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New
Reporting Standards for Noncontrolling Interests
Benefits Include Greater Comparability and
Conceptual Consistency
By Vincent C. Brenner, Vincent C. Brenner, Jr.,
and Monica Jeancola
JULY 2008 - FASB
and the International Accounting Standards Board (IASB) have been
working together to promote international convergence of accounting
standards. In 2001, FASB’s Statement of Financial Accounting
Standards (SFAS) 141, Business Combinations, changed the
method of accounting for business acquisitions by adopting the acquisition
(purchase) method and eliminating the pooling of interests as an
alternative. In specific areas in accounting for business acquisitions,
however, convergence was not achieved. As a result, in December
2007 FASB issued a revised standard, SFAS 141(R), Business Combinations,
and SFAS 160, Noncontrolling Interests in Consolidated Financial
Statements. The new standards significantly affect how consolidated
financial statements are prepared when a noncontrolling interest
is present. CPAs
should be acquainted with the differences in accounting for the
consolidation of an acquisition of a less-than-100%-ownership
interest in a subsidiary under SFASs 141 and 141(R). An example
of accounting for a typical business combination transaction is
discussed below, along with SFAS 160 and its additional required
disclosures related to noncontrolling interests. Other important
issues that the revised standards raise, such as contingent consideration,
bargain purchases, and transition issues, are beyond the scope
of this article, but readers should acquaint themselves with those
issues, nonetheless.
Reporting
Partial Ownership Under the Acquisition Method
When a company
acquires all of the equity of another company, it records all
of the assets and liabilities at their full fair value. An issue
arises when less than 100% ownership is acquired. Basically, three
views have existed regarding how the acquired company could be
recognized:
- Economic
unit view. Under this approach, the business entity acquired
is viewed as a total, indivisible entity, and 100% of its assets,
liabilities, and income are reported in consolidated statements.
Assets and liabilities are reported at their fair value on the
date of acquisition. The noncontrolling interest’s share
of these is also separately reported in the financial statements.
- Proportional
view. This approach views the acquired entity as divisible,
and only the percentage of equity acquired is used to recognize
the portion of assets, liabilities, and income to be reported.
Thus, if 90% of the equity was acquired, only 90% of assets,
liabilities, and income would be reported. Under this approach,
the noncontrolling interest’s share of the entity does
not need to be reported, because none of its share (e.g., of
assets or liabilities) is recognized.
- Parent
company view. Under this approach, all of the acquired
company’s assets, liabilities, and income are reported.
However, adjustments to fair value are made only for the portion
acquired by the parent. Noncontrolling interest is reported
at book value, with no adjustments to market value.
Exhibit
1 summarizes the reporting under the three methods. From a
conceptual standpoint, the economic unit and proportional views
are more logically consistent than the parent company view. In
addition, they are consistent throughout the reporting process.
The economic view reports all assets and liabilities at their
full fair value, reports the noncontrolling interest at fair value,
and records any additional depreciation or amortization based
on full fair value. The proportional method reports the percentage
ownership of assets and liabilities at fair value, including adjustments
for depreciation and amortization. Under this method, a noncontrolling
interest is not reported.
The parent
company view is not conceptually consistent. The approach reports
all of the asset and liability book values, but makes market adjustments
only for the portion acquired by the parent; none are made for
the noncontrolling interest’s share. This partial adjustment
is also reflected in the recognition of additional depreciation
and amortization. The noncontrolling interest’s share is
reported at book value, not fair value.
Existing
GAAP
Current GAAP
calls for the parent company method, which has been used for many
years and was continued under SFAS 141. SFAS 141(R) will eliminate
the parent company approach and adopt the economic unit method.
When consolidated
financial statements are to be prepared, a consolidation worksheet
is used to adjust the amounts reported on the parent’s and
subsidiary’s books to reflect the appropriate amounts for
the consolidated statements. These worksheet entries eliminate
the parent’s investment account against the subsidiary’s
equity accounts (to eliminate double-counting), recognize unrecorded
assets, and revalue the subsidiary’s assets and liabilities
to fair value. Exhibit
2 presents comparable consolidation worksheet entries under
SFASs 141 and 141(R). The illustration assumes that the parent,
in its books, records its investment account under the equity
method.
The first
entry eliminates the subsidiary’s beginning retained earnings
and other equity account balances against the parent’s investment
account (for its share), and it establishes a noncontrolling interest
account for the remainder. The consolidated statements will reflect
the subsidiary’s assets and liabilities, which are also
reflected in the parent’s investment account. Eliminating
the investment account eliminates the double-counting. This entry
is the same in the revised standard.
The second
entry recognizes the subsidiary’s unrecorded assets and
liabilities, revalues items to fair value, and recognizes any
goodwill. Under SFAS 141, asset and liability values are adjusted
to fair value only for the parent’s percentage of ownership.
These values are also used to recognize goodwill, which means
that total goodwill is not recognized. Under the revised standard,
adjustments to fair value are for the full amount, including the
portion belonging to the noncontrolling interest. The full amount
of subsidiary goodwill is also recognized.
The third
entry adjusts the subsidiary’s depreciation and amortization
to reflect the new asset and liability values. Under SFAS 141,
this is for the revaluation based on only the parent’s share
of ownership, while SFAS 141(R) recognizes additional expense
based on full revaluation to fair value.
Next, the
revised subsidiary net income (after the additional depreciation
from the third entry) is offset against the parent’s investment
account and the noncontrolling interest account for their respective
shares. This entry eliminates double-counting of the subsidiary’s
income because the consolidated statements will contain the subsidiary’s
revenues and expenses. The amounts eliminated under the SFAS 141
and 141 (R) differ because the revised standard recognizes full
fair value revaluations and related depreciation, not just the
parent’s share of them.
Finally,
the subsidiary’s dividends, if any, are eliminated against
both the parent’s investment account and the noncontrolling
interest accounts for their respective ownership amounts. The
consolidated statements should reflect only the parent’s
dividends. This entry will be the same under both approaches.
Example
Assume the
following information regarding the subsidiary as of the date
of acquisition, January 1, 2XXX:
| |
Book
value |
Fair
value |
Difference |
| Nondepreciable
assets |
$300,000 |
$370,000 |
$ 70,000 |
| Depreciable
assets |
$600,000 |
$800,000 |
$ 200,000 |
| Liabilities |
$100,000 |
$100,000 |
|
| Common
stock, no par |
|
$700,000 |
|
| Retained
earnings |
|
$100,000 |
|
Additional
assumptions:
- The difference
in valuation of nondepreciable assets is due to the fair value
of land exceeding its book value.
- Depreciable
assets have an average remaining life of 10 years.
- The subsidiary’s
net income for the year was $80,000, and it paid dividends of
$10,000.
- The parent
purchased 80% of the subsidiary for $950,000, and there were
no unrecorded assets or liabilities.
- The market
value of net identifiable assets on the acquisition date is
$1,187,500.
Goodwill
to be recognized. Goodwill is the excess of the
purchase price over the fair value of identifiable net assets.
Under SFAS 141, the fair value is considered to be only the parent’s
share; under SFAS 141(R), the full fair value is recognized. Note
that SFAS 141(R) makes some exceptions to fair value. These exceptions
relate to areas where other standards require a different valuation.
These areas are: 1) assets held for sale, 2) deferred tax assets
and liabilities, 3) operating leases, and 4) employee benefit
plans. As a result, the SFAS 141(R) total valuation may not equal
the total value implied by the parent’s purchase price.
Given the
illustration data and assumptions from above,
the calculation of goodwill under SFASs 141 and 141(R) is as follows:
SFAS
141
Parent’s
purchase price $
950,000
Book value of equity acquired:
80% of common stock + retained earnings
=
80% of ($700,000 + $100,000) $
640,000
Excess
$
310,000
Adjust assets
to fair value for parent’s share:
Nondepreciable:
80% of $70,000 = $ 56,000
Depreciable: 80% of $200,000 = $160,000
$ 216,000
Goodwill
$ 94,000
SFAS
141(R)
Fair value
of total net assets acquired
$1,187,500
Fair value of subsidiary’s identifiable net assets:
(assets – liabilities)
$370,000 + $800,000 – $100,000 $1,070,000
Goodwill $
117,500
In this example,
asset and liability valuations are greater under SFAS 141(R) because
they reflect full fair value, which also results in recognition
of the full amount of goodwill.
Under SFAS
141(R), the amount of goodwill must then be allocated to the controlling
and noncontrolling interests. The allocation process first assigns
the parent its goodwill, and any remaining amount is attributed
to the noncontrolling interest:
Fair value
of parent’s 80% interest (purchase price) $950,000
Less: Parent’s
share of fair value of identifiable
net assets 80% of $1,070,000
$856,000
Parent’s share of goodwill
$ 94,000
Total goodwill $117,500
Less: Parent’s share $
94,000
Noncontrolling interest’s share $
23,500
Elimination
Entries
Exhibit
3 illustrates the consolidation worksheet elimination entries
under the existing and the revised standards. The first entry
eliminates the subsidiary’s beginning equity against the
parent’s investment account and establishes the noncontrolling
interest account. This entry is the same under both standards.
The second
entry under SFAS 141 revalues the assets for the parent’s
share of the difference between book value and fair value and
also recognizes the goodwill calculated above. The second entry
under SFAS 141(R) revalues the assets for the full difference
between book value and fair value and also recognizes the entity’s
full goodwill.
The third
entry records additional subsidiary depreciation based on depreciable
asset revaluations: SFAS 141 ($160,000) and SFAS 141(R) ($200,000).
These additional amounts are depreciated over the 10-year average
remaining life of the assets.
The fourth
entry eliminates the subsidiary’s adjusted net income against
the parent’s investment account and the noncontrolling interest
account in their respective share. Because only the parent’s
share of the difference between book value and fair value is recognized
under SFAS 141, the parent’s share of income is adjusted
for additional depreciation, but the noncontrolling interest’s
share is not adjusted. The parent’s share is 80% of the
$80,000 reported subsidiary income, less the $16,000 additional
depreciation. The noncontrolling interest’s share is its
percentage of the subsidiary’s reported income, without
adjustments for additional depreciation. Under SFAS 141(R), the
full asset adjustment is made, resulting in additional depreciation
of $20,000, and the adjusted net income of $60,000 ($80,000 –
$20,000) is offset against the parent’s investment and the
noncontrolling interest for their respective ownership percentages.
The last
entry eliminates the subsidiary’s declared dividends of
$10,000 against the parent’s investment account and the
noncontrolling interest account for their respective shares.
Noncontrolling
Interest
After the
adjustments and eliminations, the noncontrolling interest under
the two standards is shown in Exhibit
4.
The amount
is larger under SFAS 141(R) because it includes full fair value
adjustments. The difference between the two ($73,500) is equal
to the noncontrolling interest’s share of the asset revaluation
($77,500), less its share of the additional depreciation [($200,000
÷ 10 years) x 20% = $4,000]. The total amounts involved
and the distribution between parent and noncontrolling interests
are summarized in Exhibit
5.
Under the
new standards, the noncontrolling interest must now be reported
as part of equity rather than in the mezzanine between liabilities
and equity. It is shown as the last item in the equity section.
Disclosure
Requirements
SFAS 160
requires the following additional disclosures:
- In the
financial statements, the portion of consolidated net income
and comprehensive income attributable to both the parent and
the noncontrolling interest.
- The amounts
attributable to the noncontrolling interest for each of the
following, if relevant—
- income
from continuing operations;
- discontinued
operations;
- n
extraordinary items; and
- n
components of other comprehensive income.
- A reconciliation
of the annual change in reported amounts of noncontrolling interest,
including separate disclosure of the following—
- consolidated
net income attributable to noncontrolling interest;
- investments
by and distributions to noncontrolling interest; and
- each
component of comprehensive income.
- A footnote
schedule showing the effects of transactions with the noncontrolling
interest on the equity attributable to the noncontrolling interest.
The standards
will generally be applied retrospectively, including the disclosure
requirements.
Benefits
of the New Method and Approach
SFAS 141(R),
effective for periods beginning on or after December 15, 2008,
represents a conceptually more consistent method of consolidation
and improves financial reporting by reflecting the economic unit
concept. The method reflects FASB’s recent emphasis on the
balance sheet rather than its traditional emphasis on the income
statement. The new method recognizes all assets and liabilities
of the acquired company and values them at full fair value. Generally,
this will result in higher consolidated assets and noncontrolling
interests. The new approach will better reflect the investment
made by the parent, enhance financial statement comparability
between companies, and provide more complete and relevant financial
information. SFAS 160, also effective for periods beginning on
or after December 15, 2008, specifies that noncontrolling interests
are to be reported as part of equity and also provides enhanced
related disclosures.
Vincent
C. Brenner, PhD, CPA, is the Beights Professor of Accounting
at Stetson University, DeLand, Fla.
Vincent C. Brenner, Jr., CPA, is managing partner
of Breakwater Consulting, North Palm Beach, Fla.
Monica Jeancola, CPA, is an instructor, also at Stetson
University.
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