The carve-out income statement should present all historical results of operations for the carve-out business, including costs incurred on its behalf. As the carve-out business represents a portion of the parent entity, certain of the costs of the parent entity are recorded by the carve-out business through cost allocation adjustments. SAB Topic 1.B, Allocation Of Expenses And Related Disclosure In Financial Statements Of Subsidiaries, Divisions Or Lesser Business Components Of Another Entity (codified in ASC 220-10-S99-3), addresses how to reflect all the costs of doing business in the financial statements.

Excerpt from ASC 220-10-S99-3

Facts: A company (the registrant) operates as a subsidiary of another company (parent). Certain expenses incurred by the parent on behalf of the subsidiary have not been charged to the subsidiary in the past. The subsidiary files a registration statement under the Securities Act of 1933 in connection with an initial public offering.
Question 1: Should the subsidiary’s historical income statements reflect all of the expenses that the parent incurred on its behalf?
Interpretive Response: In general, the staff believes that the historical income statements of a registrant should reflect all of its costs of doing business. Therefore, in specific situations, the staff has required the subsidiary to revise its financial statements to include certain expenses incurred by the parent on its behalf. Examples of such expenses may include, but are not necessarily limited to, the following (income taxes and interest are discussed separately below):
  1. Officer and employee salaries,
  2. Rent or depreciation,
  3. Advertising,
  4. Accounting and legal services, and
  5. Other selling, general and administrative expenses.
When the subsidiary’s financial statements have been previously reported on by independent accountants and have been used other than for internal purposes, the staff has accepted a presentation that shows income before tax as previously reported, followed by adjustments for expenses not previously allocated, income taxes, and adjusted net income.

Expenses that are not directly attributable to the carve-out business should be allocated using a reasonable method based on the guidance provided by the SEC staff in SAB Topic 1.B.1 Question 2 (codified as ASC 220-10-S99).

Excerpt from ASC 220-10-S99-3

Question 2: How should the amount of expenses incurred on the subsidiary’s behalf by its parent be determined, and what disclosure is required in the financial statements?
Interpretive Response: The staff expects any expenses clearly applicable to the subsidiary to be reflected in its income statements. However, the staff understands that in some situations a reasonable method of allocating common expenses to the subsidiary (e.g., incremental or proportional cost allocation) must be chosen because specific identification of expenses is not practicable. In these situations, the staff has required an explanation of the allocation method used in the notes to the financial statements along with management’s assertion that the method used is reasonable.
In addition, since agreements with related parties are by definition not at arms length and may be changed at any time, the staff has required footnote disclosure, when practicable, of management’s estimate of what the expenses (other than income taxes and interest discussed separately below) would have been on a stand alone basis, that is, the cost that would have been incurred if the subsidiary had operated as an unaffiliated entity. The disclosure has been presented for each year for which an income statement was required when such basis produced materially different results.

If the specific identification of expenses is not practicable, a reasonable method of allocating expenses to the carve-out business (e.g., incremental or proportional cost allocation) is used. Because the parent costs allocated to the carve-out business are related party transactions, management should include appropriate disclosures.
Figure CO 5-1 may be helpful in identifying a method for the reasonable allocation of corporate or other shared expenses. As the guidance is not prescriptive, other methods of allocation may be used if reasonable.
Figure CO 5-1
Potential allocation methods for shared costs
Shared cost type
Potential allocation method
Executive compensation
Percentage of sales/operating income
Employee compensation
Percentage of time spent/headcount
Rent or depreciation
Relative square footage/percentage of usage
Percentage of sales
Accounting and legal services
Percentage of sales/relative services rendered
Question CO 5-1 addresses how to allocate executive compensation to the carve-out business.
Question CO 5-1
A purchasing manager at a company historically spent 40% of her time on activities related to the carve-out business.
How should her salary be reflected in the carve-out financial statements?
PwC response
The company may determine it is appropriate to allocate 40% of the purchasing manager’s salary and related benefits to the carve-out business. The intent of this allocation is to fully burden the carve-out business with the costs that were actually incurred by the parent on its behalf. The allocated costs may not be reflective of the actual costs expected to be incurred by the carve-out business as an unaffiliated entity with its own procurement team.
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