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6.4 Subsequent measurement of NCI
Publication date: 30 Sep 2022
us Business combinations guide
Each reporting period, a reporting entity should attribute net income and comprehensive income of a consolidated subsidiary to the controlling interest and NCI, as described in BCG 6.4.1. If the NCI is classified as mezzanine equity, the reporting entity would have to consider additional requirements described in BCG 6.4.2.
6.4.1 Attribution of net income and comprehensive income
An NCI should be allocated its share of net income or loss, and its respective share of each component of other comprehensive income, in accordance with ASC 810-10-45-20. The presentation of allocated net income for an NCI is discussed in FSP 3.8.7. The presentation of other comprehensive income is discussed in FSP 4.4.1.
The accounting guidance does not specify a particular method for attributing earnings between the controlling interest and the NCI. However, the attribution method should be reasonable and appropriate given the circumstances (FAS 160.B39).
If there are contractual arrangements that determine the attribution of earnings, such as a profit sharing agreement, the attribution specified by the arrangement should be considered if it is substantive. For example, the parties may have a contractual arrangement specifying a 50/50 split of the earnings, in which case 50% of the earnings should be allocated to the controlling interest and 50% to the NCI. If there are no such contractual arrangements, the relative ownership interests in the entity should be used. For example, if the reporting entity has a 60% controlling interest of a subsidiary and the NCI has 40%, then 60% of the earnings should be allocated to the reporting entity and 40% to the NCI.
In some instances, agreements may designate splits that differ for purposes of (a) financial reporting, (b) tax, (c) ongoing distributions from operations, and (d) distributions upon liquidation. Furthermore, these splits may change with the passage of time or the occurrence of specified events. In such circumstances, it may be appropriate to apply the hypothetical liquidation at book value (HLBV) method of accounting described in EM 4.1.4 if the splits are considered substantive.
The allocation of income to noncontrolling interest in the form of preferred stock is discussed in FG 7.4.3.3.
6.4.1.1 Attribution of amounts in excess of the NCI balance
NCI is considered part of the equity of the consolidated group that participates in both the risk and rewards of ownership in a subsidiary. Accordingly, absent explicit agreements that designate a different allocation of losses, losses should continue to be attributed to the NCI even if it results in a debit balance in the NCI. Similarly, distributions in excess of the carrying amount of the NCI would also cause the NCI to have a debit balance.
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.
Example BCG 6-3 illustrates the attribution of amounts in excess of the NCI to the NCI.
EXAMPLE BCG 6-3
Attribution of amounts in excess of the NCI balance
Attribution of amounts in excess of the NCI balance
Company X has an 80% common stock controlling interest in Subsidiary A. Subsidiary A has a diverse real estate portfolio, with a carrying value of $100 million, that appreciated significantly since the subsidiary was acquired. Subsidiary A refinances the existing secured loan of $70 million with a new loan of $120 million. Total equity of Subsidiary A is $30 million, and NCI represents 20% or $6 million.
Upon refinancing, Subsidiary A generates excess cash of $50 million ($120 million - $70 million) which it distributes. NCI receives its proportional interest which is $10 million ($50 million x 20%).
Should the company adjust NCI to a debit balance?
Analysis
Yes. Distributions to NCI holders are charged against the NCI balance. The NCI should reflect a debit balance of $4 million ($6 million - $10 million) after the distribution.
6.4.1.2 Equity-classified instruments that are not shares
As noted in BCG 6.2.2, the NCI guidance applies to all equity-classified instruments, including those that are not outstanding shares.
Holders of these instruments generally do not directly participate in the profits or loss of the subsidiary. Accordingly, during the period prior to exercise or expiration, no portion of the subsidiary's profit or loss would be attributed to this component of NCI. BCG 5.4.1 and BCG 5.4.2 address the accounting upon exercise or expiration of these types of instruments.
6.4.1.3 Legacy acquisitions (prior to adoption of current guidance)
The guidance that was eventually codified in ASC 805 was adopted by calendar year end entities on January 1, 2009. For certain assets acquired under legacy acquisition guidance, amortization expense should not be attributed to the controlling interest and NCI in proportion to their interests.
Under pre-2009 guidance, only the portion of acquired assets that were attributable to the acquirer was “stepped-up” to a new basis. Accordingly, when a seller retained an interest in the acquired subsidiary, the new carrying basis of acquired assets and liabilities only partially reflected the acquisition date fair value (a “mixed-basis”). For example, if a reporting entity acquired 80% of a subsidiary in a single transaction, the intangible assets that it recognized in the acquisition would likely have been recorded at 80% of their fair value. This is because a carryover basis of zero would be used for the 20% interest not acquired, as the acquired intangible assets were previously not recognized. This issue is most pronounced with assets, such as intangibles, that may not have had any basis prior to the acquisition.
When allocating amortization expense for intangible assets that were previously unrecognized, the full amount should be allocated to the parent’s interest in accordance with FAS 160.B38. A reporting entity should apply the same guidance for other assets, such as buildings, that were acquired in a legacy acquisition and have a “mixed-basis.”
6.4.2 Subsequent accounting for a mezzanine classified NCI
The subsequent accounting for mezzanine classified NCI depends on several factors, including whether the NCI is currently redeemable.
If the mezzanine classified NCI is currently redeemable, the NCI carrying amount should be adjusted to its maximum redemption amount as of the balance sheet based on the guidance in ASC 480-10-S99-3A(15) and FG 7.4.3.2 (subject to the discussion in BCG 6.4.2.1 on limitations of reversals of mezzanine adjustments).
If the mezzanine classified NCI is not currently redeemable, the NCI carrying amount is not adjusted for the redemption feature if it is not currently probable that the NCI instrument will become redeemable at the option of the holder. However, when the holder’s ability to redeem a mezzanine classified NCI (see BCG 6.2.1.4) is probable, the NCI must be accreted to its redemption amount. The required accretion will ensure that NCI is reported at its redemption value by the date the issuer could be required to redeem it. As further described in FG 7.4.3.2, a reporting entity may either accrete these changes over the periods prior to the earliest redemption date or recognize them immediately as they occur. ASC 480-10-S99-3A(22) notes that consistent with ASC 810-10-45-23, an adjustment to the carrying amount of NCI does not impact net income or comprehensive income in the consolidated financial statements. Rather, such adjustments are treated akin to the repurchase of a noncontrolling interest (although they may be recorded to retained earnings instead of additional paid-in capital).
The process of adjusting NCI to its redemption value (the “Mezzanine Adjustment”) should be performed after attribution of the subsidiary's net income or loss pursuant to ASC 810, Consolidation (see BCG 6.4.1). The carrying amount of NCI will equal the higher of the amount resulting from application of ASC 810 or the amount resulting from the Mezzanine Adjustment.
Example BCG 6-4 illustrates an adjustment to the carrying value of redeemable equity securities.
EXAMPLE BCG 6-4
Adjustment to the carrying value of redeemable equity securities
Adjustment to the carrying value of redeemable equity securities
Parent Company A acquires 80% of the common shares of Subsidiary from Company Z. Company Z retains the remaining common shares (20%) in Subsidiary. As part of the acquisition, Parent Company A and Company Z enter into an agreement that allows Company Z to put its equity interest in Subsidiary, in its entirety, to Parent Company A based on a formula at a future specified date. Parent Company A recognizes NCI at its acquisition date fair value of $100 million.
Parent Company A concludes that the put option is embedded in the NCI, and the NCI should be presented as mezzanine equity because Parent Company A may be required to redeem it at a future date.
At the end of the first year, Subsidiary records income of $50 million. Income attributable to the NCI is $10 million ($50 million × 20%). The formula-based redemption amount is calculated as $117 million.
Parent Company A elected to recognize changes in the redemption amount immediately as they occur.
What is the carrying value of the mezzanine equity at the end of Year 1?
Analysis
$117 million. Parent Company A would first allocate $10 million to the NCI to reflect its proportionate interest in the income of Subsidiary. This would result in a carrying amount of $110 million ($100 million + $10 million). Parent Company A would then adjust the NCI by $7 million ($117 million redemption amount - $110 million carrying amount) to reflect the higher redemption amount, with the offset to equity.
6.4.2.1 Reversals of Mezzanine Adjustments
A reporting entity should reverse previous accretion of mezzanine classified instruments to reflect a decline in redemption value of the instrument. However, a reversal should only be recognized to the extent of prior accretions (as detailed in ASC 480-10-S99-3A(16(e))).
We believe that the carrying amount should also not be lower than the amount that would have otherwise been reported pursuant to ASC 810. Therefore, each reporting period, a reporting entity should:
- Identify the portion of the NCI carrying amount from the prior period that is attributable to ASC 810, and adjust it for the current period income or loss attributable to the NCI, and
- Calculate the current year’s Mezzanine Adjustment, while ensuring that a reversal, if any, is not larger than the accretion already taken.
To ensure the correct offset for each adjusting entry, a reporting entity should track the components of NCI and follow the order of the operations described above. As illustrated in Example BCG 6-5, if the basis of NCI increases due to the attribution of subsidiary income, a prior year Mezzanine Adjustment may be reversed even though the redemption price did not decrease. Example BCG 6-6 illustrates the full reversal of a prior Mezzanine Adjustment that was made to redeemable NCI.
EXAMPLE BCG 6-5
Partial reversal of a prior Mezzanine Adjustment for redeemable NCI
Partial reversal of a prior Mezzanine Adjustment for redeemable NCI
Parent Company acquires 80% of the common shares of Subsidiary from Company Z. Company Z retains the remaining common shares (20%) in Subsidiary. As part of the acquisition, Parent Company and Company Z enter into an agreement that allows Company Z to put its equity interest in Subsidiary, in its entirety, to Parent Company based on a formula at a future specified date. Parent Company recognizes NCI at its acquisition date fair value of $100 million.
Parent Company concludes that the put option is embedded in the NCI, and the NCI should be presented as mezzanine equity because Parent Company may be required to redeem it at a future date.
At the end of the first year, Subsidiary records income of $50 million. Income attributable to the NCI is $10 million ($50 million × 20%). The formula-based redemption amount is calculated as $117 million. Parent Company first allocates $10 million to the NCI to reflect its proportionate interest in the income of Subsidiary. This results in a carrying amount of $110 million ($100 million + $10 million).
As Parent Company elected to recognize changes in the redemption amount immediately as they occur, it would then adjust the NCI by $7 million ($117 million redemption amount - $110 million carrying amount) with the offset to equity so that the ultimate carrying amount of the NCI is $117 million.
In the subsequent year, Subsidiary has net income of $25 million. Accordingly, net income attributable to the NCI would be $5 million ($25 million x 20%). The formula-based redemption amount is calculated and determined to still be $117 million.
What is the carrying value of the mezzanine equity at the end of Year 2?
Analysis
The carrying amount is $117 million; however, Parent Company will need to reverse $5 million of the prior Mezzanine Adjustment.
At the end of Year 1, the NCI balance resulting from the attribution of Subsidiary’s income was $110 million. After attribution of Year 2’s income, the carrying amount would be $115 million ($110 million + $5 million). Accordingly, there is a $2 million difference between (a) the $115 carrying amount and (b) the $117 redemption amount. While the mezzanine equity ultimately should be reported on the balance sheet at $117 million, Parent Company had a previous Mezzanine Adjustment of $7 million. Therefore, to ensure that the NCI reflects the correct balance, it will need to reverse $5 million ($7 million - $2 million) of the prior Mezzanine Adjustment.
EXAMPLE BCG 6-6
Full reversal of a prior Mezzanine Adjustment made to redeemable NCI
Full reversal of a prior Mezzanine Adjustment made to redeemable NCI
Parent Company acquires 80% of the common shares of Subsidiary from Company Z. Company Z retains the remaining common shares (20%) in Subsidiary. As part of the acquisition, Parent Company and Company Z enter into an agreement that allows Company Z to put its equity interest in Subsidiary, in its entirety, to Parent Company based on a formula at a future specified date. Parent Company recognizes NCI at its acquisition date fair value of $100 million.
Parent Company concludes that the put option is embedded in the NCI, and the NCI should be presented as mezzanine equity because Parent Company may be required to redeem it at a future date.
At the end of the first year, Subsidiary records income of $50 million. Income attributable to the NCI is $10 million ($50 million × 20%). The formula-based redemption amount is calculated as $117 million. Parent Company first allocates $10 million to the NCI to reflect its proportionate interest in the income of Subsidiary. This results in a carrying amount of $110 million ($100 million + $10 million).
As Parent Company elected to recognize changes in the redemption amount immediately as they occur, it would then adjust the NCI by $7 million ($117 million redemption amount - $110 million carrying amount) with the offset to equity so that the ultimate carrying amount of the NCI is $117 million.
In the subsequent year, Subsidiary has a net loss of $30 million. Accordingly, net loss attributable to the NCI would be $6 million ($30 x 20%). The formula-based redemption amount is calculated and determined to be $102 million.
What is the carrying value of the mezzanine equity at the end of Year 2?
Analysis
The carrying amount is $104 million. At the end of Year 1, the NCI balance resulting from the attribution of Subsidiary’s income was $110 million. After attribution of the Year 2 loss, the carrying amount would be $104 million ($110 million - $6 million). As the formula-based redemption amount ($102 million) is less than the carrying amount, the entire prior Mezzanine Adjustment of $7 million should be reversed.
6.4.2.2 EPS considerations related to mezzanine classified NCI
Changes to the carrying amount of mezzanine classified NCI are intended to capture the incremental value the NCI holder may ultimately be entitled to. Specifically, the NCI holder may be entitled to receive consideration that is greater than its proportionate share of the subsidiary, for example upon its exercise of a put option.
Accordingly, for purposes of calculating earnings per share, changes in the carrying amount of mezzanine equity may be viewed as a deemed dividend, and may impact the calculation of the numerator, as further described in FSP 7.4.1.2.
FSP 7.4.1.2 explains that if the NCI is common stock and the redemption amount is other than fair value (e.g., a formula amount), a reporting entity has the option to reflect as a deemed dividend either (a) the entire change in redemption amount or (b) only the amount by which the redemption amount exceeds fair value. The rationale is that the change in redemption value attributable to changes in the fair value of the NCI does not provide the NCI holder with any value that is incremental to what other common stockholders are entitled to. As noted in FSP 7.4.1.2, if the NCI is preferred stock, the entire change in the redemption amount should be reflected as a deemed dividend in the calculation of income available to the parent company common stockholders.
In practice, redemption formulas often do not approximate fair value (e.g., a formula based on an EBITDA multiple), and accordingly, reporting entities that wish to elect alternative (b) must calculate the difference between the redemption formula and fair value. While electing alternative (b) may result in a smaller EPS impact, it is also more difficult operationally, as the reporting entity must determine the fair value of the NCI each reporting period.
Example BCG 6-7 illustrates the impact of a redeemable NCI security on earnings per share.
EXAMPLE BCG 6-7
Impact of a redeemable NCI security on earnings per share
Impact of a redeemable NCI security on earnings per share
Parent Company acquires 80% of the common shares of Subsidiary from Company Z. Company Z retains the remaining common shares (20%) in Subsidiary. As part of the acquisition, Parent Company and Company Z enter into an agreement that allows Company Z to put its equity interest in Subsidiary, in its entirety, to Parent Company based on a formula at a future specified date. Parent Company recognizes NCI at its acquisition date fair value of $100 million.
Parent Company concludes that the put option is embedded in the NCI, and the NCI should be presented as mezzanine equity because Parent Company may be required to redeem it at a future date.
At the end of the first year, Subsidiary records income of $50 million. Income attributable to the NCI is $10 million ($50 million × 20%). The formula-based redemption amount is calculated as $117 million. Parent Company first allocates $10 million to the NCI to reflect its proportionate interest in the income of Subsidiary. This results in a carrying amount of $110 million ($100 million + $10 million).
As Parent Company elected to recognize changes in the redemption amount immediately as they occur, it would then adjust the NCI by $7 million ($117 million redemption amount - $110 million carrying amount) with the offset to equity so that the ultimate carrying amount of the NCI is $117 million.
It is determined at the end of the first year that the fair value of the NCI is $115 million. Furthermore, Parent Company elects to recognize a deemed dividend only to the extent the redemption amount exceeds fair value.
What is the impact on the income attributable to the parent, or income available to common stockholders of the parent, at the end of the first year?
Analysis
The basic EPS numerator would be reduced by $2 million ($117 million redemption price - $115 million fair value). While the Mezzanine Adjustment is $7 million, all common shareholders would benefit due to an increase in their share value. Only the excess over the fair value would be deemed a dividend impacting earnings per share.
6.4.2.3 NCI that no longer requires mezzanine classification
A reporting entity may determine that mezzanine classification is no longer appropriate. This may occur if the put option lapses, or the reporting entity changes the terms of the instrument. Such changes should be accounted for as a modification rather than an extinguishment, as described in FG 7.8.
The reporting entity would reclassify the NCI from mezzanine to permanent equity on the date of the event that caused the reclassification. Prior financial statements should not be adjusted. Additionally, the reporting entity should not reverse any adjustments to the carrying amount of the equity instrument (see ASC 480-10-S99-3A(18)).
If the reporting entity determines it is appropriate to deconsolidate a subsidiary with mezzanine classified NCI, it should reverse prior accretion, as described in BCG 5.5.1. Previously accreted amounts should not impact the amount of the gain or loss recorded upon deconsolidation.
See BCG 5.4 for a description of the accounting if the NCI holder exercises its put option, or the reporting entity repurchases the NCI.
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