EITF ABSTRACTS
Issue No. 00-4 Title: Majority Owner’s Accounting for a Transaction in the Shares of a Consolidated
Subsidiary and a Derivative Indexed to the Noncontrolling Interest in That Subsidiary1
Dates Discussed: January 19–20, 2000; May 17–18, 2000; July 19–20, 2000 References: FASB Statement No. 66, Accounting for Sales of Real Estate
FASB Statement No. 94, Consolidation of All Majority-Owned
Subsidiaries
FASB Statement No. 125, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities
FASB Statement No. 133, Accounting for Derivative Instruments and
Hedging Activities
FASB Statement No. 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity
FASB Statement No. 160, Noncontrolling Interests in Consolidated
Financial Statements
FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R) FASB Interpretation No. 43, Real Estate Sales
FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others
FASB Interpretation No. 46, Consolidation of Variable Interest Entities FASB Interpretation No. 46 (revised December 2003), Consolidation of
Variable Interest Entities
FASB Staff Position FIN46-6, “Effective Date of FASB Interpretation No. 46”
Statement 133 Implementation Issue No. C6, “Derivative Instruments Related to Assets Transferred in Financing Transactions”
Statement 133 Implementation Issue No. K1, “Determining Whether Separate Transactions Should Be Viewed as a Unit”
AICPA Accounting Research Bulletin No. 51, Consolidated Financial
Statements
AICPA Audit and Accounting Guide, Audits of Investment Companies
1
Issue 00-4 was previously titled “Majority Owner’s Accounting for the Minority Interest in a Subsidiary and a Derivative,” and later “Majority Owner’s Accounting for a Transaction in the Shares of a Consolidated Subsidiary and a Derivative Indexed to the Minority Interest in That Subsidiary,” and is a subset of Issue No. 00-6, “Accounting for Freestanding Derivative Financial Instruments Indexed to, and Potentially Settled in, the Stock of a Consolidated Subsidiary.”
ISSUE
1. A controlling majority owner (parent) holds 80 percent of a subsidiary’s equity shares. The remaining 20 percent (the noncontrolling interest) is owned by an unrelated entity (the noncontrolling interest holder). Simultaneous with the acquisition of the noncontrolling interest, the noncontrolling interest holder and the parent enter into a derivative contract that is indexed to the subsidiary’s equity shares. The terms of the derivative contract may be any of the following:
Derivative 1—The parent has a fixed-price forward contract to buy the other 20
percent at a stated future date
Derivative 2—The parent has a call option to buy the other 20 percent at a fixed
price at a stated future date, and the noncontrolling interest holder has a put option to sell the other 20 percent to the parent under those same terms, that is, the fixed price of the call is equal to the fixed price of the put option
Derivative 3—The parent and the noncontrolling interest holder enter into a “total
return swap.” The parent will pay to the counterparty (initially the noncontrolling interest holder) an amount computed based on the London Interbank Offered Rate (LIBOR), plus an agreed spread, plus, at the termination date, any net depreciation of the fair value of the 20 percent interest since inception of the swap. The counterparty will pay to the parent an amount equal to dividends paid on the 20 percent interest and, at the termination date, any net appreciation of the fair value of the 20 percent interest since inception of the swap. At the termination date, the net change in the fair value of the 20 percent interest may be determined through an appraisal or the sale of the stock.
[Note: See STATUS section.] 2. The issues are:
Issue 1(a)—How an enterprise that owns a controlling majority ownership interest (80 percent) in a business and separately enters into a derivative transaction with
the owner of the other 20 percent at the same time the noncontrolling owner purchases its interest should account for that arrangement
Issue 1(b)—How an enterprise that acquires a controlling majority ownership interest (80 percent) in a business and separately enters into a derivative transaction with the seller (owner of the other 20 percent) at the same time the parent purchases its interest should account for that arrangement
Issue 2—How an enterprise that sells a 20 percent noncontrolling interest of a 100 percent owned subsidiary to a third party and simultaneously enters into, with that same party, a derivative transaction of the nature described above should account for that arrangement. [Note: See STATUS section.]
EITF DISCUSSION
3. The Task Force observed that the scope of this Issue is limited to circumstances in which the parent owns a majority of the subsidiary’s outstanding common stock and consolidates that subsidiary at inception of the derivative contract. [Note: See STATUS section.] The Task Force also observed that this Issue is limited to the specific derivatives described in this Issue.
4. The Task Force reached a consensus that for Derivatives 1 and 2 under Issues 1(a), 1(b), and 2, the forward or combination of option contracts should be viewed on a combined basis with the noncontrolling interest and accounted for as a financing of the parent’s purchase of the noncontrolling interest. [Note: See STATUS section.] Under that approach, the parent would consolidate 100 percent of the subsidiary and would
attribute the stated yield earned under the combined derivative and noncontrolling interest position to interest expense (that is, the financing would be accreted to the strike price of the forward or option over the period until settlement). [Note: See STATUS section.] Further, for Issue 2, no gain or loss would be recognized on the “sale” of the noncontrolling interest by the parent to the noncontrolling interest holder at the inception of the contract. The Task Force also reached a consensus that the same accounting should apply to Derivative 2 even if the exercise prices of the put and call options are not equal, as long as those exercise prices are not significantly different. [Note: See STATUS section.]
5. The Task Force also reached a consensus that Derivative 3 should be viewed on a combined basis with the noncontrolling interest and accounted for as a financing of the parent’s purchase or retention of the noncontrolling interest. Under that approach, the parent consolidates 100 percent of the subsidiary and attributes the stated yield earned under the combined derivative and noncontrolling interest position to interest expense. Further, for Issue 2, no gain is recognized on the “sale” of the noncontrolling interest by the parent to the noncontrolling interest holder at the inception of the contract. [Note: See STATUS section.]
6. Task Force members observed that under each of the issues and derivatives in this Issue, the risks and rewards of owning the noncontrolling interest have been retained by the parent during the period of the derivative, notwithstanding the legal ownership of the noncontrolling interest by the counterparty. The EITF concluded in these specific circumstances that combining the two transactions clearly reflected the substance of the transactions; that the counterparty is financing the noncontrolling interest. Therefore, the
derivative instrument should be combined with the noncontrolling interest and accounted for as a financing. [Note: See STATUS section.] Upon such combination, the resulting instrument is not a derivative subject to Statement 133. The Task Force noted that the Derivatives Implementation Group reached a similar conclusion to account for two transactions as one in Implementation Issue K-1 based on the following criteria:
a. The transactions were entered into contemporaneously and in contemplation of one another,
b. The transactions were executed with the same counterparty (or structured through an intermediary),
c. The transactions relate to the same risk, and
d. There is no apparent economic need nor substantive business purpose for structuring the transactions separately that could not also have been accomplished in a single transaction.
7. Examples of the accounting for a total return swap in circumstances in which (a) the swap expires and the parent acquires the noncontrolling interest, (b) the swap is replaced with a new swap with the same terms, and (c) the swap expires without replacement are included in Exhibit 00-4A. [Note: See STATUS section.]
8. The consensuses in this Issue should be applied to transactions entered into after July 20, 2000.
STATUS
9. Interpretation 45, which was issued in November 2002, requires a guarantor to recognize, at inception of the guarantee, a liability for the obligation undertaken in issuing the guarantee. The Interpretation also elaborates on the disclosures to be made by a guarantor.
10. Interpretation 46(R), as amended by Statement 167, addresses consolidation by business enterprises of variable interest entities, which include corporations that are thinly capitalized or in which shareholders lack certain rights and obligations traditionally associated with corporate shareholders. That Interpretation requires a variable interest entity to be consolidated by an enterprise if that enterprise has a variable interest (or a combination of variable interests) that provides the enterprise with a controlling financial interest. Paragraphs 14–14G of Interpretation 46(R), as amended by Statement 167, provide guidance on determining whether an enterprise has a controlling financial interest in a variable interest entity.
11. Interpretation 46 was issued in January 2003. The consolidation requirements of Interpretation 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established.
12. FSP FIN46-6 deferred the effective date for applying the provisions of Interpretation 46 for:
a. Interests held by a public entity in variable interest entities created before February 1, 2003, if the public entity has not issued financial statements reporting that interest in accordance with Interpretation 46. The application of Interpretation 46 to those interests is deferred until the end of the first period ending after December 15, 2003.
b. Nonregistered investment companies accounting for their investments in accordance with the specialized accounting guidance in the investment company Guide.
13. Interpretation 46(R) was issued on December 24, 2003, and replaced Interpretation 46. An enterprise with an interest in an entity to which the provisions of Interpretation 46 were not applied as of December 24, 2003, must apply the effective date and transitions provisions in Interpretation 46(R) to that entity. Application by public companies of Interpretation 46 or Interpretation 46(R) to entities commonly referred to as special-purpose entities is required no later than as of the end of the first reporting period that ends after December 15, 2003. Public enterprises must apply Interpretation 46(R) to all entities no later than the end of the first reporting period that ends after March 15, 2004 (public enterprises other than small business issuers) or December 15, 2004 (small business issuers). Nonpublic enterprises must apply Interpretation 46(R) to entities created after December 31, 2003, immediately and to all other entities by the beginning of the first annual period beginning after December 15, 2004. An enterprise that has applied Interpretation 46 to an entity prior to the effective date of Interpretation 46(R) shall either continue to apply Interpretation 46 until the effective date of Interpretation 46(R) or apply Interpretation 46(R) at an earlier date.
14. Statement 167 was issued in June 2009 and amends Interpretation 46(R). Statement 167 shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited.
15. Statement 150 was issued in May 2003 and is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the interim period beginning after June 15, 2003, except for mandatorily redeemable
financial instruments of a nonpublic entity. Statement 150 establishes standards for issuer’s classification and measurement of certain financial instruments with characteristics of both liabilities and equity and requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances).
16. Under Statement 150, Derivatives 1, 2, and 3 are accounted for as follows:
Derivative 1—The forward purchase contract that requires physical settlement by
repurchase of a fixed number of shares (the noncontrolling interest) in exchange for cash is recognized as a liability, initially measured at the present value of the contract amount; the noncontrolling interest is correspondingly reduced. Subsequently, accrual to the contract amount and any amounts paid or to be paid to holders of those contracts are reflected as interest cost. The accounting required for this forward purchase contract under Statement 150 is similar to the combined accounting required under the consensus in this Issue, that is, the parent accounts for the transaction as a financing of the noncontrolling interest and, consequently, consolidates 100 percent of the subsidiary.
Derivative 2—Depending on how the derivative was issued, one of three different
accounting methods applies. If Derivative 2 was issued as a single freestanding instrument, under Statement 150 it is accounted for in its entirety as a liability (or an asset in some circumstances), initially and subsequently measured at fair value. If the written put option and the purchased call option in Derivative 2 were issued as freestanding instruments, the written put option is accounted for under Statement 150 as a liability measured at fair value, and the purchased call option
would be accounted for under Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock,” and Issue No. 08-8, “Accounting for an Instrument (or an Embedded Feature) with a Settlement Amount That Is Based on the Stock of an Entity’s Consolidated Subsidiary.” Under both of those situations, the noncontrolling interest is accounted for separately from the derivatives under applicable guidance. However, if the written put option and purchased call option are embedded in the shares (noncontrolling interest) and the shares are not mandatorily redeemable, the freestanding instrument is not in the scope of Statement 150 and continues to be accounted for under this Issue with the parent consolidating 100 percent of the subsidiary.
Derivative 3—The total return swap is indexed to an obligation to repurchase the
issuer’s shares and may require the issuer to settle the obligation by transferring assets. Therefore it is in the scope of Statement 150 and is required to be accounted for as a liability (or asset in some circumstances), initially, and subsequently measured at fair value. The noncontrolling interest is accounted for separately from the total return swap.
17. In applying paragraphs 9–12 of Statement 150 to determine classification, a freestanding financial instrument within its scope is precluded from being combined with another freestanding financial instrument, unless combination is required under the provisions of Statement 133 and its related guidance; therefore, unless under the particular facts and circumstances Statement 133 and its related guidance provide
otherwise, freestanding derivatives in the scope of Statement 150 would not be combined with the noncontrolling interest.
18. Statement 150 nullifies the consensuses reached in this Issue unless the derivative in Derivative 2 is not freestanding of the noncontrolling interest.
19. Statement 160 was issued in December 2007. It amends ARB 51 to establish accounting and reporting standards for noncontrolling interests in subsidiaries. Other than changing the term minority interest to noncontrolling interest, it does not affect the consensus guidance reached in this Issue.
Exhibit 00-4A
EXAMPLE ILLUSTRATING THE APPLICATION OF THE EITF CONSENSUSES ON ISSUE 00-4 TO A TOTAL RETURN SWAP
A corporation (Parent) acquires 80 percent (800,000 shares) of the common shares of another corporation (Subsidiary) for $80 million. Simultaneously, an investment bank (Bank) acquires 20 percent (200,000 shares) of the common shares of Subsidiary for $20 million. Parent and Bank enter into a total return swap indexed to 200,000 shares of Subsidiary common stock for no consideration. The total return swap and Bank’s acquisition of the equity in Subsidiary are not contractually linked. That is, the total return swap does not require Bank to acquire the 20 percent interest in Subsidiary. The specific terms of the total return swap are as follows:
a. The underlying equity is an amount equal to 200,000 shares of Subsidiary’s outstanding common shares.
b. The notional amount of the total return swap is an amount equal to the market value of the underlying equity at the commencement of the equity swap transaction, or $20 million.
c. The term of the total return swap is two years.
d. During the term of the total return swap, Parent pays to Bank amounts equivalent to interest (8.5 percent, which is LIBOR plus 2 percent) on the notional amount.
e. During the term of the total return swap, Bank pays to Parent amounts equivalent to dividends paid on the underlying equity (in this example, Subsidiary pays no dividends).
f. At the end of the total return swap term, the market value of the underlying equity as of the termination date (“the Final Price”) is determined and:
1. If the Final Price is greater than the notional amount, Bank pays the excess to Parent, and
2. If the Final Price is less than the notional amount, Parent pays the shortfall to Bank.
g. Parent has a right to terminate the total return swap prior to maturity.
h. The total return swap is a cash settled derivative transaction. It does not provide for physical settlement and neither party has any right, power, or option to have the total return swap physically settled.
i. Parent has no right or obligation to acquire the underlying equity owned by Bank, and Bank has no right or obligation to sell the underlying equity to Parent.
1. If there is a sale of the underlying equity at or about the termination of the total return swap, the Final Price will be the sale price of the underlying equity. To ensure that the sale of the underlying equity is at market price, Bank will inform potentially interested parties (including, but not limited to, Parent)of Bank’s intention to sell the underlying equity and then sell the underlying equity to the highest bidder.
2. If there is no sale of the underlying equity at the termination of the total return swap but, at or about the termination of the total return swap, Bank enters into another total return swap (whether with Parent or a third party) for the underlying equity, the Final Price will be the notional amount for the new total return swap. Bank has sole discretion as to whether to enter into another total return swap. This method of determining the Final Price will apply only if Bank informs potentially interested parties (including, but not limited to, Parent) that Bank intends to enter into a total return swap transaction for the underlying equity and then give due consideration to any offer made by a prospective equity swap counterparty. Bank will then (subject to credit and market risk issues) enter into the total return swap with the party that makes the highest offer; or
3. If neither (1) nor (2), above, occurs, the Final Price will be determined by reference to a valuation by an independent valuation expert.
Parent would record the transaction as follows:
To record the acquisition of 100 percent of Subsidiary and the financing of 20 percent of that acquisition:
Investment in subsidiary $100,000,000
Cash $80,000,000
Debt 20,000,000
To record interest payments under the equity derivative during the two year contract period (this example assumes that interest is paid at expiration of the contract):
Interest expense $3,400,000
Debt $3,400,000
1. Parent acquires the noncontrolling interest at settlement for $22 million.2
Debt $23,400,000
Cash $23,400,000
2. Parent renews the swap at the same notional amount.
In this scenario, the $20 million in debt remains outstanding and parent pays the accrued but unpaid interest on the debt.
Debt $3,400,000
Cash $3,400,000
3. The swap expires without renewal and Bank either retains the noncontrolling interest or sells the noncontrolling interest to a third party.
If the total return swap expires without renewal and without Parent’s acquisition of the noncontrolling interest from Bank, then Parent is deemed to have sold the 20 percent noncontrolling interest at the date the swap expires. The sale price of the subsidiary shares equals the accreted value of the debt. Assume for purposes of this example that subsidiary recognized $5 million in after-tax income during the contract period and, therefore, Parent’s carrying amount of the shares sold is $21 million [($100,000,000 + $5,000,000) × 20%]. Also assume that the fair value of the 20 percent interest in the subsidiary was determined, pursuant to the terms of the contract, to be $22 million. Therefore, in addition to the interest payments required to be made by Parent under the contract ($3.4 million), Parent is entitled to receive $2 million as a result of the increase in the fair value of the 20 percent interest in its subsidiary. Accordingly, Parent must pay Bank $1.4 million to settle the total return swap.
2
Although the acquisition of the noncontrolling interest by Parent upon termination of the equity swap is assumed for purposes of this example, as indicated by the terms of the agreement, a third party could have acquired the noncontrolling interest. The amount paid by Parent for the noncontrolling interest in excess of $20 million would be returned to Parent at the termination of the equity swap. Accordingly, regardless of how much Parent bids for the noncontrolling interest, its net payment for the noncontrolling interest after settlement of the equity swap would be $20 million (plus any interest payable on the swap). As an example, assume that the equity swap is terminated on the maturity date (that is, 2 years after initiation) and that, after the competitive bidding process described in paragraph (j)(1), above, the underlying equity is sold by Bank to Parent for $22 million (the Final Price). As a result, the following cash payments would be made pursuant to the equity swap:
$ 3,400,000 Interest payments (paid by Parent to Bank)
22,000,000 "Acquisition" of noncontrolling interest (paid by Parent to Bank)
(2,000,000) Settlement of equity swap (Bank pays to Parent the excess of the $22 million fair value over the $20 million notional amount)
$23,400,000 Net payment by Parent to Bank to “acquire” noncontrolling interest and settle equity swap.
Debt $23,400,000
Cash $ 1,400,000
Noncontrolling interest 21,000,000
Suggested Index Entries for EITF Issue No. 00-4, “Majority Owner’s Accounting for the Minority Interest in a Subsidiary and a Derivative”
CONSOLIDATION
Majority Owner’s Accounting for the Minority
Interest in a Subsidiary and a Derivative 00-4 DERIVATIVE FINANCIAL INSTRUMENTS
Majority Owner’s Accounting for the Minority
Interest in a Subsidiary and a Derivative 00-4 FORWARD COMMITMENTS
Majority Owner’s Accounting for the Minority
Interest in a Subsidiary and a Derivative 00-4 MINORITY INTERESTS
Majority Owner’s Accounting for the Minority
Interest in a Subsidiary and a Derivative 00-4 OPTIONS
Majority Owner’s Accounting for the Minority
Interest in a Subsidiary and a Derivative 00-4 PUT OPTIONS
Majority Owner’s Accounting for the Minority