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4.2 Balance sheet—assets
Publication date: 30 Nov 2022 (updated 31 Mar 2023)
us Carve-out financial statements guide 4.2
The carve-out balance sheet should include assets that relate to the operations of the carve-out business. In determining the assets to include, management should consider:
- the extent to which the asset was used by the carve-out business;
- whether the asset will be transferred in the transaction; and
- which entity holds the legal title, and whether that legal entity will be transferred in the transaction.
4.2.1 Cash and investments
When the carve-out entity includes legal entities that have legal ownership over bank accounts, the cash is included within the carve-out financial statements. See CO 4.5.1 for accounting for cash sweep accounts.
Whether or not the carve-out business has bank accounts, the statement of cash flows should reflect the inflows and outflows of cash during the period related to the activities of the carve-out business. See CO 6.4 for more on the statement of cash flows.
4.2.2 Accounts receivable
Accounts receivable are included in the carve-out balance sheet when they result from sales of products or services by the carve-out business. That is, a portion of the parent entity’s accounts receivable and related allowance for doubtful accounts may be directly related to the carve-out business. However, it may not be straightforward to identify which portion of the accounts receivable relates to the carve-out business if the information is not readily available at the level at which the carve-out financial statements are being prepared. For example, it can be challenging when the customers of the carve-out business are the same as those of the businesses being retained by the parent entity. Management should develop a process to attribute the receivables to the carve-out business. For example, management may be able to identify SKUs or other carve-out-specific identifiers, such as product lines or product categories, to identify the transactions related to the carve-out business.
4.2.3 Investments
When the carve-out entity includes legal entities that have investments in debt or equity securities, those investments are included within the carve-out financial statements. Such legal entities may have independently elected to apply the fair value option in their own financial statements, regardless of the election made by the parent entity, as noted in ASC 825-10-25-6.
An acquirer, parent, or primary beneficiary decides whether to apply the fair value option to eligible items of an acquiree, subsidiary, or consolidated VIE, but that decision applies only in the consolidated financial statements. Fair value option choices made by an acquired entity, subsidiary, or VIE continue to apply in separate financial statements of those entities if they issue separate financial statements.
When the election of the carve-out business differs from the parent, the election of the carve-out entity should be used for purposes of the carve-out financials.
4.2.4 Inventory
Finished goods inventories are typically easily identified for purposes of preparing the carve-out financial statements. However, it can be challenging to identify raw materials or work in process that may have alternative uses (e.g., used in products sold by the carve-out business and other unrelated businesses of the parent). Therefore, attribution methods may need to be developed by management in order to identify the inventory recorded in the carve-out financial statements.
Another challenge can arise when management uses the last-in first-out (LIFO) method to account for inventory. In these situations, management may prepare a separate LIFO pool calculation for the carve-out business or it may use an attribution method.
Management also needs to identify any inventory reserves (e.g., lower-of-cost and net realizable value, reserves for excess and obsolete inventory) related to the carve-out entity’s inventory.
4.2.5 Property, plant, and equipment
In certain situations, attribution of property, plant, and equipment is straightforward as the asset is used solely by the carve-out entity and the carve-out entity has title to the asset. Other times, long-lived assets are used by the parent (or other subsidiaries) and the carve-out business, such as a shared production line in a plant owned by the parent.
Long-lived assets are frequently shared resources. Generally the concept of "allocating" a percentage of an asset to the balance sheet would not be appropriate. The carve-out entity must determine whether it should recognize or exclude the entire asset based on the criteria described in CO 4.2. See CO 5.4 for a discussion on the expense allocation related to shared assets.
Example CO 4-1 provides an example of attribution of shared assets to a carve-out entity.
EXAMPLE CO 4-1
Shared assets attribution in carve out scenario
Shared assets attribution in carve out scenario
The carve-out business holds legal title to the equipment. Approximately 50% of the production capacity of the equipment is used to manufacture products for the carve-out business and the equipment will be part of the divestiture transaction. The other 50% of production capacity is used by the parent.
Should the carve-out balance sheet reflect this shared equipment?
Analysis
Yes. Although the equipment is used by the parent entity and the carve-out business, because the carve-out business holds legal title and the equipment will be transferred as part of the divestiture transaction, it would be appropriate to attribute the equipment to the carve-out business. While the income statement of the carve-out financial statements would reflect the depreciation of the equipment, that charge may be offset by a benefit for the usage by the parent as described in CO 5.4.2.
4.2.5.1 Property, plant, and equipment impairment
When testing for impairment, ASC 360, Property, Plant, and Equipment, requires assets to be grouped at the lowest level for which identifiable cash flows are largely independent of cash flows from other assets and liabilities. Management should determine the asset groups from the perspective of the carve-out business as they may be different than the parent entity’s asset groups. For example, assume five production facilities were considered a single asset group by the parent entity because the cash flows from these facilities were highly interdependent. If the carve-out business only includes one of the five facilities, the asset group of the carve-out might be at the individual facility level.
Long-lived assets (asset groups) must be tested for recoverability whenever changes in circumstances indicate that the carrying amount may not be recoverable, as discussed in ASC 360-10-35-21. Accordingly, when asset groups in the carve-out financial statements differ from the parent entity’s asset groups, management will need to evaluate whether the carrying amount of the asset groups are recoverable for all periods for which carve-out financial statements are being prepared, based on the carve-out asset grouping. In determining whether an impairment trigger existed in the historical periods, hindsight should not be used. That is, the assessment and related cash flows should be based on the information that existed at the time and should not reflect subsequent events.
Another difference that may exist between the parent entity and the carve-out entity is the accounting model used. Specifically, the parent may be required to apply the held-for-sale impairment model either in a sale transaction or contemporaneously with a spin-off. However the carve-out business would continue to apply the held-and-used model. Accordingly, it is possible that the parent entity could be required to record an impairment for assets that are not otherwise impaired at the carve-out level.
Example CO 4-2 illustrates a long-lived asset impairment analysis.
EXAMPLE CO 4-2
Long-lived asset impairment analysis
Long-lived asset impairment analysis
On August 31, Company P entered into an arrangement to sell Business C for $500. The carrying value of Business C in Company P's financial statements is $700. Assume for simplicity that there are no costs expected to be incurred to sell Business C. The decision by Company P to sell Business C meets the requirements for the disposal group to be evaluated for impairment under the held-for-sale model. If Business C were to review its long-lived assets for impairment under the held-and-used model, undiscounted cash flows would exceed the carrying value of the long-lived assets and, therefore, indicate that the carrying amount of the asset group is recoverable.
Should Company P and/or Business C record an impairment charge for the long-lived assets?
Analysis
An impairment charge of $200 should be recorded in the consolidated financial statements of Company P under the held-for-sale model. No impairment loss should be recorded in the carve-out financial statements of Business C because its long-lived assets are not impaired based on testing under the held-and-used model. That is, the $200 loss recorded by Company P should not be pushed down to Business B’s financial statements.
4.2.6 Leases from the lessee’s perspective—after adoption of ASC 842
If the carve-out business contains a legal entity, management should evaluate its contracts to determine if the contracts are or contain leases. The carve-out business will need to determine if it has a contract with the parent. ASC 606-10-25-2 provides the definition of a contract.
A contract is an agreement between two or more parties that creates enforceable rights and obligations. Enforceability of the rights and obligations in a contract is a matter of law. Contracts can be written, oral, or implied by an entity’s customary business practices. The practices and processes for establishing contracts with customers vary across legal jurisdictions, industries, and entities. In addition, they may vary within an entity (for example, they may depend on the class of customer or the nature of the promised goods or services). An entity shall consider those practices and processes in determining whether and when an agreement with a customer creates enforceable rights and obligations.
If the carve-out business has a contract with the parent, management should consider the flowchart depicted in ASC 842-10-55-1 to determine whether the contract is or contains a lease. If the contract contains a lease, the carve-out entity would reflect a ROU asset and ROU liability on its balance sheet.
If the parent is a lessee and the carve-out business determined that it did not have a lease with the parent, the ROU asset and liability would typically not be reflected in the carve-out financial statements. However, if the leased asset is used solely in the operations of the carve-out business and the lease will be assumed by the carve-out entity, management may determine that the economics of the transaction would be best captured by reflecting a ROU asset and ROU liability in the carve-out financial statements.
Regardless of whether an asset or a liability is recognized, if the leased asset is utilized in the operations of the carve-out business, the carve-out financial statements would include an allocation of expense from the parent entity. See CO 5.2 for a discussion of the income statement allocation.
4.2.7 Goodwill
Goodwill may need to be reflected in the carve-out financial statements. In making this determination, management should consider whether the assets and liabilities of the carve-out business will be reflected at the ultimate parent’s basis. See CO 3.6 for a discussion on when the assets and liabilities of the carve-out business should be reflected at the ultimate parent’s basis.
4.2.7.1 Attribution of goodwill
If the carve-out financial statements reflect the parent’s basis, the financial statements would usually include the historical goodwill amount. That is, acquisition-specific goodwill recognized by the parent that directly relates to the carve-out business would be presented in the carve-out financial statements.
Conceptually, goodwill should be attributed to the carve-out entity based on the amount that would have been recognized when it was acquired, as discussed in ASC 350-20-35-42. That means that management would need to consider the fair value of the carve-out business and its assets and liabilities at the date of original acquisition. The amount of the goodwill recognized in the carve-out financial statements may not be the same as the amount of goodwill assigned by the parent to the divested business. See BCG 9.10.5 for more information on accounting by the parent entity.
When it is impracticable to determine what the fair value of the carve-out business and its assets and liabilities were at the date of original acquisition, management should develop a reasonable and supportable methodology for determining the goodwill attributable to the carve-out business and apply the methodology consistently for all periods presented. For example, an approach may include attribution based on the proportionate fair value of the acquired business included in the carve-out business relative to the fair value of the acquired business as a whole on the date of acquisition.
Attribution of goodwill may be complex when the carve-out business was acquired as part of a larger acquisition, and may be even more so if the carve-out includes components of multiple acquisitions. For example, if the carve-out business represents one out of three businesses acquired in a single transaction, and the entire transaction was assigned to a single reporting unit at the parent level, management would need to determine what portion of the goodwill resulting from the acquisition should be attributed to the carve-out business.
In some cases, goodwill may have lost its identity subsequent to acquisition due to reorganizations of the business (including changes in segments or reporting units), or the valuation performed at the time of the original acquisition may not have included information at a level of detail sufficient to determine the relative fair values as of that date. In such cases, another reasonable methodology may be utilized to determine the amount of goodwill to attribute to the carve-out business.
Example CO 4-3 provides an example of initial recognition of goodwill in carve-out financial statements, and Example CO 4-4 provides an example of the allocation of goodwill to reporting units in carve-out financial statements.
EXAMPLE CO 4-3
Historical goodwill presentation
Historical goodwill presentation
On March 1, 20X3, Company A acquired Business B for $500 million. The fair value of the identifiable net assets acquired was $360 million and goodwill was $140 million. Business B is included in Company A’s reporting unit RU2. RU2 also includes the net assets ($200 million) and goodwill ($30 million) of Business C, which was acquired by Company A on March 1, 20X1.
On March 1, 20X6, Company A decides to spin off Business B and will retain the remaining assets in RU2 attributable to Business C. What is the amount of goodwill that should be included in the carve-out financial statements?
Analysis
Acquisition-specific goodwill related to Company A’s acquisition of Business B of $140 million would be included in the carve-out financial statements. This is because that historical goodwill is identifiable and relates specifically to the carve-out business.
EXAMPLE CO 4-4
Allocation of goodwill to reporting units
Allocation of goodwill to reporting units
On March 1, 20X1, Company A acquires Entity C, which is comprised of two businesses, for $300 million and records $140 million of goodwill. On the acquisition date, one of the businesses (Business B) had a fair value of $150 million with identifiable net tangible and intangible assets comprising $60 million of that amount.
On March 1, 20X4, Company A decides to spin off Business B and prepares carve-out financial statements. What is the amount of goodwill that should be included in the carve-out financial statements?
Analysis
In order to determine the amount of goodwill to attribute to the carve-out financial statements, management would first consider the fair value of the business being sold on the date it was acquired. This value would be the basis for deriving the carve-out goodwill following the guidance in ASC 350-20-35-42. As a result, the acquisition-specific goodwill attributed to the carve-out business is $90 million, or the difference between Business B’s $150 million fair value and $60 million net assets based on the information that was available on the acquisition date.
If this method is impracticable because Company A did not perform a separate analysis of identifiable net assets of the two business on the acquisition date, Company A may consider an approach that compares the fair value as of the acquisition date (i.e., March 1, 20X1) of the business to be sold ($150) to Entity C ($300). Given the carve-out business represented 50% of the acquisition date fair value, $70 million of acquisition-specific goodwill (50% of the $140 million goodwill balance) would be attributed to the carve-out business.
In instances when the attribution of goodwill to the carve-out business represents only a portion of a parent entity’s reporting unit and an impairment charge was recorded prior to the opening balance sheet date presented in the carve-out financial statements, management should consider what portion, if any, to attribute to the carve-out business. ASC 350-20-40, which provides guidance on accounting for the disposal of all or a portion of a reporting unit, may be helpful to consider in these situations.
4.2.7.2 Private company accounting alternatives
There may be instances when the carve-out entity is a private entity that has elected to adopt the private company accounting alternatives, which include but are not limited to:
- electing to amortize goodwill, and
- not recognizing noncompetition agreements and customer-related intangibles in an acquisition (unless they are capable of being sold or licensed independent from the other assets of the acquired business).
Accordingly, the goodwill balance in the carve-out entity may differ from that shown by the parent.
If the carve-out business elects not to recognize noncompetition agreements and customer-related intangibles, it must also elect to amortize goodwill.
Private company accounting alternatives cannot be used in financial statements that will be included in an SEC filing. See BCG 9.11 for further discussion of the goodwill alternative for private companies/NFP entities. See BCG 4.7 for further discussion of the intangible assets alternative for private companies/NFP entities.
4.2.7.3 Goodwill impairment
Goodwill attributed to the carve-out financial statements should be tested for impairment as if the carve-out entity was a standalone entity, as described in ASC 350-20-35-48. As a result, the carve-out business will need to determine its chief operating decision maker (CODM) to determine its operating segments and reporting units. The reporting units may be different from those of the parent entity. See FSP 25 for further details regarding the identification of operating segments and information related to the CODM.
Once the reporting units of the carve-out business and the amount of goodwill attributable to each reporting unit(s) have been determined, management should assess goodwill for impairment as of the first day of the initial year presented in the carve-out financial statements (i.e., the opening balance sheet date), and at least annually thereafter, based on the reporting units of the carve-out business. Impairment tests performed for the carve-out business may result in impairment charges that were not previously recognized by the parent entity.
4.2.8 Intangible assets
Similar to goodwill (discussed in CO 4.2.7), intangible assets recorded in prior acquisitions may need to be reflected in the carve-out financial statements. It may be difficult to determine whether to attribute the intangible assets to the carve-out business if the assets are shared between the carve-out business and other affiliated entities of the parent. See CO 4.2 for the factors to consider when determining whether to attribute intangible assets to the carve-out entity.
Management should consider whether the assets and liabilities of the carve-out business will be reflected at the ultimate parent’s basis. See CO 3.6 for the discussion on when the assets and liabilities of the carve-out business should be reflected at the ultimate parent’s basis.
4.2.8.1 Finite-lived intangible assets
If the carve-out business reflects a finite-lived intangible asset on its balance sheet based on the criteria described in CO 4.2, the corresponding amortization expense is also recognized. However, when the carve-out business does not reflect the carrying amount of the finite-lived intangible asset, management should calculate a charge for its use of the intangible as described in CO 5.4.2.
Example CO 4-5 and Example CO 4-6 provide examples of the initial recognition of a finite-lived intangible asset in carve-out financial statements.
EXAMPLE CO 4-5
Intangible asset - finite-lived asset
Intangible asset - finite-lived asset
The carve-out business and several other business units use the parent entity’s brand name, which is legally owned by the parent entity. The rights to the brand name will not be sold as part of the divestiture. The brand name is a finite-lived intangible asset (i.e., it was not internally developed).
Should the brand name intangible asset be included in the carve-out financial statements?
Analysis
No. Because the brand name is legally owned by the parent entity, will not be sold as part of the transaction, and is not solely utilized in the operations of the carve-out business, it would not be attributed to the carve-out business. The carve-out income statement would, however, reflect an allocation of the parent entity’s amortization expense, as discussed in CO 5.4.2.
EXAMPLE CO 4-6
Intangible asset - finite-lived asset
Intangible asset - finite-lived asset
The carve-out business is the exclusive user of a patent that is legally owned by the parent entity. The rights to the patent will be sold as part of the divestiture. The patent is a finite-lived intangible asset (i.e., it was not internally developed).
Should the patent be included in the carve-out financial statements?
Analysis
Yes. Because the patent will be sold as part of the divestiture and the patent was used exclusively by the carve-out business, it would be appropriate to attribute the patent to the carve-out business. Because the patent is solely used by the carve-out business, the carve-out income statement would reflect the full cost of amortization of the patent, as described in CO 5.4.2.
Finite-lived intangible asset impairment
Finite-lived intangible assets are tested for impairment under ASC 360 whenever changes in circumstances indicate that the carrying amount may not be recoverable. See CO 4.2.5.1.
4.2.8.2 Indefinite-lived intangible assets
If the carve-out business and the parent use the indefinite-lived intangible asset, then management needs to determine whether it should reflect the indefinite-lived intangible asset in the carve-out financial statements based on the criteria described in CO 4.2.
Indefinite-lived intangible asset impairment
When indefinite-lived intangible assets are recorded in the carve-out financial statements, management must determine the unit of account for purposes of impairment testing in accordance with ASC 350-30-35-21 through ASC 350-30-35-28. In some instances, indefinite-lived intangibles may be operated as a single asset (i.e., they are inseparable from one another) and are combined into a single unit of account for impairment testing. See BCG 8.3.2.1 for more on the unit of account for indefinite-lived intangibles.
Indefinite-lived intangible assets are assessed for impairment at least annually and when triggering events have occurred during the period. If the unit of account and the basis of accounting of the parent and carve-out entity business are consistent, the assessments performed in support of the carrying value of the indefinite-lived intangible assets for the parent entity could be used to support management’s impairment assessment for the assets attributable to the carve-out business. When the unit of account of the carve-out business differs from that of the parent entity, or when the assets reflected in the carve-out financial statements are not recorded at the ultimate parent’s basis, management must assess the indefinite-lived intangible assets for impairment as of the opening balance sheet date and for each of the subsequent years included in the carve-out financial statements. This should be performed without the benefit of hindsight.
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