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3.18 Consolidation during bankruptcy
Publication date: 28 Feb 2023
us Bankruptcy & liquidation guide
The filing of the bankruptcy petition by one or more companies within a consolidated group gives rise to consolidation issues depending on which companies are included in the filing. It is important to understand the legal entities and subsidiaries that are included in a Chapter 11 filing. In some cases, only certain subsidiaries, but not the parent, are included in the filing. In other cases, some subsidiaries are excluded from a parent's Chapter 11 filing. The specific provisions of ASC 852 apply only to bankrupt entities. Some of the more common scenarios are presented below.
3.18.1 Bankrupt subsidiary and nonbankrupt parent
Under ASC 810-10-15, consolidation of a majority-owned subsidiary is precluded where control does not rest with the majority owners—for instance, where the subsidiary is in legal reorganization or bankruptcy. Accordingly, when a subsidiary files for bankruptcy, it is usually appropriate for a solvent parent to deconsolidate the subsidiary. Under ASC 810, this loss of control would likely trigger a gain or loss for the parent as the parent would remeasure its retained noncontrolling investment at fair value. The parent should consider whether it needs to separately recognize any obligations related to its ownership of the subsidiary, which may reduce the gain or increase the loss upon deconsolidation. Examples of such obligations might include the parent's guarantees of subsidiary debt or other obligations for which the Court might hold the parent responsible. A parent that has lost control and deconsolidated a bankrupt subsidiary for which the parents provides a guarantee of the subsidiary's debt should recognize a liability under the guidance in ASC 460, Guarantees, for the fair value of the guarantee. In the unusual circumstance when a parent has not lost control of its bankrupt subsidiary, the recognition of a guarantee liability would not be appropriate.
Question BLG 3-8
When should a parent company, which is not in bankruptcy, deconsolidate a subsidiary that has filed for bankruptcy?
When should a parent company, which is not in bankruptcy, deconsolidate a subsidiary that has filed for bankruptcy?
PwC response
A parent deconsolidates a subsidiary as of the date the parent no longer has control of the subsidiary. Examples of events that result in deconsolidation of a subsidiary include when a subsidiary becomes subject to the control of a government, court, administrator, or regulator. Normally, once a subsidiary files for bankruptcy protection, a parent no longer has control over the subsidiary (as the Court must approve all significant actions), and the subsidiary should be deconsolidated on that date. See BCG 1.1 for discussion on the definition of control.
Question BLG 3-9
Should a parent company, which is not in bankruptcy and has a negative investment in a subsidiary, recognize a gain upon the subsidiary's filing for bankruptcy?
Should a parent company, which is not in bankruptcy and has a negative investment in a subsidiary, recognize a gain upon the subsidiary's filing for bankruptcy?
PwC response
Following the guidance in ASC 810-10, a parent would derecognize the negative investment and determine the amount of gain or loss to recognize on the date of the bankruptcy filing. The parent should consider the fair value of its retained investment when making this determination. This includes consideration of whether it needs to separately recognize any obligations related to its ownership of the subsidiary, which would reduce the gain or increase the loss on deconsolidation (e.g., the parent has guaranteed, or the Court will hold the parent liable for, certain obligations of the subsidiary).
Upon deconsolidation, the equity method in ASC 323 usually should not be used to account for a majority-owned subsidiary that is not consolidated because, as a result of bankruptcy, the parent usually does not have significant influence over the investee. Some of the factors to consider in determining if the parent should apply the equity method include whether (1) the parent company operates the subsidiary as a debtor-in-possession, (2) other factors indicate that the creditors and other beneficiaries (e.g., litigants) will be made whole in the bankruptcy proceeding (i.e., there are no substantive adverse parties), (3) the facts indicate that the subsidiary will be in bankruptcy for a relatively short period of time, and (4) the bankruptcy filing is being used by the parent company to accomplish certain narrow objectives (such as the rejection of selected leases).
Accordingly, assuming the reporting entity is precluded from applying ASC 810 or ASC 323, it should account for its equity investments in accordance with ASC 321, Investments–Equity Securities, which generally requires equity investments to be measured at fair value with changes in fair value recorded in current earnings. However, entities may elect a measurement alternative per ASC 321-10-35-2 if the equity investment does not have a readily determinable fair value and does not qualify for the practical expedient to estimate fair value in accordance with ASC 820-10-35-59. The measurement alternative initially measures a reporting entity’s investment at cost. The investment is remeasured to fair value if impaired or upon an observable price change that results from an orderly transaction of an identical or similar investment from the same issuer.
A reporting entity should make an election to use the measurement alternative for each investment separately and reassess at each reporting period whether the equity investment continues to qualify to be measured in accordance with ASC 321-10-35-2. See LI 2.3 for additional discussion of the accounting for equity investments.
When a nonbankrupt parent deconsolidates a bankrupt subsidiary, the parent should consider whether the historical operating results of that subsidiary should be reported as discontinued operations following the criteria in ASC 205 and ASC 360. If the parent concludes at the time of deconsolidation that the former subsidiary does not qualify for discontinued operations, the subsequent disposition of an investment accounted for in accordance with ASC 321-10-35-2 would not be eligible for discontinued operations treatment.
Question BLG 3-10
Should a nonbankrupt parent continue to consolidate a variable interest entity (VIE) which has filed for bankruptcy?
Should a nonbankrupt parent continue to consolidate a variable interest entity (VIE) which has filed for bankruptcy?
PwC response
When a nonbankrupt parent consolidates a VIE prior to the VIE's filing for bankruptcy, the parent should consider whether it is still the primary beneficiary of the VIE after the VIE files for bankruptcy. Generally, the parent would no longer be able to assert that it has the power to direct the activities of the VIE that most significantly impact the VIE's economic performance. Such power typically resides with the Court once the VIE has filed for bankruptcy.
3.18.2 Bankrupt parent and nonbankrupt subsidiary
A bankrupt parent should continue to consolidate its nonbankrupt subsidiary because the parent continues to control the subsidiary, notwithstanding the fact that the parent is controlled by the Court.
3.18.3 Bankrupt parent and bankrupt subsidiary
The treatment when both the parent and any subsidiaries are in bankruptcy depends on how the bankruptcy case is treated by the Court. In some cases, a bankrupt parent effectively retains control of a bankrupt subsidiary because they are under the same Court jurisdiction and will be viewed as a group during the bankruptcy process (the group's assets will be used to settle the claims of the group's creditors). Therefore, in the eyes of the Court and the creditors, the bankrupt parent and subsidiary are viewed as one entity and continued consolidation may be appropriate.
In other situations, even though both the parent and subsidiary are under the jurisdiction of the same Court which will administer the bankruptcy on a joint basis, the Court may respect the individual entity claims and assets available to satisfy those claims. In these instances, the parent and subsidiary would be described more accurately as under the supervision of the Court. In this situation, the presentation of combined, as opposed to consolidated, financial statements may be more appropriate.
Finally, if the bankrupt parent and bankrupt subsidiary are in different legal jurisdictions, continued consolidation or combined presentation would generally not be appropriate.
3.18.4 Reporting entity disclosure requirements during bankruptcy
When one or more entities in the consolidated group are in bankruptcy and one or more entities in the consolidated group are not in bankruptcy, the reporting entity is required under ASC 852-10-45-14 to disclose in its consolidated financial statements the condensed combined financial statements of only the entities in bankruptcy. Generally, these condensed combined financial statements are presented in a footnote disclosure. For example, if a parent company and two of its three subsidiaries have filed for bankruptcy, and one of the subsidiaries has not filed for bankruptcy, the parent company financial statements should separately include the condensed combined financial statements of only the entities in bankruptcy. If all entities in the consolidated group are in bankruptcy, the requirement to present the condensed combined financial statements is not applicable. Refer to BLG 7.3 for further discussion of these disclosure requirements.
3.18.5 Intercompany balances during bankruptcy
Intercompany balances may exist between affiliated entities in which only certain of the entities are included in a Chapter 11 filing. When outstanding balances of a parent or subsidiary represent a claim in bankruptcy against a debtor, they should be accounted for the same as claims with an unaffiliated third party.
In instances when a parent has lost control of a bankrupt subsidiary and the subsidiary has an intercompany payable to the former parent or another parent-controlled entity, the entity in bankruptcy should no longer recognize an intercompany payable on its books. Such amounts should be recorded as liabilities subject to compromise at the expected amount of the allowed claim in the same manner as amounts due to unaffiliated third party creditors.
In situations when a parent has lost control of a bankrupt subsidiary and that subsidiary has an intercompany receivable from its former parent or another parent-controlled entity, the entity in bankruptcy should no longer recognize an intercompany receivable on its books. Such amounts should be recorded as a receivable in accordance with ASC 310 as if they were owed from a third party.
3.18.6 Foreign currency during bankruptcy
When an entity in a consolidated group files for bankruptcy protection, it may deconsolidate or lose significant influence over an investment in a foreign entity. A foreign entity, as defined in ASC 830, Foreign Currency Matters, is a distinct and separable operation (for example, subsidiary, division, branch, joint venture) that is combined, consolidated, or accounted for using the equity method of accounting and has a functional currency other than the reporting entity’s reporting currency. See FX 8.5 for a discussion on the guidance to consider when accounting for the deconsolidation of a foreign entity and the recognition of any cumulative translation adjustment associated with such an event.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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