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6.2 Disposals by sale
Publication date: 28 Feb 2022
us PP&E and other assets guide 6.2
Long-lived assets are often disposed of by a sale to a third party (e.g., sale of a plant by a manufacturing company). Each transaction should be evaluated to determine the appropriate derecognition guidance to apply in accounting for the disposal.
A reporting entity should first determine whether the transaction is partially in the scope of other topics. For example, a guarantee created in conjunction with the transfer of a nonfinancial asset, or a seller’s obligation to provide a separate identifiable service to the buyer will likely be accounted for separate from the disposal. See PPE 6.2.1 for further discussion on transactions that are partially in the scope of other topics.
The reporting entity will need to determine whether the transaction is in the scope of ASC 610-20, Gains and Losses from the Derecognition of Nonfinancial Assets, or other topics. For example, the sale of assets in the ordinary course of business (e.g., sale of a car by a car dealer) are governed by the revenue guidance in ASC 606, Revenue from Contracts with Customers. Furthermore, the sale of a group of long-lived assets that constitutes a business and that is not a sale to a customer should be accounted for in accordance with ASC 810-10-40, unless it is a conveyance of oil and gas mineral rights (see ASC 932-360, Extractive Activities – Oil and Gas, Property, Plant, and Equipment). As discussed in PPE 6.2.2.5, financial assets (e.g., equity method investments) that are disposed in conjunction with the sale of nonfinancial assets may also be within the scope of ASC 610-20 when they are determined to be in substance nonfinancial assets. See PPE 6.2.2 for further details on evaluating the appropriate derecognition model for various disposals.
Once it is determined that the disposal is within the scope of ASC 610-20, the entity will need to allocate the contract consideration (see PPE 6.2.3), determine whether the disposal meets the derecognition criteria (see PPE 6.2.4), and measure the gain or loss upon derecognition (see PPE 6.2.5).
Figure PPE 6-1 provides an overview of the steps to consider when applying the guidance in ASC 610-20.
Figure PPE 6-1
Steps to consider in applying the guidance in ASC 610-20
Steps to consider in applying the guidance in ASC 610-20
6.2.1 Assessing what is part of a disposal
The seller may have certain arrangements that should be accounted for separately from the disposal transaction. In many disposal transactions, a seller may make certain representations and warranties associated with the sale. See PPE 6.2.1.1 for further considerations when accounting for these arrangements.
The seller and buyer may have a preexisting relationship before negotiations for the sale of long-lived assets or they may enter into an arrangement during the sale negotiations that are separate from the sale of long-lived assets. For example, a buyer might pay a lump-sum amount to a seller in exchange for a warehouse and the seller’s commitment to provide maintenance services for the 12-month period after the sale. A question arises as to whether a portion of the lump-sum payment should be allocated to the maintenance services.
If the arrangements include the seller’s obligation to provide a separate identifiable service to the buyer or settle a preexisting relationship between the seller and buyer, the seller should evaluate whether each of the arrangements are entered into on an arm’s length basis. This may impact the measurement of the gain or loss on the sale of the long-lived assets and the accounting for the subsequent service arrangement or settlement of the preexisting relationship. There is no explicit guidance for determining what is part of a disposal under US GAAP. In making this determination, among other things, the seller should consider the reasons for the transaction, who initiated the transaction, and the timing of the transaction, by analogy to the guidance for an acquisition in ASC 805-10-55-18. The assessment is a matter of judgment and should be based on the individual facts and circumstances.
Example PPE 6-1 further demonstrates the accounting for a transition services agreement.
EXAMPLE PPE 6-1
Accounting for a transition services agreement when the seller of a plant will perform services at no cost to the buyer
Accounting for a transition services agreement when the seller of a plant will perform services at no cost to the buyer
Manufacturing Co agrees to sell a manufacturing plant for $100 million to PPE Corp. Manufacturing Co's net book value of the assets sold to PPE Corp is $70 million, with a fair value of $95 million. In connection with the purchase and sale agreement, Manufacturing Co and PPE Corp also enter into a transition services agreement (TSA) under which Manufacturing Co agrees to provide building management services to PPE Corp for a period of one year at no cost to PPE Corp. Manufacturing Co estimates the fair value of the services to be provided under the TSA to be $5 million, at a cost of $3 million. For simplicity, all tax effects have been ignored, and assume that there are no direct costs to sell the manufacturing plant.
How should Manufacturing Co determine the gain to be recognized upon sale of the plant to PPE Corp?
Analysis
On the date of sale, Manufacturing Co should allocate a portion of the proceeds to the fair value of the services to be rendered under the TSA. Although the TSA agreement stipulates that the services will be performed by Manufacturing Co at no cost to PPE Corp, the substance of the transaction is that a portion of the consideration for the sale of the plant relates to the transition services that will be provided in the future. Manufacturing Co should recognize the $5 million (i.e., the estimated fair value of the services to be provided under the TSA) over the period during which the services are rendered. Expenses related to the TSA should be recognized as incurred. On the date of the sale, Manufacturing Co should recognize a gain on disposal of the plant of $25 million ($100 million sales price - $5 million allocated to the TSA - $70 million net book value).
Manufacturing Co should report the proceeds received from providing the service under the TSA as “other income,” assuming such services do not relate to the primary business in which Manufacturing Co operates. Expenses should be reported in their natural expense classifications.
6.2.1.1 Seller representations
In many disposal transactions, a seller may make general representations and warranties associated with the sale. In addition, the seller may agree to indemnify the buyer for events that occurred prior to the sale (e.g., environmental or litigation exposure). When a sales agreement includes a provision that may cause the seller to not receive all of the stated sales proceeds (or to return some or all of the initial sales consideration), consideration should be given to the amount and timing of recognition of the gain or loss on sale.
Absent evidence to the contrary, general representations and warranties provided by the seller as a part of the sale are usually valid as of the sale date. A future claim by the buyer is usually not expected and therefore would not affect the gain or loss recognized on the date of sale.
If the representations and warranties are indemnifications that fall under the guidance of ASC 460-10-15-4(c) (within the "Guarantees" subtopic), a liability should be recorded at the sale date by the seller (i.e., the seller should recognize the potential for a future cash outflow resulting from the indemnifications). The nature of the indemnifications determines whether they would be within the scope of ASC 460-10. ASC 460-10-15-4(c) refers to indemnification agreements that "contingently require the indemnifying party (guarantor) to make payments to an indemnified party (guaranteed party) based on changes in an underlying that is related to an asset, a liability, or an equity security of the indemnified party." In applying this guidance, a general representation and warranty as to the authorized capital stock of an acquired entity, a common item included in acquisition agreements, would not represent an indemnification within the scope of ASC 460-10 as it is not related to a change in an underlying asset, liability, or equity security. On the other hand, if the seller offered an indemnification limiting a buyer’s economic exposure to a specific foreign tax position related to an entity being sold, it would most likely be appropriate to recognize a liability for the fair value of the guarantee following the guidance in ASC 460-10 (see TX 15.8 for further guidance on tax-related indemnifications).
If the guarantee was created in conjunction with the contemporaneous transfer of a nonfinancial asset, it would represent a distinct element outside the scope of ASC 610-20. Accordingly, a reporting entity would reduce the transaction price of the nonfinancial asset by the fair value of the guarantee liability. The residual transaction price would be allocated to the remaining elements, as discussed in PPE 6.2.3. This is further explored in Example PPE 6-2.
EXAMPLE PPE 6-2
Calculating the gain or loss on the sale of a long-lived asset when the seller provides an indemnification
Calculating the gain or loss on the sale of a long-lived asset when the seller provides an indemnification
Seller Corp sells a machine with a carrying value of $5,000 to Buyer Corp for $8,000. The sales price can be reduced by up to $1,000 based on Buyer Corp’s verification of Seller Corp’s representation of the machine’s tax basis. Seller Corp concludes that the tax indemnification is within the scope of ASC 460. In accordance with ASC 460-10, Seller Corp recognizes a liability for the fair value of the tax indemnification at the date of the sale, which is estimated to be $500.
How should Seller Corp determine the gain to be recognized upon sale of the machine?
Analysis
Seller Corp would record a $2,500 gain in the period of the disposal of the machine, which is equal to the sales price less the carrying value less the fair value of the indemnification ($8,000-$5,000-$500).
Indemnifications, guarantees, and warranties not within the scope of ASC 460-10 should be evaluated to determine if such amounts represent variable consideration. If such amounts are determined to be variable consideration, the seller should evaluate whether the amounts to be received from the buyer at a future date, would be constrained. See PPE 6.2.5.1 for further details.
In some disposal transactions, part of the consideration for the sale of an asset is held in an escrow account and released to the seller at a later date, usually upon the passage of time or upon the satisfaction of certain considerations. Proceeds held in escrow may represent variable consideration (i.e., based on future events occurring or conditions being met) or collateralize the seller’s representations and warranties associated with the sale. When an escrow arrangement is established, the seller should consider the accounting implication of the arrangement. Assuming the proceeds in escrow are not included on the seller’s balance sheet, it may be appropriate to recognize a receivable for part or all of the proceeds held in an escrow account at the time of sale and to include such amounts as part of the consideration received for the sale of the asset when determining the gain or loss on sale. Recognition of amounts in escrow is further explored in Example PPE 6-3.
EXAMPLE PPE 6-3
Recognition of amounts in escrow
Recognition of amounts in escrow
Seller Corp sold one of its manufacturing facilities, Plant A, to Buyer Corp for $10 million in cash, of which $1 million was placed in an escrow account. The $1 million set aside is to be used to compensate Buyer Corp for any violations of the general representations and warranties listed in the purchase agreement. Seller Corp is not aware of any potential claims and has assessed the probability of having incurred a violation to be insignificant. Barring any violations, the cash in the escrow account will be released to Seller Corp one year after the sale. Management has determined that the $1 million in the escrow account does not represent contingent consideration.
How should the $1 million in the escrow account be recognized by Seller Corp?
Analysis
As management of Seller Corp has determined its representations and warranties do not represent indemnifications within the scope of ASC 460-10, and the probability that a violation will occur is insignificant, the entire sales price of $10 million, which includes the $1 million held in escrow, should be recorded at the closing date and considered in determining the gain or loss on sale of Plant A.
6.2.2 Determining the derecognition model for the disposal
After determining whether the contract is partially in the scope of other topics and determining what is part of the disposal transaction, each disposal should be evaluated to determine the appropriate derecognition guidance to apply in accounting for the transaction. Figure PPE 6-2 provides a decision tree for evaluating the applicable derecognition model for various nonfinancial asset disposals and references where further details can be found.
Figure PPE 6-2
Determining assets that are in the scope of ASC 610-20 for derecognition
Determining assets that are in the scope of ASC 610-20 for derecognition
6.2.2.1 Determining whether a sale is to a customer
Per ASC 610-20-15-4(a), if the counterparty in the transaction is a customer and the assets being transferred are an output of the reporting entity’s ordinary activities, the transaction is within the scope of ASC 606. As stated in ASC 606, a customer is a party that has contracted with an entity to obtain goods or services that are an output of the reporting entity’s ordinary activities in exchange for consideration (e.g., a car manufacturer sells a car that it produced to a customer, a homebuilder sells a home that it developed to a customer). Transactions with customers are addressed in PwC’s guide, Revenue from contracts with customers. See RR 2.4 for further guidance on identifying the customer in a contract.
The sale of a nonfinancial asset that is not an output of the reporting entity’s ordinary activities would be accounted for under ASC 610-20 because the counterparty does not meet the definition of a customer for that specific transaction. For example, when a telecommunications company sells its phone service to a customer, the phone service is considered to be an output of that company’s ordinary activity. However, if the same company sells that counterparty trucks that it no longer needs to maintain its equipment, the trucks are not an output of the company’s ordinary activity and are not considered to be a sale to a customer.
A counterparty to the contract would not be a customer if the counterparty has contracted with the entity to participate in an activity or process in which the parties to the contract share in the risks and benefits that result from the activity or process (such as developing an asset in a collaboration arrangement) rather than to obtain the output of the reporting entity’s ordinary activities.
Determining whether the counterparty to a disposal arrangement is a customer is important as revenue from contracts with customers will follow the guidance in ASC 606. While ASC 610-20 includes certain recognition and measurement principles of ASC 606, there are different presentation and disclosure requirements. For example, transactions with customers will be reported in revenue and cost of goods sold under ASC 606 while transactions with non-customers will usually be presented as a gain or loss included in income from continuing operations before income taxes under ASC 610-20 (per the guidance in ASC 610-20-45-1, which refers to the guidance in ASC 360-10-45-5 for presentation of the gain or loss on sale).
This determination could also impact the elimination of intercompany profits and losses for transfers of nonfinancial assets between an investor and an equity method investee. The guidance in ASC 323-10-35-7 provides an exception which excludes arm’s-length transactions when an investor sells a nonfinancial asset that is in the scope of ASC 610-20 to an equity method investee. Under the exception, when an equity method investor sells a nonfinancial asset that is within the scope of ASC 610-20 to its equity method investee in an arm’s-length transaction, the investor is not required to eliminate the intercompany gain or loss on sale from this transaction. See EM 4.2 for further details regarding the elimination of intercompany transactions for investments accounted for under the equity method.
6.2.2.2 Sale of a business
Per ASC 610-20-15-4(b), if the transferred set meets the definition of a business under ASC 805 and is not a sale to a customer, the transaction is within the scope of the derecognition guidance in ASC 810, regardless of whether a legal entity is transferred. For additional guidance on the definition of a business, see BCG 1.2.
ASC 810-10-40 requires the reporting entity to deconsolidate a subsidiary or derecognize a group of long-lived assets as of the date the reporting entity ceases to have a controlling financial interest. Full gain or loss is recognized in net income in the period of deconsolidation or derecognition. See BCG 5.5 for further details regarding the sale of businesses.
6.2.2.3 Sale of financial assets under ASC 860
Per ASC 610-20-15-4(e), if the transaction is entirely within the scope of ASC 860 (e.g., the only asset transferred in the transaction is a financial asset), then apply ASC 860. When a sale includes both financial and nonfinancial assets, the financial assets will be within the scope of ASC 610-20 if they are determined to be in substance nonfinancial assets. See PPE 6.2.2.5 for details regarding which financial assets are determined to be in substance nonfinancial assets.
Financial assets under the scope of ASC 860 include the transfer of investments accounted for under ASC 323, Investments - Equity Method and Joint Ventures. Regardless of whether the sale is of an entire position or a partial sale of an equity method investment, entities should apply the guidance contained in ASC 860 to assess such transfers. Under ASC 610-20, entities will no longer “look through” these investments to determine if the underlying assets should be accounted for under other guidance, as was previously required under the real estate-specific guidance. For example, if a reporting entity only sells its interest in an equity method investment (i.e., the company does not sell the interest in conjunction with other assets or liabilities), the transaction would be entirely within the scope of ASC 860, even if the only assets held by the equity method investee are nonfinancial assets.
6.2.2.4 Other scope exceptions (ASC 610-20)
In addition to the scope exceptions for a sale to a customer, sale of a business, and transfer of financial assets, there are other scope exceptions in ASC 610-20-15-4, these exceptions include:
- Sale and leaseback transactions within the scope of ASC 842-40 (or prior to adoption of ASC 842, a real estate sale-leaseback transaction or a non-real estate sale-leaseback transaction within the scope of ASC 360-20 or ASC 840-40, respectively). See LG 6 for more information on accounting for sale and leaseback transactions.
- Conveyances of oil and gas mineral rights within the scope of ASC 932-360
- Transfers of nonfinancial assets that are part of the consideration in a business combination within the scope of ASC 805, which should be recorded following ASC 805-30-30-8. See PwC’s Business combinations and noncontrolling interests guide for details on accounting for business combinations.
- Nonmonetary exchanges within the scope of ASC 845. See PPE 2.3.1.1 for details on accounting for nonmonetary exchanges in an asset acquisition.
- Lease contracts within the scope of ASC 842 (or ASC 840 prior to the adoption of ASU 2016-02, Leases). See PwC’s Leases guide for details on accounting for leases.
- Transfers of nonfinancial or in substance nonfinancial assets solely between entities under common control. See BCG 7 for more information on the accounting for common control transactions.
- An exchange of takeoff and landing slots within ASC 908-350
- A contribution of cash and other assets, including a promise to give, within the scope of ASC 720-25, Other expenses - Contributions made, or ASC 958-605, Not-for-profit entities – Revenue recognition.
- Transfer of an investment in a venture accounted for by proportionate consolidation, as described in ASC 810-10-45-14
6.2.2.5 Nonfinancial assets and in substance nonfinancial assets
If one of the scope exceptions in ASC 610-20 does not apply, the reporting entity will need to determine whether the assets transferred are nonfinancial assets or in substance nonfinancial assets, which are in the scope of ASC 610-20. Some examples of nonfinancial assets include intangible assets, long lived assets (e.g., land, building, machinery, equipment), materials, and supplies.
In substance nonfinancial assets are defined in ASC 610-20-15-5.
Excerpt from ASC 610-20-15-5
An in substance nonfinancial asset is a financial asset (for example, a receivable) promised to a counterparty in a contract if substantially all of the fair value of the assets (recognized and unrecognized) that are promised to the counterparty in the contract is concentrated in nonfinancial assets.
If substantially all of the fair value of the assets that are promised in a contract is concentrated in nonfinancial assets, the financial assets promised to the counterparty are considered to be in substance nonfinancial assets and are in the scope of ASC 610-20. For example, if a reporting entity transfers a building and receivables that together do not comprise a business to a non-customer and substantially all of the fair value is concentrated in the building (i.e., a nonfinancial asset), the receivables would be considered in substance nonfinancial assets. Consequently, both the building and the receivables would follow the derecognition guidance in ASC 610-20 (i.e., the receivables are not in the scope of ASC 860 for derecognition).
ASC 610-20 does not define what constitutes “substantially all.” However, the term is used in other areas of GAAP (e.g., definition of a business, leases) and, while not a bright line, is typically interpreted to mean approximately 90% or greater.
Cash, cash equivalents, deferred taxes, and liabilities are excluded from the determination of whether substantially all of the fair value of the assets transferred is concentrated in nonfinancial assets. Cash transferred with the assets should be considered a reduction of the transaction price, consistent with ASC 606 for consideration payable to a customer. See RR 4.6 for details.
If a transaction includes the transfer of multiple assets that are transferred either as a direct ownership interest in the individual assets or transferred through an ownership interest in one or more consolidated subsidiaries, the transaction should be assessed in the aggregate to determine if it is in the scope of ASC 610-20. When a reporting entity transfers an ownership interest in one or more consolidated subsidiaries (that is not a business), it must look to the underlying assets of the subsidiaries for this determination. If the assets transferred in the transaction are comprised of substantially all nonfinancial assets, the transaction is accounted for under ASC 610-20. Otherwise, each individual asset and each individual subsidiary will be evaluated separately to determine whether they are within the scope of ASC 610-20.
When a transferred subsidiary is not in the scope of ASC 610-20 (e.g., the transaction in the aggregate is not comprised of substantially all nonfinancial assets and when assessed individually the subsidiary is not comprised of substantially all nonfinancial assets), the entire subsidiary would be derecognized using the guidance in ASC 810-10-40-3A(c) or ASC 810-10-45-21A(b)(2), unless other guidance addresses the substance of the transaction (e.g., ASC 805, ASC 606, ASC 845, ASC 860, ASC 932). When derecognizing the subsidiary, the reporting entity should not separate the individual assets transferred; rather, the entire subsidiary should be derecognized under the same derecognition model.
When an ownership interest in an unconsolidated entity (e.g., equity method investments, investments in joint ventures) is transferred, the investor does not need to evaluate the underlying assets of the investee. The ownership interest of an equity investee is a financial asset.
Example PPE 6-4, Example PPE 6-5, and Example PPE 6-6 illustrate the evaluation of financial assets and nonfinancial assets sold in a single transaction that, when combined, are not a business or sale to a customer. Figure PPE 6-2 is a decision tree which includes an overview of the evaluation of nonfinancial assets and in substance nonfinancial assets, including those held in consolidated subsidiaries.
EXAMPLE PPE 6-4
Transfer of subsidiaries – Substantially all of the fair value is concentrated in nonfinancial assets
Transfer of subsidiaries – Substantially all of the fair value is concentrated in nonfinancial assets
Seller Corp transfers ownership interests in Subsidiaries A and B to Buyer Corp, a non-customer. Individually and when combined, Subsidiaries A and B are not businesses and contain the following types of assets at fair value, excluding cash.
Financial |
Nonfinancial |
Percent nonfinancial |
|
Subsidiary A |
$5 |
$95 |
95% |
Subsidiary B |
3 |
7 |
70% |
$8 |
$102 |
93% |
Should Seller Corp derecognize Subsidiary A and Subsidiary B using the guidance in ASC 610?
Analysis
Yes. Given that substantially all of the fair value of the underlying assets on an aggregate basis is concentrated in nonfinancial assets (i.e., 93% nonfinancial assets), all of the financial assets are considered in substance nonfinancial assets. Consequently, the assets in Subsidiary A and Subsidiary B would be derecognized by Seller Corp using the guidance in ASC 610-20.
EXAMPLE PPE 6-5
Transfer of subsidiaries - Substantially all of the fair value is not concentrated in nonfinancial assets
Transfer of subsidiaries - Substantially all of the fair value is not concentrated in nonfinancial assets
Seller Corp transfers ownership interests in Subsidiaries C and D to Buyer Corp, a non-customer. Individually and when combined Subsidiaries C and D are not businesses and contain the following types of assets at fair value, excluding cash.
Financial |
Nonfinancial |
Percent nonfinancial |
|
Subsidiary C |
$5 |
$95 |
95% |
Subsidiary D |
30 |
70 |
70% |
$35 |
$165 |
83% |
Should Seller Corp derecognize Subsidiary C and Subsidiary D using the guidance in ASC 610?
Analysis
On an aggregate basis, substantially all of the fair value of the underlying assets is not concentrated in nonfinancial assets (i.e., 83% nonfinancial assets). Therefore, each of the entities would be evaluated separately. The assets in Subsidiary C would be derecognized under ASC 610-20 because substantially all of the fair value of the underlying assets in that subsidiary is concentrated in nonfinancial assets (i.e., 95% nonfinancial assets). However, the guidance in ASC 810 would be applied to the transfer of Subsidiary D.
EXAMPLE PPE 6-6
Transfer of subsidiaries and other individual assets - Substantially all of the fair value is not concentrated in nonfinancial assets
Transfer of subsidiaries and other individual assets - Substantially all of the fair value is not concentrated in nonfinancial assets
Seller Corp transfers ownership interests in Subsidiaries C and D to Buyer Corp, a non-customer. Additionally, in conjunction with the transfer, Seller Corp transfers ownership interests in other individual assets, which include its interest in an equity method investment and its interest in a long-lived asset (equipment). Individually and when combined the individual assets, Subsidiary C and Subsidiary D are not businesses and contain the following types of assets at fair value, excluding cash.
Financial |
Nonfinancial |
Percent nonfinancial |
|
Individual assets |
$8 |
$92 |
92% |
Subsidiary C |
5 |
95 |
95% |
Subsidiary D |
30 |
70 |
70% |
$43 |
$257 |
86% |
Should Seller Corp derecognize the individual assets, Subsidiary C, and Subsidiary D using the guidance in ASC 610?
Analysis
On an aggregate basis, substantially all of the fair value of the underlying assets is not concentrated in nonfinancial assets (i.e., 86% nonfinancial assets). Therefore, each distinct asset and each individual subsidiary would be evaluated separately. The equity method investment is a financial asset and will be derecognized under ASC 860. The long-lived asset is a nonfinancial asset and will be derecognized under ASC 610-20. The assets in Subsidiary C would be derecognized under ASC 610-20 because substantially all of the fair value of the underlying assets in that subsidiary is concentrated in nonfinancial assets (i.e., 95% nonfinancial assets). However, the other relevant guidance in ASC 810 would apply to the transfer of Subsidiary D.
6.2.2.6 Examples of typical disposal transactions
Figure PPE 6-3 summarizes the main categories of disposal transactions and where such disposals are further discussed, either in this chapter or in other PwC guides.
Figure PPE 6-3
Key types of disposal transactions
Key types of disposal transactions
Type of transactions |
Accounting literature |
Reference for more information |
|---|---|---|
Sale of nonfinancial assets * that meet the definition of a business to a noncustomer |
||
Sale of a legal entity that owns substantially all nonfinancial assets * or that is otherwise in the scope of ASC 610-20 |
||
Contribution of nonfinancial assets * to an entity in exchange for an equity method investment in that entity |
||
Contribution of nonfinancial assets * to an entity in exchange for an equity interest in that entity accounted for under ASC 321 |
||
Contribution of nonfinancial assets * to a joint venture in exchange for an interest in that joint venture |
||
Other transactions |
||
Sale of an undivided interest accounted for using the proportionate consolidation method |
CG 6.4 |
|
Sale of a legal entity that does not own substantially all nonfinancial assets * and that is not otherwise in the scope of ASC 610-20 |
||
Distribution of nonfinancial assets that constitute a business to owners in a spinoff transaction |
||
* This includes real estate. ASC 610-20 eliminated specific guidance for sales of real estate and in substance real estate. However, a conveyance of oil and gas mineral rights was and continues to be excluded from the scope of the referenced guidance. See ASC 932 for guidance on conveyances of oil and gas mineral rights and related transactions.
** This includes when an investee owns substantially all real estate or in substance real estate. The ASC 860 scope exception for sales of in substance real estate was removed by ASU 2017-05, which clarifies that the sale of an equity method investment in a real estate venture is no longer treated as an in substance sale of real estate. Instead, those transactions are required to be analyzed like any sale of an ownership interest subject to the sales of financial assets guidance in ASC 860.
6.2.3 Allocating consideration partially within the scope of ASC 610-20
In some transactions the contract may be partially within the scope of ASC 610-20 and partially within the scope of other topics. When nonfinancial assets are transferred directly (i.e., not through the sale of ownership interests in a legal entity) and do not represent substantially all of the fair value of the assets transferred, the contract may be partially within the scope of ASC 610-20 and partially within the scope of other guidance. Additionally, as discussed in PPE 6.2.1.1, guarantees that are in the scope of ASC 460 are also outside the scope of ASC 610-20. In such instances, the guidance in ASC 610-20-15-9 directs entities to consider the separation and allocation guidance within ASC 606. ASC 606-10-15-4 requires each part of the contract to be evaluated to determine if other applicable guidance specifies how to separate and measure the element. The portion of the contract for which other guidance specifically applies would be separated and/or initially measured based on that guidance. If the other guidance does not specifically address how to determine the consideration for the element, the allocation would be performed based on the relative standalone selling prices. See RR 2.2 for additional detail regarding how to identify and separate parts of a contract that are partially within the scope of ASC 606 and ASC 610-20. Each element would then be derecognized based on the relevant disposal model applicable to that element. Example PPE 6-7 provides an example of allocating consideration to each transferred element.
EXAMPLE PPE 6-7
Derecognition using multiple models
Derecognition using multiple models
Real Estate Corp enters into a contract to transfer several real estate-related assets to PPE Corp for $2,500. The asset group includes one wholly-owned office building (the nonfinancial asset) as well as several equity method investments holding similar real estate assets (the financial assets). The set is not a business, PPE Corp is not considered a customer, no liabilities are transferred with the set, and ownership in a legal entity that is (or has been) previously consolidated under ASC 810 was not transferred. The carrying and fair values of the assets promised are as follows (assume the fair value amounts are equal to the stand alone selling prices).
Carrying value |
Fair value |
|
Office building |
$1,100 |
$1,350 |
Equity method investments |
1,000 |
1,150 |
$2,100 |
$2,500 |
How would Real Estate Corp allocate the contract consideration between the components?
Analysis
Substantially all of the fair value of the assets promised in the contract is not concentrated in nonfinancial assets because of the significant amount of financial assets (i.e., equity method investments).
The office building would be derecognized using the nonfinancial asset guidance in ASC 610-20. The equity method investments would be derecognized using the financial asset guidance in ASC 860. Depending on the facts and circumstances and the application of the respective guidance in ASC 610-20 and ASC 860, these assets may not be derecognized at the same time. There may also be different disclosure or presentation requirements for assets that are derecognized under different topics. As a result, it would be necessary to separate and allocate consideration to each asset in the transaction.
Since ASC 860 does not specifically address the determination of the transaction price when a group of transferred assets includes assets within the scope of ASC 860, the separation and allocation guidance in ASC 606 should be applied. Accordingly, $1,350 of the transaction price would be allocated to the office building (the transaction price of $2,500 × 54% (standalone selling price of the office building of $1,350 / total standalone price of $2,500)). The remaining transaction price of $1,150 ($2,500 × 46%) would be allocated to the equity method investments, which would be derecognized in accordance with ASC 860.
6.2.4 Derecognition of nonfinancial assets
In order for a reporting entity to derecognize assets that are within the scope of ASC 610-20, the entity must transfer control of the assets to the counterparty. To determine if an entity has transferred control of the assets, the seller should first evaluate whether it has (or continues to have) a controlling financial interest under ASC 810 (see PPE 6.2.4.1).
If the reporting entity determines it does not have a controlling financial interest in either the entity that holds the assets (if ownership interests are transferred) or the counterparty (if the asset is directly transferred), the entity should evaluate whether the arrangement meets the contract criteria in ASC 606-10-25-1 (see PPE 6.2.4.2).
If the contract criteria are met, the reporting entity should next evaluate whether there are separate and distinct assets being transferred (see PPE 6.2.4.3). Each distinct asset will need to be evaluated to consider whether the counterparty obtains control over the distinct asset following the criteria in ASC 606 (see PPE 6.2.4.4). When the counterparty obtains control of the distinct asset, the asset will be derecognized, and the reporting entity will need to determine the resulting gain or loss upon derecognition (see PPE 6.2.5).
If the contract criteria are not met, the entity would continue to recognize the asset and apply the guidance in ASC 350-10-40-3 or ASC 360-10-40-3C. Additionally, the entity will record a liability for any consideration received and apply the guidance in ASC 606-10-25-8. Subsequently, the entity will continue to assess the contract to determine the point at which the contract criteria are met (see PPE 6.2.4.2).
When the contract criteria have been met, but the counterparty has not yet obtained control over the distinct asset, the entity will not derecognize the asset and will apply the guidance in ASC 606-10-45-2 to record a liability for any consideration received (see PPE 6.2.4.4).
Figure PPE 6-4 includes an overview of the guidance to consider when determining whether to derecognize an asset in the scope of ASC 610-20.
Figure PPE 6-4
Derecognition under ASC 610-20
Derecognition under ASC 610-20
6.2.4.1 Assessing if the transferor has lost control in an asset disposal
In accordance with ASC 610-20-25-2, a reporting entity should first assess whether it has lost control of the assets following the guidance under ASC 810. This analysis will differ based on whether the transferor sold the assets directly or indirectly through the transfer of a controlled subsidiary. If the assets are transferred directly, the transferor must not have a controlling financial interest in the transferee that receives the assets. If transferred indirectly through a controlled subsidiary, the transferor must relinquish control of the transferred subsidiary to demonstrate loss of control. For example, assume an entity holds nonfinancial assets within a consolidated subsidiary that is not a business and sells a noncontrolling interest in that subsidiary to a third party (i.e., the entity continues to consolidate the subsidiary under ASC 810). Since the selling entity controls the subsidiary before and after the transaction, the subsidiary would not be derecognized and will apply the guidance in ASC 810-10-45-21A through ASC 810-10-45-24. See CG 1.4.2.2 for the accounting considerations related to the loss of control.
Partial sales transactions
A long-lived asset may be partially disposed of either by sale or by other means, such as an exchange. In a partial sales transaction, an entity usually transfers control of a nonfinancial asset in exchange for a noncontrolling interest in the counterparty. Sometimes when a nonfinancial asset is held in a subsidiary and control is lost, a partial interest in the subsidiary is transferred in exchange for cash, and a noncontrolling interest in the subsidiary is retained.
Partial sales are most common in the real estate industry but also occur in other industries. Prior to the adoption of ASC 610-20, all partial sales of real estate were in the scope of ASC 360-20. Under ASC 360-20, the retained portion not subject to sale was held at its pro-rata carryover basis subsequent to the transaction and a gain or loss was only recorded to the extent of the sold portion. Under ASC 610-20, partial sales are not treated differently from other sales. For example, when a partial sale transaction is within the scope of ASC 610-20 and the derecognition criteria have been met, the entire gain or loss on sale would be recorded. Example PPE 6-8 illustrates the accounting for a partial sale under ASC 610-20.
Under ASC 610-20, the consideration received by the seller in partial sales transactions will be measured using the concepts in ASC 606. For example, non-cash consideration (e.g., a noncontrolling interest in the buyer of the nonfinancial assets) will be measured at its fair value.
EXAMPLE PPE 6-8
Partial sale of real estate
Partial sale of real estate
PPE Corp owns 100% of an office building that is not a business and has a carrying value of $50 and a fair value of $100. PPE Corp transfers the entirety of its interest in the office building to Real Estate Corp for $60 and a 40% noncontrolling interest in Real Estate Corp, which held no assets or liabilities other than the cash required to purchase a 60% interest in the office building. As a result, the fair value of Real Estate Corp is $100 after the transfer. Prior to the transaction, Real Estate Corp is owned by an unrelated third party that is not a customer in this transaction.
How should PPE Corp determine the gain on the sale of the office building?
Analysis
PPE Corp’s effective ownership interest in the office building is reduced from 100% to 40% as a result of the transaction. The noncontrolling interest (accounted for under the equity method) that PPE Corp has accepted as partial consideration for the transfer is valued at $40 ($100 fair value of Real Estate Corp × 40% ownership interest). Total consideration transferred is $100 ($60 in cash + $40 noncontrolling interest).
Consideration received is $100 and the building’s previous carrying value was $50, so a gain of $50 would be recognized. The equity investment in Real Estate Corp would be recognized at its fair value of $40.
Partial sales transactions may occur when two or more parties form an accounting joint venture (or other entity) and no single party has a controlling financial interest. If any entity transfers nonfinancial assets to an accounting joint venture (i.e., a corporate joint venture, see EM 6 for further details) in return for an investment in the venture, it may recognize the full gain or loss under ASC 610-20. Whether the full gain or loss is recognized depends on whether the seller has transferred control of the assets to the joint venture. That is, for the purpose of determining whether control has transferred when an entity receives a noncontrolling interest in a legal entity in exchange for a nonfinancial asset, ASC 610-20-25-7 states that control should be obtained by the legal owner. Example PPE 6-9 provides an illustration of a partial sale transaction with an accounting joint venture following the adoption of ASC 610-20.
EXAMPLE PPE 6-9
Sale of nonfinancial asset to an accounting joint venture
Sale of nonfinancial asset to an accounting joint venture
PPE Corp and Manufacturing Corp form Venture Co, an accounting joint venture in which neither party is determined to have a controlling financial interest under ASC 810. In exchange for their ownership interests, PPE Corp and Manufacturing Corp contributed manufacturing equipment and cash, respectively. The sale of manufacturing equipment is not part of PPE Corp’s ordinary business activities.
Should PPE Corp recognize a gain upon the sale of the manufacturing equipment to Venture Co?
Analysis
Yes. The transfer of nonfinancial assets to a joint venture will result in the loss of control by the transferor as PPE Corp does not have a controlling financial interest in Venture Co and Venture Co has gained control of the nonfinancial assets. The joint venture is not considered a customer as the sale of manufacturing equipment is not part of PPE Corp’s ordinary business activities. If the joint venture is determined to have gained control of nonfinancial assets, PPE Corp would record (1) its investment in Venture Co at fair value and (2) the full gain or loss upon derecognition of the nonfinancial assets sold. Additionally, PPE Corp should consider whether the recognition of its interest in Venture Co at fair value results in any equity method basis differences (for example, if Venture Co recognizes the assets received at PPE Corp’s historical cost).
6.2.4.2 Determining whether the contract criteria have been met
When assessing whether the transferee has gained control of an asset in the scope of ASC 610-20, the transferor must determine whether the contract criteria in ASC 606-10-25-1 have been met.
An entity shall account for a contract with a customer that is within the scope of this Topic only when all of the following criteria are met:
- The parties to the contract have approved the contract (in writing, orally, or in accordance with other customary business practices) and are committed to perform their respective obligations.
- The entity can identify each party’s rights regarding the goods or services to be transferred.
- The entity can identify the payment terms for the goods or services to be transferred.
- The contract has commercial substance (that is, the risk, timing, or amount of the entity’s future cash flows is expected to change as a result of the contract).
- It is probable that the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer (see paragraphs 606-10-55-3A through 55-3C). In evaluating whether collectibility of an amount of consideration is probable, an entity shall consider only the customer’s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession (see paragraph 606-10-32-7).
Each of these criteria are discussed further in RR 2.6.1.1 through RR 2.6.1.5.
The criteria that addresses collectability may be one of the more subjective areas in this analysis. When seller financing is provided as a part of the transaction, the asset being sold may serve as collateral for the financing (e.g., nonrecourse debt). As noted in ASC 606-10-55-3C, the entity’s ability to repossess an asset transferred should not be considered for the purpose of assessing the entity’s ability to mitigate its exposure to credit risk. For additional accounting considerations related to a financing component, refer to PPE 6.2.5.2.
If an arrangement does not meet all of the criteria in ASC 606-10-25-1, a contract does not exist for accounting purposes and a reporting entity should not derecognize the assets transferred. Instead, the reporting entity should continue to report the assets in its financial statements and apply the guidance in ASC 350-10-40-3 for any intangible assets or ASC 360-10-40-3C for any property, plant, and equipment. Subsequently, the reporting entity should continue to assess whether the contract criteria in ASC 606-10-25-1 have been met.
Any consideration received before the contract criteria have been met should be recorded as a liability until one of the events described in ASC 606-10-25-7 has occurred, or until the contract criteria in ASC 606-10-25-1 have been met. Refer to RR 2.6.2 for further discussion.
Example PPE 6-10 illustrates the accounting for nonrecourse seller financing when consideration is received prior to the derecognition of the nonfinancial asset.
EXAMPLE PPE 6-10
Sale of a nonfinancial asset subject to nonrecourse debt and consideration is received prior to derecognition
Sale of a nonfinancial asset subject to nonrecourse debt and consideration is received prior to derecognition
On January 16, 20X1, Manufacturing Corp sells a manufacturing facility with a carrying value of $1.2M to XYZ Corp for $5M. XYZ Corp makes a nonrefundable payment of $500,000 in conjunction with the transfer on January 16, 20X1. Manufacturing Corp provides nonrecourse debt for the remaining $4.5M.
The facility was closed prior to the sale and will require significant capital improvements before XYZ Corp can begin operating the facility. The nonrecourse debt is payable at the earlier of five years from the date of sale (i.e., January 16, 20X6), or one year from the commencement of operations at the facility. On January 16, 20X1, it is uncertain whether XYZ Corp will be able to generate sufficient cash proceeds at the facility to repay the nonrecourse debt of $4.5M.
On September 9, 20X1, XYZ Corp began operating the manufacturing facility. On December 31, 20X1, Manufacturing Corp concluded that it was probable that XYZ Corp will be able to repay the debt when due on September 9, 20X2. On December 31, 20X1, Manufacturing Corp also concluded that XYZ Corp obtained control over the asset following the guidance in ASC 606, as they obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from the asset (see PPE 6.2.4.4 for considerations regarding control).
The terms of the nonrecourse debt, including the interest rate, are determined to be at market for this transaction. The accounting for interest has been excluded for the purposes of this example.
The transaction is not a sale to a customer, does not represent the sale of a business, and does not meet any of the other scope exceptions in ASC 610-20. As such, Manufacturing Corp has concluded that the transaction is within the scope of ASC 610-20.
How should Manufacturing Corp account for the sale of the manufacturing facility on January 16, 20X1 and on December 31, 20X1?
Analysis
On January 16, 20X1 and up until December 31, 20X1, the transaction does not meet the contract criteria under ASC 606-10-25-1 because Manufacturing Corp concluded that it is not probable that substantially all of the consideration is collectible. Although the debt is secured by the underlying asset (i.e., the manufacturing facility), the value of the asset cannot be taken into consideration when determining whether the consideration is collectible. The $500,000 that Manufacturing Corp received on the date of sale would be considered collectible, as it is nonrefundable; however, it does not represent substantially all of the contract consideration of $5M.
As a result, consistent with the guidance in ASC 360-10-40-3C, Manufacturing Corp would not derecognize the facility and would not record the note receivable. Given that the contract criteria have not been met and control of the asset (under ASC 606) has not transferred to the buyer, the consideration received of $500,000 will be recorded as a liability.
On December 31, 20X1, Manufacturing Corp has concluded that the contract criteria under ASC 606-10-25-1 have been met and that XYZ Corp has obtained control over the asset. As a result, Manufacturing Corp will derecognize the nonfinancial asset, record a gain on sale, and record a note receivable for the nonrecourse debt outstanding.
The following journal entry would be recorded on January 16, 20X1:
Dr. Cash |
$500,000 |
|
Cr. Contract liability |
$500,000 |
The following journal entry would be recorded on December 31, 20X1:
Dr. Note receivable |
$4,500,000 |
|
Dr. Contract liability |
$500,000 |
|
Cr. Manufacturing facility |
$1,200,000 * |
|
Cr. Gain on sale |
$3,800,000 * |
*The impact of any depreciation expense recorded during the period from January 19, 20X1 to December 31, 20X1 has been excluded. During this period, Manufacturing Corp would apply the guidance in ASC 360-10-40-3C to determine the appropriate amount of depreciation to record, if any.
6.2.4.3 Identifying distinct assets
Once a contract meets the criteria in ASC 606-10-25-1, the reporting entity should identify the distinct assets promised to the counterparty and derecognize each distinct asset once it has transferred control over it. See PPE 6.2.4.4 for further details regarding control. For many transactions within the scope of ASC 610-20, control over each asset in the contract will transfer at the same time (e.g., nonfinancial assets sold through the sale of a subsidiary). This means that the assets transferred would be derecognized at the same time. Therefore, in practice, the reporting entity may not need to separate and allocate the consideration to each distinct asset. However, for other transactions within the scope of ASC 610-20, control over each distinct asset may not transfer at the same time. This would result in those assets being derecognized at different points in time, making it necessary to separate and allocate consideration to each distinct asset in the transaction.
Each distinct asset is the unit of account for the purposes of applying the derecognition guidance and will form the basis for how and when the asset is derecognized. An asset is distinct when it meets both of the criteria in ASC 606-10-25-19. The first criteria is that the counterparty can benefit from the asset on its own or with other resources that are readily available. The second criteria is that the asset must be separately identifiable from other promises in the contract. For further discussion over these two criteria, refer to RR 3.4. For information on determining the unit of account for indefinite-lived intangible assets, refer to BCG 8.3.2.1.
6.2.4.4 Determining whether the transferee has gained control
After determining that the transferor has lost control of the asset under ASC 810 (see PPE 6.2.4.1) and that the contract criteria in ASC 606 have been met (see PPE 6.2.4.2), ASC 610-20 requires the transferee to gain control under ASC 606 before the transferor can derecognize the distinct asset(s). ASC 606-10-25-25 defines control as “the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset,” including the ability to prevent others from directing the use of the asset and obtaining the benefits from it. ASC 606-10-25-30 includes indicators to consider in determining when control of an asset transfers to the buyer.
If a performance obligation is not satisfied over time in accordance with paragraphs 606-10-25-27 through 25-29, an entity satisfies the performance obligation at a point in time. To determine the point in time at which a customer obtains control of a promised asset and the entity satisfies a performance obligation, the entity shall consider the guidance on control in paragraphs 606-10-25-23 through 25-26. In addition, an entity shall consider indicators of the transfer of control, which include, but are not limited to, the following:
- The entity has a present right to payment for the asset—If a customer presently is obliged to pay for an asset, then that may indicate that the customer has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset in exchange.
- The customer has legal title to the asset—Legal title may indicate which party to a contract has the ability to direct the use of, and obtain substantially all of the remaining benefits from, an asset or to restrict the access of other entities to those benefits. Therefore, the transfer of legal title of an asset may indicate that the customer has obtained control of the asset. If an entity retains legal title solely as protection against the customer’s failure to pay, those rights of the entity would not preclude the customer from obtaining control of an asset.
- The entity has transferred physical possession of the asset—The customer’s physical possession of an asset may indicate that the customer has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset or to restrict the access of other entities to those benefits. However, physical possession may not coincide with control of an asset. For example, in some repurchase agreements and in some consignment arrangements, a customer or consignee may have physical possession of an asset that the entity controls. Conversely, in some bill-and-hold arrangements, the entity may have physical possession of an asset that the customer controls. Paragraphs 606-10-55-66 through 55-78, 606-10-55-79 through 55-80, and 606-10-55-81 through 55-84 provide guidance on accounting for repurchase agreements, consignment arrangements, and bill-and-hold arrangements, respectively.
- The customer has the significant risks and rewards of ownership of the asset—The transfer of the significant risks and rewards of ownership of an asset to the customer may indicate that the customer has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. However, when evaluating the risks and rewards of ownership of a promised asset, an entity shall exclude any risks that give rise to a separate performance obligation in addition to the performance obligation to transfer the asset. For example, an entity may have transferred control of an asset to a customer but not yet satisfied an additional performance obligation to provide maintenance services related to the transferred asset.
- The customer has accepted the asset—The customer’s acceptance of an asset may indicate that it has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. To evaluate the effect of a contractual customer acceptance clause on when control of an asset is transferred, an entity shall consider the guidance in paragraphs 606-10-55-85 through 55-88.
All of the indicators do not need to be met for the entity to conclude that control has transferred. These indicators need to be evaluated collectively to determine whether they indicate that the transferee has obtained control over the distinct asset. This assessment should be focused primarily on the transferee’s perspective. For further discussion related to these indicators, refer to RR 6.5.
In evaluating whether the transferee has obtained control, all terms of the contract need to be considered, including whether there are any post-sale restrictions or repurchase agreements (e.g., call options, forward options, put options). These arrangements are discussed in more detail in the following sections.
ASC 610-20-25-7 clarifies that when a reporting entity has a noncontrolling interest in the legal entity that acquires a distinct asset, the determination of whether the transferee has gained control is evaluated at the legal entity (i.e., transferee); that is, the determination is based on whether the legal entity has obtained control over the assets.
When a reporting entity concludes that the transferee has not yet obtained control over a distinct asset, the reporting entity will not derecognize the asset and subsequently, will continue to evaluate the guidance to determine the point at which the transferee obtains control over the asset. Any consideration received from the transferee, including any liabilities assumed by the transferee, in advance of obtaining control over the asset will be recorded as a contract liability following the guidance in ASC 610-20-45-2 and ASC 610-20-45-3.
Repurchase agreements
Under ASC 606-10-25-30(c), repurchase arrangements may preclude derecognition because while physical possession has transferred, another party has the right to dictate the future ownership of the asset, which indicates that control has not transferred. The accounting for a sale of a nonfinancial asset with a repurchase agreement depends on whether the agreement is (1) a seller repurchase right (i.e., a call option) or obligation (i.e., a forward agreement), or (2) a buyer repurchase right (i.e., a put option).
Call options and forward agreements
ASC 606 indicates that when a call option or forward agreement exists, a sale has not occurred and that the accounting for the arrangement is determined by the exercise price of the repurchase option. If the repurchase amount is greater than or equal to the original selling price, the arrangement should be accounted for as a financing transaction. If the repurchase amount is less than the original selling price, it should be accounted for as a lease, unless the contract is part of a sale-leaseback transaction. See RR 8.7.1 for further details.
If the arrangement is to be accounted for as a lease, the arrangement should be accounted for as a lease regardless of whether it meets the definition of a lease under ASC 842 (or ASC 840 prior to adoption). However, lease classification (operating, sales type, or direct financing) should be determined under the applicable leases guidance for each asset. Generally, when consideration transferred for the nonfinancial asset is greater than or equal to its carrying value, these arrangements would be accounted for as sales-type leases based on the lease accounting guidance, and the lessor would derecognize the nonfinancial asset despite control not being transferred under ASC 606 (and therefore ASC 610-20).
ASC 606 does not distinguish between the types of call options or discuss their specific terms. The implementation guidance and accompanying examples in ASC 610-20 and ASC 606 illustrate the accounting implications associated with fixed price call options that are exercisable by the seller without any restrictions. We believe there may be instances when the mere existence of a call option does not preclude sale accounting. The assessment of whether or not a call option precludes sale accounting should consider the substance of the call option. Factors that may impact whether the call option is substantive include the amount of the repurchase price (e.g., fixed, fair value, or formula priced) and its relationship to the fair value of the underlying asset(s), the presence and probability of any exercise contingencies associated with the option, and time to expiry, among other factors. Additionally, we believe that a fair value call option on a nonfinancial asset that is readily obtainable in the marketplace would not preclude sale accounting. However, not all call options with a fair value exercise price would result in sales treatment, as ASC 606 requires that the buyer obtains control of the asset.
We believe call options that are conditionally exercisable upon the occurrence of an event or other factors that are not within the control of the seller would not necessarily preclude sale accounting. In determining whether control has transferred to the buyer, reporting entities should evaluate the nature and conditions associated with the exercisability of the call option, the likelihood that the exercise conditions will be met, and whether the exercise conditions are based on factors outside the seller’s control. A call option that is nonsubstantive also would not preclude sale treatment (absent other factors). For example, a deep out-of-the-money call option whose exercise is remote is unlikely to have economic substance.
Put options
Generally, put options would not preclude sale accounting, as the buyer is able to obtain control of the asset and has the option, but not the obligation, to require the seller to reacquire the nonfinancial asset. However, ASC 606 indicates that under certain circumstances, a sale may not occur and the arrangement would be required to be accounted for as a financing or lease (see lease considerations for call options). Consideration should be given to circumstances when the asset sold is unique or otherwise illiquid such that the buyer (i.e., option holder) may have a significant economic incentive to exercise the put option. See RR 8.7.2 for a detailed framework for evaluating put options.
Post-sale restrictions
In considering whether a buyer has gained control of the transferred nonfinancial or in substance nonfinancial assets, ASC 606-10-25-30 notes that physical possession may indicate that the customer has the ability to direct the use of, and obtain substantially all of the remaining benefits from the transferred assets. However, physical possession may not always coincide with the buyer gaining control of the transferred assets. Consideration should be given to post-sale restrictions imposed by the seller that could directly or indirectly impede the buyer from otherwise directing the use of and obtaining substantially all of the remaining benefits from the transferred assets. Absent other factors, we generally would not expect that terms such as transfer restrictions when approval of the subsequent transfer is not to be unreasonably withheld, rights of first refusal, or regulatory limitations would preclude the buyer from obtaining control of the transferred nonfinancial or in substance nonfinancial assets under ASC 606-10-25-30.
6.2.5 Measuring the gain or loss on a disposal
Once a reporting entity determines that it should derecognize an asset under ASC 610-20, the gain or loss on the transfer must be determined. The gain or loss is calculated as the difference between the consideration allocated to each distinct asset and its carrying amount. Refer to PPE 6.2.5.6 for details regarding the allocation of consideration to more than one distinct asset.
Nonfinancial assets will likely be subject to impairment testing prior to derecognition, therefore significant losses are not expected upon derecognition. See PPE 5 for details on impairment testing and PPE 5.3 for considerations related to held for sale accounting.
Determining the consideration received in a contract can be complex as total consideration may not be for a fixed amount. See PPE 6.2.5.1 for discussion of variable consideration. The transaction may also include a financing component that may need to be separately accounted for. See PPE 6.2.5.2 for details. Total consideration may take various forms, such as noncash consideration (see PPE 6.2.5.3), consideration payable to the buyer (see PPE 6.2.5.4), or liabilities that are assumed or relieved by the buyer (see PPE 6.2.5.5).
6.2.5.1 Variable consideration
Entities are required to estimate the amount of variable consideration to which they are entitled. Entities will need to estimate variable consideration, including contingent consideration associated with the sale, using either an expected value or most likely amount method (see RR 4.3.1). As discussed in ASC 606, variable consideration may take various forms including, but not limited to, price concessions, volume discounts, rebates, refunds, credits, incentives, performance bonuses, milestone payments, and royalties.
Variable consideration promised for a nonfinancial asset may include payments that are contingent upon the occurrence or nonoccurrence of one or more future events. Generally, these contingent payments should be accounted for as variable consideration. However, consideration should be given to whether the contingency is unrelated to the nonfinancial asset that is sold or the performance of one of the parties to the contract. In such cases, reporting entities should also consider whether the variable consideration arrangement is or contains a derivative that should be accounted for separately under ASC 815. See RR 4.3 for details regarding the recognition of variable consideration, including additional examples.
Variable consideration can only be included in a reporting entity's estimate of consideration when it is probable that the amount will not be subject to a significant reversal in the future (i.e., constraint on variable consideration). The assessment of whether variable consideration should be constrained is largely a qualitative one that has two elements: the magnitude and the likelihood of a change in estimate. The estimate of variable consideration and evaluation of the constraint on variable consideration should be reassessed at each reporting period, with any subsequent changes recorded in the income statement. See RR 4.3.2 for further details.
Example PPE 6-11 provides an example of variable consideration in a contract.
EXAMPLE PPE 6-11
Variable consideration subject to constraint
Variable consideration subject to constraint
Pharma Corp sells rights to certain in-process research and development assets (IPR&D) that have a fair value of $100 million (book value of $75 million). Pharma Corp has concluded that the IPR&D assets are subject to the nonfinancial asset derecognition guidance because they do not comprise a business and are not an output of its ordinary activities that would be considered a contract with a customer. The buyer has agreed to pay $10 million in cash at closing and will pay a royalty equal to 3% of sales derived from the IPR&D for the next five years. The royalty payments to be received by Pharma Corp were determined to not be a freestanding or embedded derivative under ASC 815.
Derecognition is appropriate because Pharma Corp does not have a controlling financial interest in the buyer (under ASC 810), and the buyer has taken control of the IPR&D (under ASC 606).
What consideration should Pharma Corp recognize upon sale?
Analysis
Pharma Corp should recognize a $65 million contract loss on sale ($75 million carrying value less $10 million upfront payment). Although Pharma Corp can develop an estimate of the sales-based royalties and does not expect to ultimately incur a loss on this transaction, the variable consideration is considered “constrained” in accordance with ASC 606-10-32-11, as Pharma Corp cannot conclude it is probable that recognizing the variable royalties in other income would not result in a significant reversal. (Note that the constraint on estimates of variable consideration is different than the narrow exception granted for licenses of intellectual property with consideration in the form of sale or usage-based royalties whereby such royalties are not recognized until usage occurs. See RR 4.3.5 for details.) Pharma Corp should update its estimate at each reporting date until the uncertainty associated with the royalties is resolved. In subsequent periods, Pharma Corp should reassess the variable consideration and record other income for any amount that is no longer subject to the “constraint.”
6.2.5.2 Significant financing component
In certain situations, consideration may be transferred significantly before or significantly after the buyer obtains control of the nonfinancial asset. These contracts may contain either an explicit or implicit financing component. This financing component should be assessed to determine whether it represents a significant financing component that needs to be recorded. The amount of consideration may need to be adjusted for the time value of money by discounting it, with an appropriate discount rate, over the expected payment period and recording the difference over time as either interest income or expense, as appropriate. Any explicit rate in the contract should be assessed to determine if it represents a prevailing rate for a similar transaction, or if a more representative rate should be imputed. See RR 4.4 for further details.
The guidance in ASC 606-10-32-18 provides a practical expedient that allows entities to disregard the effects of a financing component if the entity expects, at contract inception, that the period between when the entity transfers the asset and when the counterparty pays for that asset will be one year or less. See RR 4.4.2 for further details.
6.2.5.3 Noncash consideration
Noncash consideration transferred, such as equity shares or inventory, needs to be measured at fair value at contract inception and included when determining the transaction price (i.e., when the transfer has met the criteria in ASC 606-10-25-1). This may be different than the date when the noncash consideration is received by the transferor. See RR 4.5 for details.
The reporting entity may not be able to reliably determine the fair value of noncash consideration in some situations. In this case the value of the noncash consideration received should be measured indirectly by reference to the standalone selling price of the assets transferred by the reporting entity.
6.2.5.4 Consideration payable to a counterparty
An entity might pay, or expect to pay, consideration to the buyer. The consideration payable can be cash, either in the form of rebates or upfront payments, or could alternatively be a credit or some other form of incentive that reduces amounts owed to the entity by a counterparty. Consideration payable to a counterparty is recorded as a reduction of the consideration transferred, unless the payment is for a distinct good or service received from the counterparty. See RR 4.6.1 for further details.
6.2.5.5 Liabilities that are assumed or relieved
As noted in ASC 610-20-32-5, if a counterparty promises to assume or relieve a liability of an entity in exchange for a transfer of assets, the transferring entity should include the carrying amount of the liability in the consideration used to calculate the gain or loss on the net asset sale.
As discussed in ASC 610-20-45-3, a reporting entity will apply other guidance to derecognize the liability (e.g., ASC 405). If a reporting entity transfers control of an asset before derecognizing a liability assumed by a counterparty, the reporting entity would recognize a contract asset to the extent the carrying amount of the liability is included in the calculation of the gain or loss. Conversely, if a reporting entity transfers control of an asset after derecognizing a liability assumed by a counterparty, the reporting entity would recognize a contract liability.
A reporting entity is still required to perform impairment testing in accordance with applicable guidance for the assets to be disposed (e.g., ASC 360, ASC 350) prior to derecognition. For example, nonfinancial assets subject to nonrecourse debt that are determined to be impaired under ASC 360 may need to be written down to fair value that is less than the carrying value of the debt. Often, this occurs in foreclosures of real estate. In situations when the real estate has been written down to a value below the carrying amount of the debt, a net gain upon derecognition will result, largely comprised of a gain on debt forgiveness. See Example PPE 5-7 in PPE 5.2.5 for additional considerations for debt in impairment testing.
6.2.5.6 Allocating consideration to more than one distinct asset
When a contract includes the transfer of more than one distinct asset, an entity should allocate the consideration to each distinct asset in accordance with ASC 606-10-32-28 through ASC 606-10-32-41. Generally, this means that the consideration will be allocated to the distinct assets based on their relative standalone selling price. The objective is for an entity to allocate the consideration in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the distinct asset to the counterparty. For further details on the determination of the standalone selling price and other considerations related to the allocation of consideration, refer to RR 5.
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