amount of the instrument should be reclassified from the noncontrolling interest to the controlling interest. If it is not exercised and were entered into by the subsidiary, there is no reclassification to be made.

The 1986 AICPA Options Paper provides potential measurement alternatives to be evaluated if it were determined that neither ASC 815-10 nor ASC 815-40 applied.

Forward contract to acquire the noncontrolling interest Contemporaneous with creation of noncontrolling interest Payment amount and settlement date are fixed

If embedded

The noncontrolling interest would be a mandatorily redeemable financial instrument classified as a liability pursuant to ASC 480-10-30-1 and measured initially at fair value.8_{Noncontrolling interest is}

not recognized and no earnings are allocated to the noncontrolling interest. The parent accounts for this transaction as a financing and recognizes 100% of the subsidiary’s assets and liabilities.

If freestanding

The forward contract is classified as a liability and initially measured at an appropriate value.9_{The liability is accreted to the settlement}

amount over the term of the forward contract with the resulting expense recognized as interest cost. Noncontrolling interest is not recognized and no earnings are allocated to the noncontrolling interest.. The parent accounts for this transaction as a financing and recognizes 100% of the subsidiary’s assets and liabilities. (ASC 480-10-30-3 and ASC 480-10-55-53 through 55-54) When the forward contract is settled, the liability is derecognized.

8_{Subsequently, whether the measurement requirements of ASC 480-10 or ASC 480-10-S99 would be required depends on the}

application of the transition guidance in ASC 480-10-65-1(b). If the measurement guidance under ASC480-10 is applicable, the liability is measured at the present value of the amount to be paid at settlement, accruing interest cost using the rate implicit at inception based on the initial measurement.

9_{When addressing the initial measurement of a forward contract on shares of a subsidiary, there are three conflicting}

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Contemporaneous with creation of noncontrolling interest

Payment amount or settlement date vary based on certain conditions

If embedded

The resulting mandatorily redeemable financial instrument is a liability pursuant to ASC 480 and measured initially at fair value.10

Noncontrolling interest is not recognized and no earnings are allocated to the noncontrolling interest. The parent accounts for this transaction as a financing and recognizes 100% of the subsidiary’s assets and liabilities.

If freestanding

The forward contract is not subject to ASC 480-10-55-54 as the settlement price is not fixed. Pursuant to other sections of ASC 480, a liability should be recognized at the fair value of the shares at inception, adjusted for any consideration or unstated rights or privileges. The liability is subsequently measured at the amount that would be paid on the reporting date with any change in value from the previous reporting date recognized as interest cost. Noncontrolling interest is not recognized and no earnings are allocated to the noncontrolling interest. The parent accounts for this transaction as a financing and recognizes 100% of the subsidiary’s assets and liabilities.

Forward contract to acquire the noncontrolling interest (continued) Subsequent to creation of noncontrolling interest

Payment amount and settlement date are fixed

Pursuant to ASC 480, the freestanding forward contract is recognized as a liability at the date on which the forward contract was entered into. The liability is initially measured at the fair value of the shares at inception adjusted for any consideration or unstated rights or privileges. Subsequent measurement is at the present value of the amount to be paid at settlement, accruing interest cost using the rate implicit at inception based on the initial measurement. The previously recognized noncontrolling interest is derecognized and any difference between the amount of the liability and the noncontrolling interest’s carrying amount is recognized in APIC. No further attribution of earnings is necessary because there is no noncontrolling interest.

Either payment amount or settlement date varies based on certain conditions

Same as the accounting if the settlement date is fixed except that the liability is subsequently measured at the amount that would be paid on the reporting date with any change in value from the previous reporting date recognized as interest cost. No further attribution of earnings is necessary because there is no noncontrolling interest.

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Written put option and purchased call option with same (or not significantly different) strike price and same exercise date

Contemporaneous with creation of noncontrolling interest

Fixed Price If embedded11

Pursuant to ASC 480-10-55-59 through 55-62, the options are viewed on a combined basis with the noncontrolling interest. The combined instrument is classified as a liability, initially measured at the present value of the settlement amount.12_{Subsequently, the}

liability is accreted to the strike price with the accretion recognized as interest expense. Noncontrolling interest is not recognized and earnings are not attributed. The parent accounts for this transaction as a financing and consolidates 100% of the subsidiary. (ASC 480-10-55-55, 55-59 and 55-62)

The combined option is reported separately at fair value with changes in fair value recorded in earnings. The noncontrolling interest is recognized and measured pursuant to ASC 810. For SEC reporting, additional consideration of ASC 480-10-S99-3A is required for the host equity derivative.

If freestanding

The written put and purchased call should be evaluated to determine if they are a single instrument or two instruments. If viewed as a single instrument, the combined instrument containing a written put is recognized as a liability (or assets in certain instances) and measured at fair value. If viewed as two freestanding instruments, the written put option is recognized as a liability pursuant to ASC 480 and the purchased call option is evaluated pursuant to ASC 815-10 and ASC 815-40 and may be recognized as an asset or equity (refer to discussion in the table above for separate written puts and purchased calls).

11 _{ASC 480-10-55-55 establishes three scenarios for the written put/purchased call scenario, including one single instrument}

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Written put option and purchased call option with same (or not significantly different) strike price and same exercise date (continued) Contemporaneous with creation of noncontrolling interest (continued)

Other than fixed price

If embedded

The noncontrolling interest with the embedded options is not subject ASC 480-10-55-59 through 55-62. Noncontrolling interest is not mandatorily redeemable and no liability should be recognized at inception. The options are recognized as part of the noncontrolling interest. Changes in the fair value of options are not recognized. Earnings are generally attributed to the controlling interest and noncontrolling interest without considering the put option. For SEC reporting, additional consideration of ASC 480-10-S99-3A is required.

The combined option is reported separately at fair value with changes in fair value recorded in earnings. The noncontrolling interest is recognized and measured pursuant to ASC 810. For SEC reporting, additional consideration of ASC 480-10-S99-3A is required for the host equity derivative.

If freestanding

The written put and purchased call should be evaluated to determine if they are a single instrument or two instruments. If viewed as a single instrument, the combined instrument containing a written put is recognized as a liability (or assets in certain instances) and measured at fair value. If viewed as two freestanding instruments, the written put option is recognized as a liability pursuant to ASC 480 and the purchased call option is evaluated pursuant to ASC 815-10 and ASC 815-40 and may be recognized as an asset or equity (refer to discussion in the table above for separate written puts and purchased calls).

Issued subsequent to creation of noncontrolling interest and issued as freestanding instruments

Fixed price or other than fixed price

Refer to freestanding analysis above.

2.2.6 Redeemable or convertible equity securities and UPREIT structures

A real estate investment trust (REIT) with an ―umbrella partnership REIT‖ structure (UPREIT) will typically have a consolidated operating partnership (OP) that has issued ownership units to

noncontrolling parties. Based on the features typically found in the OP units, a REIT should carefully consider the guidance in ASC 480-10-S99-3A when classifying and measuring noncontrolling OP units in the consolidated financial statements.

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For example, arrangements vary as to with which entity the investor can redeem the units (e.g., only with the OP or only with the parent REIT or with the parent REIT deciding which entity will redeem the units). Typically, the redeeming entity (parent REIT or OP) will have the choice of the redemption consideration, which could be cash or shares of the parent REIT. The amount of the redemption could be based on a fixed amount, a formulaic amount, or most frequently, a fixed exchange ratio of OP units for parent REIT shares (or the then-current value of those public shares in cash).

As the OP units are redeemable (or exchangeable) at the option of the investor, the OP units potentially represent redeemable noncontrolling interests in the consolidated financial statements. Pursuant to the redeemable equity guidance in ASC 480-10-S99-3A, if the OP units may be redeemed for cash outside the control of the reporting entity (the consolidated REIT in this case), the noncontrolling interest should be classified in the mezzanine section and measured in accordance with the SEC’s guidance. Therefore, identifying what settlement alternatives exist and whether they are solely within the control of the reporting entity is important.

Based on discussions with the SEC staff, for the consolidated financial statements, we believe that the parent REIT and OP can be considered essentially a single decision maker in evaluating the redemption provisions if both of the following conditions are met:

• The parent REIT is the general partner in the operating partnership and the entities share the same corporate governance structures.

• The parent REIT can freely exercise all choices afforded it without conflicting with its fiduciary duties to its shareholders.

This will often result in a conclusion that the parent REIT/OP can elect share settlement upon redemption of the OP units. However, as discussed in ASC 480-10-S99-3A, the guidance in ASC 815-40-25 should be evaluated to determine whether the parent REIT/OP controls the actions or events necessary to issue the maximum number of parent REIT shares that could be required to be delivered under share

settlement of the contract. If the parent REIT/OP controls those actions or events, the OP units would not be within the scope of the SEC’s guidance. However, if those actions or events are not completely within their control, the presentation and measurement guidance in ASC 480-10-S99-3A would apply. There may be separate SEC reporting requirements for the OP. For example, if the OP has public debt outstanding, many of the concepts described above would be considered in determining the classification of the OP units in the stand-alone financial statements of the OP. However, it is important to realize that the OP units would be redeemable equity instruments rather than redeemable noncontrolling interests, and thus there would be different elements of ASC 480-10-S99-3A to be considered.

2.2.7 Redeemable noncontrolling interest denominated in a foreign currency

When a redeemable noncontrolling interest is denominated in a foreign currency, additional

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Insurer’s consolidation of fund partially owned by insurer’s separate accounts on behalf of

contract holders

Question 2.1 How should an insurer consolidate a controlled investment fund if a portion of the consolidated investment fund is owned by the insurer’s separate accounts?

In accordance with ASC 944-80-25-12, the insurer should consolidate the investment fund in the following manner:

• The portion of the fund assets representing the contract holder’s interests should be included as separate account assets and liabilities in accordance with ASC 944-80-25-3

• The remaining portion of the fund assets (including the portion owned by any other investors) should be included in the general account of the insurer on a line-by-line basis

• Noncontrolling interests should not be included in the separate account liability but rather classified as a liability or equity based on other applicable guidance

It should be noted that pursuant to ASC 944-80-25-3,13_{when evaluating an entity for consolidation, an}

insurer should not consider any separate account interests held for the benefit of policy holders to be the insurer’s interests, nor should it combine any separate account interests held for the benefit of policy holders with the insurer’s general account interest in the same investment.

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3 Attribution of net income or loss and

comprehensive income or loss

3.1 Attribution procedure

Excerpt from Accounting Standards Codification

Attributing Net Income and Comprehensive Income to the Parent and the Noncontrolling Interest 810-10-45-19

Revenues, expenses, gains, losses, net income or loss, and other comprehensive income shall be reported in the consolidated financial statements at the consolidated amounts, which include the amounts attributable to the owners of the parent and the noncontrolling interest.

810-10-45-20

Net income or loss and comprehensive income or loss, as described in Topic 220, shall be attributed to the parent and the noncontrolling interest.

810-10-45-21

Losses attributable to the parent and the noncontrolling interest in a subsidiary may exceed their interests in the subsidiary’s equity. The excess, and any further losses attributable to the parent and the noncontrolling interest, shall be attributed to those interests. That is, the noncontrolling interest shall continue to be attributed its share of losses even if that attribution results in a deficit

noncontrolling interest balance.

While ASC 810-10 requires net income or loss and comprehensive income or loss to be attributed to the controlling and noncontrolling interests, it does not prescribe a method for making these attributions. We believe that net income or loss, including other comprehensive income or loss, of a partially-owned subsidiary should be attributed between controlling and noncontrolling interests based on the terms of a substantive profit sharing agreement. If a substantive profit sharing agreement does not exist, we generally believe the relative ownership interests in the subsidiary should be used. Accordingly, in the latter case, the attribution may be as simple as multiplying the net income or loss and comprehensive income or loss of the partially-owned subsidiary by the relative ownership interests in the subsidiary.

3.1.1 Substantive profit sharing arrangements

We believe that, if substantive, a contractual arrangement that specifies how net income or loss,

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3 Attribution of net income or loss and comprehensive income or loss

Determining whether a profit sharing arrangement is substantive is a matter of individual facts and circumstances requiring the use of professional judgment. In particular, care should be exercised when different formulae are used to allocate cash distributions and liquidating distributions from taxable earnings. In these situations, the tax allocation should be carefully evaluated to ensure that the basis used for financial reporting purposes representationally reflects the allocations of earnings agreed by the parties. ASC 970-323-35-17 provides guidance on this point.

―Specified profit and loss allocation ratios should not be used … if the allocation of cash distributions and liquidating distributions are determined on some other basis. For example, if … [an] agreement between two investors purports to allocate all depreciation expense to one investor and to allocate all other revenues and expenses equally, but further provides that irrespective of such allocations, distributions to the investors will be made simultaneously and divided equally between them, there is no substance to the purported allocation of depreciation expense.‖

Additionally, we believe that it would be appropriate to disclose the terms and effects of any material substantive profit sharing arrangement. Also, the SEC staff has asked public companies to enhance their disclosures to include how such allocations among controlling and noncontrolling interests are made. Again, if a substantive profit sharing agreement does not exist, we generally believe the relative ownership interests in the subsidiary should be used. Accordingly, the attribution may be as simple as multiplying the net income or loss and comprehensive income or loss of the partially-owned subsidiary by the relative ownership interests in the subsidiary.

Question 3.1 Can the hypothetical liquidation at book value (HLBV) method14_{be used to attribute net income or}

loss and comprehensive income or loss between the controlling and noncontrolling interests?

As noted above, all attributions of net income or loss, including other comprehensive income or loss, should follow a substantive profit sharing agreement (or relative ownership percentage in the absence of a substantive profit sharing arrangement). When a substantive profit sharing arrangement exists, an entity will have to develop methodologies that reflect the substantive arrangement to allocate net income or loss and comprehensive income or loss. The HLBV allocation methodology is one such possible methodology. However any developed methodology is not necessarily a substantive profit sharing arrangement. Therefore, use of the HLBV method (or any other methodology) to make such attributions is only be appropriate if it reflects the terms of an existing substantive profit sharing arrangement. Determining whether the terms of an arrangement are substantive and whether the HLBV method (or any other allocation methodology) reflects that substance requires a careful evaluation of the individual facts and circumstances and requires the use of professional judgment. In evaluating the substance of the terms, the investor should consider whether the terms retain their purported economic outcome over time and whether subsequent events have the potential to retroactively affect or ―unwind‖ prior attributions.