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Excerpts from Speeches by the Staff of the Office of the Chief Accountant through December 6, 2001

Prepared by staff members of the Office of the Chief Accountant
U.S. Securities and Exchange Commission
Washington, D.C.

Summary: This document contains excerpts from speeches made in years prior to 2001 by the staff of the Office of the Chief Accountant. The excerpts contained in this document address matters with broad applicability that the FASB is currently addressing or that the staff plans to refer to the EITF for possible further consideration as well as matters related to pooling-of-interests accounting under Accounting Principles Board Opinion No. 16, Business Combinations. The staff believes that these views provide an accurate presentation of current practice. The views on pooling-of-interests accounting will be removed from this website once the transition period for FASB Statements NO. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets, has ended. The views on the remaining matters will be removed once resolved by the FASB or the EITF process.

Table of Contents

Business Combination Issues — other than Pooling

A. Common control transactions (Coallier, 1997)

B. Joint ventures - Gain recognition upon formation (Book, 1993)

C. LBO — Definition of "highly leveraged" in the context of EITF 88-16 (SEC staff, 1992)

D. Push down accounting where public debt is not significant (Casey, 1999)

E. Other

1. Reverse spin-off accounting (Blackley, 2000)

2. Leveraged recapitalization of a division (Casey, 1998)

Speech Outline

Business Combination Issues — Other than Pooling

A. Common control transactions (Coallier, 1997)

Another frequent question in registrant submissions over the last year is: How to account for combinations of, or transfers or exchanges between, entities with a high degree of common ownership? Specifically, the staff is asked to concur that these transactions should be accounted for at historical cost. In assessing whether to account for these transactions at historical cost or fair value, two questions are relevant:

Are the entities under common control as described in AIN 391 and does the transfer lack substance as described in FTB 85-5?2

When there is a transfer or an exchange between companies under common control, AIN 39 states that "assets and liabilities so transferred would be accounted for at historical cost in a manner similar to that in pooling-of-interests accounting".3 Registrants have asserted that common control exists between different companies when there is common majority ownership by an individual, a family, or a group affiliated in some other way.

Common control between different companies often exists when one shareholder holds more than 50% of the voting ownership of each company. Common control may also exist when a group of shareholders holds more than 50% of the voting ownership of each company, and all members of the group agree to vote those shares in concert.

The staff generally does not object to assertions that immediate family members vote their shares in concert absent evidence contradicting those assertions. The staff believes immediate family members include a married couple and their children, but not the married couple's grandchildren. Businesses owned in varying combinations by a married couple and their children or among living siblings and their children may be viewed by the staff to be under common control.

However, the staff has objected to assertions that different companies owned by individuals that are not members of an immediate family are under common control unless there is contemporaneous written evidence of an agreement to vote a majority of an entity's shares in concert. The staff has not accepted oral agreements as evidence of common control outside of an immediate family. Nor has the staff accepted new agreements as evidence that the companies were operated under common control in the past.

B. Joint ventures — Gain recognition upon formation (Book, 1993)

Another aspect of accounting by the investor involves the propriety of gain recognition upon the contribution of assets to a joint venture. The staff's position has been, and continues to be, that contributing assets to a joint venture is not the culmination of the earnings process — it is an exchange of a portion of operating assets for a 50% interest in a larger pool of operating assets. The staff has modified its position when cash is received for the contribution of assets, and certain other conditions are met. This is similar to the guidance provided in SOP 78-9, Accounting for Investments in Real Estate Ventures. Sometimes, cash is paid to balance the fair market values of the contributed assets.

For example, Company A contributes a business with a book value of $30 and a fair value of $100. Company B contributes a business with a book value of $20 and a fair value of $70, plus cash of $30. The joint venture then pays the $30 to Company A. The staff would not object to recognition of up to 50% of the indicated gain by Company A, limited to the amount of cash received. (Thus the calculated $35 gain would be limited to $30).

This assumes that Company A has no obligation to refund the cash to the joint venture or to Company B. The staff has also allowed gain recognition to the extent that other near-cash, monetary assets or traded, marketable securities are part of the settlement.

C. LBO — Definition of "highly leveraged" in the context of EITF 88-16 (SEC staff, 1992)

One of the criteria for the application of EITF 88-16, "Basis in Leveraged Buyout Transactions", to a purchase transaction is that the acquisition be highly leveraged. The SEC staff believes that a 60 percent or greater debt financed transaction would meet the highly leveraged test. If the transaction is 50 percent or more debt financed it is probably highly leveraged. Acquisitions involving leverage of significantly less than 50 percent would not meet the criteria for following EITF Issue 88-16 accounting.

D. Push down accounting where public debt is not significant (Casey, 1999)

In a recent registrant matter, a parent entity proposed buying out the minority interest in its majority owned subsidiary. The subsidiary had convertible debt outstanding that traded on a foreign exchange. The question posed to the staff was whether the parent, after buying out the minority interest, was required to push its basis down to the subsidiary's financial statements for purposes of any separate issuance of the subsidiary's financial statements. The parent intended to effect an IPO of the subsidiary shortly after the minority interest buyout.

The interpretive response to Question 2 in SAB 544 states, "The staff recognizes that the existence of outstanding public debt, preferred stock, or a significant minority interest in a subsidiary might impact the parent's ability to control the form of ownership. Although encouraging its use, the staff generally does not insist on the application of push down accounting in these circumstances"

The registrant argued that SAB 54 refers to significance only in the context of minority interest, not public debt, indicating that push down accounting is not required where any public debt is outstanding at the subsidiary level. Because its subsidiary had convertible public debt outstanding, the registrant believed that it was not required to push its basis down to the subsidiary's stand alone financial statements that would be filed with the subsequent planned public offering of subsidiary shares.

The staff objected to the registrant's conclusions.

The staff believes that fair value information may generally be more relevant or meaningful to financial statement users than historical cost information. Furthermore, the staff believes that SAB 54 recognizes that as the population of investors or users of financial statements decreases and the majority investor's ability to control the subsidiary's form of ownership increases, fair value information prevails over continuity of the subsidiary's historical cost financial information. So, while SAB 54 does not explicitly refer to significance of public debt, the staff believes that it is reasonable and consistent with the general principles in SAB 54 to consider the significance of public debt in assessing the applicability of push down accounting. To do otherwise would also appear to establish a different threshold for investors in public debt than for minority interest holders without an obvious conceptual basis for creating such a distinction.

In evaluating the significance of public debt, the staff believes that it is reasonable and appropriate to consider both the quantitative and qualitative significance of the public debt. In this specific registrant's fact pattern, the staff concluded that the public debt was neither quantitatively nor qualitatively significant. Quantitatively, the debt amounted to approximately 5 percent of the subsidiary's net book value and less than 1 percent of the subsidiary's fair value. The debt holders, in the aggregate, would hold an approximately 1 percent interest in the subsidiary on an as-if-converted basis. Qualitatively, the debt holders had virtually no ability to control or influence the form of the parent's ownership of its subsidiary, nor did the debtholders have any consent rights regarding the buying out of the existing minority interests, issuing subsidiary equity, or the subsidiary paying dividends.

Because the outstanding public debt was neither quantitatively nor qualitatively significant, the staff believes the parent is required to apply pushdown accounting.

E. Other

1. Reverse spin-off accounting (Blackley, 2000)

The staff has received questions about whether a spin-off must be accounted for in accordance with the legal form or if it may be accounted for in accordance with its substance, often referred to as a "reverse spin-off." Let me provide an example; assume Oldco distributed the stock of a subsidiary, ABC Company, to its shareholders. As part of a planned transaction, immediately following the spin-off, Oldco is acquired by another entity. The intent of the series of transactions is for Oldco to dispose of all of its operations except ABC Company.

In my example, assume that ABC Company was larger than the post spin-off Oldco based on estimated fair value, total historical assets and net assets, revenue and net income. On that basis, some believe that the accounting for the transaction should be that of a reverse spin-off that does not follow the legal form, instead reflecting the substance of the transaction. In a reverse spinoff, the financial statements of each entity are presented as if the legal spinee, ABC Company, had spun-off the legal spinnor, Oldco.

Some accountants believe that from the perspective of the shareholders of ABC Company, the transaction was the sale of all of the Oldco operations other than ABC Company and the continuation of ABC Company's operations. Frequently in these types of transactions, the legal form of the spin-off is based on tax consequences and has little to do with the substance of the transaction. In my example, had Oldco sold all of its operations except ABC Company and then distributed the resulting cash or equity proceeds as a dividend to shareholders, the sale would have been taxable to Oldco and the dividend would have been taxable to the shareholders.

The staff believes that reverse spin-off accounting is permitted only when it is the most relevant presentation and clearly is a faithful representation of the transaction. Accordingly, evaluating when reverse spin-off accounting is appropriate requires the use of sound professional judgment and consideration of whether shareholders are best served by a presentation that differs from the legal form. The staff has considered the following indicators of when reverse spin-off accounting is appropriate:

  • Which company retained the executive management and officers of the formerly combined enterprise?
  • Is the entity to be treated as the continuing enterprise for accounting purposes larger than the entity being spun-off? All relevant factors should be considered in measuring relative size such as revenue, operating earnings and net income as well as both book value and fair value of total and net assets.
  • Did tax-planning consequences have a significant impact on the legal form?

In regards to the presentation of a reverse spin-off, the staff has also considered if the sale of Oldco must be presented as a distribution of the legal spinnor to the shareholders. Some have asked if the transaction may be presented as the sale of the legal spinnor followed by a distribution of the proceeds, resulting in the recognition of a gain or loss on disposal. This question arises since Oldco was sold immediately following the spin-off of ABC Company.

The staff believes the provisions of APB 295 indicate that the spin-off transaction should be reflected as a distribution of Oldco, recorded at net book value. In addition, APB 29 requires that prior to the spin-off the net book value of Oldco must be reduced for impairment, when indicated.

In the example of Oldco and ABC Company, the staff observes that neither company would receive the proceeds from the sale of Oldco. Rather, in the example the proceeds from the sale of Oldco would go directly to the shareholders. In addition, had the company received the proceeds, an additional tax liability would have been incurred. These substantive factors indicate that reflecting the distribution of Oldco at net book reflects the substance of the transaction.

2. Leveraged recapitalization of a division (Casey, 1998)

The staff recently considered a transaction where a parent and a new financial investor entered into a planned series of integrated transactions in order to transfer control of a division. The staff concluded that the transactions could notbe separated but rather should be viewed as a single transaction.

As background assume a Parent wanted to dispose of a division within one of its wholly owned subsidiaries. In order to accomplish this, Parent and financial investor negotiated the following series of transactions. First, Parent formed Newco, a wholly owned subsidiary, immediately transferring the net assets and business operations of the division to it. Second, Newco issued shares to a financial investor and incurred debt. Third, using the proceeds from the sale of shares and the debt, Newco repurchased Parent's shares in Newco. Upon completion of the transactions Parent's ownership interest in Newco was diluted down to 6%, with the financial investor owning the remaining 94%.

The formation of surviving Newco and the transfer of net assets and business operations of the division into surviving Newco were integral conditions of the transaction. The steps were necessary in order to accommodate investment by new investors and facilitate the financing and collateralization of the debt incurred in the recapitalization. The issue presented to the staff was whether the planned subsequent steps, which resulted in a change in control of Newco, should result in a change in basis of the net assets of Newco at the Newco level. The registrant analogized to EITF Issue 94-26 and SAB 477 in arguing that the change in control should not result in a new basis of accounting at the Newco level.

The staff objected to this conclusion. In the staff s view, this was an integrated, planned series of transactions negotiated by the parent and a new financial investor or collaborative group in conjunction with transferring control of the division to the new investor or collaborative group. That is, the parent participated with a known counterparty to establish the structure and order of transactions so as to facilitate the transfer of control of the business to the counterparty. Therefore, in the facts and circumstances presented, the two steps (transferring assets and obtaining control) could not be separated. The staff believed that they should be viewed as a single transaction.

Furthermore, if this integrated, planned series of transactions had been structured such that the financial investor had formed the surviving Newco, this transaction would have been within the scope of EITF Issue 88-168 and partial step up at the Newco level would have been required. The staff did not believe the negotiated form of the transaction between parent and financial investor should yield a different accounting conclusion. The staff therefore concluded that the basis of the division's net assets transferred to Newco should be recorded at fair value as specified by EITF Issue 88-16.


1 AICPA Accounting Interpretation 39 to APB Opinion No. 16, Business Combinations (AIN 39), addresses transfers and exchanges between entities under common control.

2 FASB Technical Bulletin No. 85-5 (FTB 85-5) addresses issues relating to accounting for business combinations, including stock transactions between companies under common control.

3 AIN 39 also states that "purchase accounting applies when the effect of a transfer or exchange is to acquire all or part of the outstanding shares held by the minority interest of a subsidiary". FTB 85-5 provides guidance on determining whether a minority interest is acquired.

4 Staff Accounting Bulletin No. 54, Application of "Pushdown" Basis of Accounting in Financial Statements of Subsidiaries Acquired by Purchase (SAB 54).

5 See paragraph 23 of Accounting Principles Board (APB) Opinion No. 29, Accounting for Nonmonetary Transactions.

6 EITF Issue No. 94-2, Treatment of Minority Interests in Certain Real Estate Investment Trusts.

7 Staff Accounting Bulletin No. 47, Financial Statements of Oil And Gas Producers, Exchange Offers.

8 EITF Issue 88-16, Basis in Leveraged Buyout Transactions.



Modified: 08/27/2004