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Going for a spin: Accounting and reporting for spinoffs · PwC's accounting podcast

0:00
SPEAKER_00: Thought Leadership from PWC's National Office.
0:07
SPEAKER_02: Hello and welcome to PWC's Accounting Podcast.
0:10
SPEAKER_02: I'm Heather Horn.
0:12
SPEAKER_02: Today we're diving into the world of spin-off transactions, a topic that's top of mind for many companies looking to unlock value and refine their strategic focus.
0:21
SPEAKER_02: If a spin-off is on your radar, it's important to understand the unique accounting and reporting implications that these transactions bring with them.
0:28
SPEAKER_02: In today's episode, we'll discuss key considerations and share insights to help you navigate the complexities.
0:37
SPEAKER_02: Joining me for the conversation today, I'm happy to welcome back to the podcast Matt Sabatini and Katie Dreessen, both partners and PWC's national office.
0:46
SPEAKER_01: Happy to be here.
0:47
SPEAKER_02: Thank you for having us.
0:48
SPEAKER_02: Thanks both.
0:49
SPEAKER_02: All right.
0:49
SPEAKER_02: So as I said in the intro, today we're going to talk about some of the key accounting issues that we need to think about when companies are executing spin-off transactions.
0:57
SPEAKER_02: And I think spin, spin-off, some of this terminology is something our listeners will have heard the terms, but often they may not be familiar with actually what that means or how you define if you have a spin transaction.
1:12
SPEAKER_02: So, Matt, maybe just to start things off, can you explain what we mean when we say a spin and how that might be different than other types of disposals or divestitures, such as the sale?
1:23
SPEAKER_01: Sure.
1:24
SPEAKER_01: Happy to.
1:25
SPEAKER_01: So I think you're right that um the term spin-off is probably one of those terms that's used very broadly, right?
1:31
SPEAKER_01: Like so the the layperson's terminology of spin off might be um we want to spin our technology off or right.
1:38
SPEAKER_01: We want to so it it is a defined term in gap, right?
1:41
SPEAKER_01: So it's like joint ventures, right?
1:43
SPEAKER_01: Joint ventures, a lot of times out in the in the in the world, is used very loosely and very broadly to a lot of things, but it is a defined term in gap.
1:49
SPEAKER_01: So for spin-offs, right, it's defined in AAC 50560.
1:54
SPEAKER_01: I promise that's the last time I'm gonna say that.
1:57
SPEAKER_01: Um and it's it's defined as a transfer of assets that constitute a business into a new legal entity, followed by a prorata distribution of those shares of the new entity to the to the spin-or's shareholder group.
2:12
SPEAKER_01: So I know that was a lot, right?
2:13
SPEAKER_01: So we break it if we break it down to steps, it's a lot easier to think about, right?
2:16
SPEAKER_01: So it's essentially the transfer of a business to the existing shareholders, right?
2:20
SPEAKER_01: So think about a parent, which we often call the spin-or, um, decides for whatever reason, and we could talk about a few of them, um, that it wants to distribute a business that it owns to its shareholders.
2:30
SPEAKER_01: What it would do is transfer that business into a new legal entity, take the shares of that legal entity and make a pro-rata distribution to its shareholders.
2:37
SPEAKER_01: Almost like uh you're dividending out the shares of that new entity to your shareholders.
2:43
SPEAKER_01: It's important to understand, you know, I used some terminology there on purpose.
2:46
SPEAKER_01: I said pro-rata distribution.
2:48
SPEAKER_01: So that's a key determining feature of a of a spin-off in order to get what we call spin-off accounting.
2:53
SPEAKER_01: And trust me, we're gonna go into what that means.
2:55
SPEAKER_01: All right, so that was one important term.
2:57
SPEAKER_01: Um, and the other thing is that it's it's gotta be a non-reciprocal transaction, right?
3:02
SPEAKER_01: So you gotta have a situation where it's a one-way transfer of the shares of the new entity to your existing shareholders and not receiving something in return.
3:10
SPEAKER_01: So you're not getting cash back, you're not getting shares of the parent back.
3:13
SPEAKER_01: When the spin is executed, this new legal entity that I'm talking about really becomes its own standalone reporting entity, right?
3:19
SPEAKER_01: It's got its own shareholders, which happen to be your old shareholders is the spin or and it's got its own capital structure.
3:25
SPEAKER_01: Um so the other term that I made sure to focus on and and will continue to do so is that the it's important that the set of assets that the spin or has put into the new legal entity meets the definition of a business.
3:37
SPEAKER_01: And that's you know the definition that's consistent in a on the buy side under AAC 805.
3:42
SPEAKER_01: Um, because if you don't meet the definition of a business, then spin accounting doesn't get applied.
3:47
SPEAKER_01: Um I know I said there might be a variety of reasons why companies might think about or enter into a spin transaction.
3:54
SPEAKER_01: Um it could be a way to maybe unlock value from uh a subsidiary that wasn't getting enough um attention or capital or resources.
4:02
SPEAKER_01: It could be a way for a parent or spinor to refocus on core operations or core business by divesting or spinning of non-core operations.
4:10
SPEAKER_01: Um the other time we see it come up is kind of in anticipation of a merger transaction.
4:15
SPEAKER_01: Um it's a transaction we see called the rever reverse Morris Trust.
4:19
SPEAKER_01: And I promise I won't get into too much details, but it's a tax-driven transaction where the first step is a spin-off, a tax-free spin off and an accounting spin uh of a subsidiary.
4:26
SPEAKER_01: And then that subsidiary merges into a third-party company.
4:30
SPEAKER_02: All right.
4:30
SPEAKER_02: Sounds like if you're doing that transaction, they need to call you.
4:33
SPEAKER_01: That's fair.
4:34
SPEAKER_02: All right.
4:35
SPEAKER_02: So, Matt, I think that's helpful background.
4:38
SPEAKER_02: I will definitely have some follow-up questions as we go along.
4:41
SPEAKER_02: But Katie, I'm gonna go to you because I obviously people hear the term spin, spin-off.
4:47
SPEAKER_02: And now Matt has made it very clear that you can't use like a colloquial definition.
4:52
SPEAKER_02: You need to make sure you meet this definition in the ASCs.
4:55
SPEAKER_02: But the other term people use sometimes is a split-off.
4:58
SPEAKER_02: And so can you just explain the difference?
5:00
SPEAKER_02: Are those the same?
5:01
SPEAKER_02: What does it mean if I say I'm doing a split-off?
5:04
SPEAKER_03: Yeah, absolutely.
5:05
SPEAKER_03: Um, it's a great question.
5:06
SPEAKER_03: And they may seem similar at face value, but they are actually different and are treated quite differently from an accounting perspective.
5:13
SPEAKER_03: So, in a split-off, um, a parent entity will give its shareholders the opportunity to exchange some of their parent entity stock for an interest in one of their subsidiaries.
5:22
SPEAKER_03: So there's optionality here.
5:23
SPEAKER_03: The shareholders do not have to participate in that offer.
5:27
SPEAKER_03: So, versus in a spin-off, this distribution is going to happen on a pro rata basis with all their shareholders.
5:32
SPEAKER_03: Um, that's really important from a treatment perspective on the accounting side.
5:36
SPEAKER_03: To get to a spin-off treatment, there has to be this pro-rata distribution.
5:40
SPEAKER_03: Um, so you may have a situation in a split-off that there are some shareholders that have shares in just the parent entity, they have shares in just the subsidiary entity or some of both.
5:49
SPEAKER_03: And for that reason, um, because you don't have this pro-rata form, it's treated similarly to the sale of a business.
5:56
SPEAKER_03: So quite a different perspective from an accounting standpoint.
5:58
SPEAKER_02: All right.
5:59
SPEAKER_02: So people could go back to last week's episode to hear the guidance on sale of a business.
6:04
SPEAKER_02: Um, Matt, I know you briefly touched on this, but let me just ask a follow-up question.
6:08
SPEAKER_02: So we've talked about a sale, we've talked about abandonment, which you told us last episode, it's not common.
6:13
SPEAKER_02: You talked about spins, Katie just talked about a split.
6:16
SPEAKER_02: Um, I know you guys both have worked with a lot of companies that are contemplating how to, I'll say, monetize a subsidiary or some other part of the business.
6:26
SPEAKER_02: From a practical point of view, it's probably a whole episode.
6:30
SPEAKER_02: But how do people really think through which of these avenues makes the most sense for them?
6:36
SPEAKER_01: Yeah, I mean, I'm sure there are a ton of factors that'll probably go into it.
6:39
SPEAKER_01: What I often hear folks say, and maybe there's a little cynical, that is like what are the tax impacts?
6:44
SPEAKER_01: So a lot of them are tax-driven.
6:46
SPEAKER_01: A lot of them are also strategic.
6:48
SPEAKER_01: Um, but ultimately I think one of the main reasons folks pursue a spin-off is because it's a tax-free way to make a distribution of property to your shareholders, right?
6:55
SPEAKER_01: Most distributions to shareholders of assets or or stock are actually taxable transactions, and and this one is not.
7:02
SPEAKER_01: So it is heavily, heavily driven by tax.
7:05
SPEAKER_02: Um Yeah, I was focused on the fact that, oh, if you have a sale, you are actually bringing capital into the business.
7:12
SPEAKER_02: But I guess then you would say, well, you could also sell shares to bring capital into the business.
7:16
SPEAKER_02: So or there's other ways to bring in capital besides selling your subsidiaries.
7:21
SPEAKER_01: That's fair.
7:21
SPEAKER_01: And it's not always tax, right?
7:23
SPEAKER_01: So you are right, that is a way to raise capital, right?
7:25
SPEAKER_01: Um, so so there could be there could be multiple reasons driving the which strategy folks pursue.
7:31
SPEAKER_01: And frankly, a lot of companies pursue multiple at the same time.
7:33
SPEAKER_01: And we talked about that on our last podcast as well, right?
7:36
SPEAKER_02: Yeah, just to see what makes the most sense.
7:38
SPEAKER_02: Okay, well, let's move on so we can get into the accounting.
7:40
SPEAKER_02: But before we do that, uh, Matt, one of the things I always think is so interesting as we talk about, you know, a spin, but then there's this whole concept of a reverse spin-off.
7:49
SPEAKER_02: And so what does that really mean?
7:52
SPEAKER_01: Right.
7:52
SPEAKER_01: I guess I'll start with that a reverse spin-off happens.
7:56
SPEAKER_01: It's it's a concept out there, but it is rare.
7:58
SPEAKER_01: I know you like when I tell you things.
8:00
SPEAKER_02: This one's really rare.
8:02
SPEAKER_01: This one really is, though.
8:02
SPEAKER_01: So, like it's a similar concept to when you're on the on the buy side, and we've talked about this in our accounting acquirer podcast as well.
8:09
SPEAKER_01: Um, when you when you have a share deal, you're trying to figure out which entity in a business combination is the accounting acquirer.
8:15
SPEAKER_01: Well, here in the spin, you could have a situation where the legal form spin, really the legal form spin over is the smaller of the two companies or the legal spin or the entire management team senior management team is going with the spin E or the spin co.
8:29
SPEAKER_01: Um in those situations, it feels more like the spin was actually reversed, right?
8:34
SPEAKER_01: So that that's the concept behind it is that you would actually account for the spin-off reverse of how the legal form worked.
8:40
SPEAKER_01: And that's why it's called the reverse spin-off.
8:42
SPEAKER_01: The criteria that I just went through are kind of the ones you would look at.
8:46
SPEAKER_01: The different the biggest difference between this and and the accounting acquired determination is there is a rebuttable presumption included in the spin-off guidance that the legal spin-off is going to be the accounting spin-off as well.
8:57
SPEAKER_01: So there's a rebuttable presumption.
8:58
SPEAKER_01: You've got to have like really high thresholds to overcome that on these criteria in order to start accounting for it in the reverse way.
9:05
SPEAKER_02: Okay.
9:05
SPEAKER_02: That's helpful just from a sort of context setting.
9:08
SPEAKER_02: So let's focus then on and just plain, I'll say plain vanilla spin-off if there is such a thing.
9:15
SPEAKER_02: But really, sort of you meet the definition of spin-off, and now we have to think about the accounting for that.
9:21
SPEAKER_02: And so, Katie, maybe you can start, and then I have a lot of questions.
9:24
SPEAKER_03: Sounds good.
9:25
SPEAKER_03: Um, so when a spin-off happens, that entity is going to be issuing new shares to the spin-or shareholders.
9:31
SPEAKER_03: Um, usually the spin is executed at the same time as an initial listing of those shares of the spin-e company.
9:37
SPEAKER_03: Um, they're typically registered with the SEC through a Form 10 registration statement.
9:42
SPEAKER_03: And that form 10 will include standalone carve-out historical financial statements and other required information.
9:48
SPEAKER_03: So proformas, for example.
9:50
SPEAKER_02: All right.
9:50
SPEAKER_02: So I already have two questions that I sort of meant to ask before.
9:53
SPEAKER_02: Um, and either one of you can answer this.
9:55
SPEAKER_02: So one of my questions was if this idea of a spin-off always has to be like a public company, that this is not really something you can do as a private company or or can you?
10:06
SPEAKER_03: You can.
10:07
SPEAKER_03: I don't know if I've ever seen it in practice of a private company.
10:10
SPEAKER_02: That's a very good answer.
10:11
SPEAKER_02: And then my other question is, you know, in last week's episode, we were talking about sale of a business, discontinued operations, and meeting the held for sale criteria.
10:20
SPEAKER_02: And so in all in that case, there's accounting before the transaction occurs.
10:25
SPEAKER_02: But in this case, what you're saying is you can be preparing, but all that counting on the spin-oars side is going to happen at the point in time that you actually record the spinoff.
10:35
SPEAKER_03: That's right.
10:35
SPEAKER_03: You can't meet held for sale criteria related to a spin-off transaction, um, just based on the nature of this type of transaction.
10:42
SPEAKER_03: Yeah.
10:43
SPEAKER_02: Okay, that's very helpful.
10:44
SPEAKER_02: So let's take, I'm gonna ask some follow-up questions on that.
10:47
SPEAKER_02: But for now, you talked about carve out financial statements.
10:49
SPEAKER_02: That's always can be not the easiest.
10:53
SPEAKER_02: So, what can you share when we start to think about those types of financial statements?
10:57
SPEAKER_03: Sure.
10:58
SPEAKER_03: Um, I would say there could be situations where it's relatively straightforward.
11:01
SPEAKER_03: You might have a reportable segment that you're planning to spin off, in which case you have separated financial information that you've historically relied on.
11:09
SPEAKER_03: Maybe easy to pull that together in terms of preparing um carve-out financial statements.
11:13
SPEAKER_03: Often it's never that easy.
11:14
SPEAKER_03: It's taking different parts of the business, combining them together.
11:18
SPEAKER_03: There could be shared assets or management teams in place.
11:22
SPEAKER_03: And so figuring out the appropriate attributions and allocations can be really complicated.
11:26
SPEAKER_03: Um, and it's critical to making sure that you have appropriate information reflected in those carve-out financial statements.
11:32
SPEAKER_03: I would say some hot topics that we see in terms of questions are goodwill allocation and impairment assessments in the historical carve outs, income taxes, which is everybody's favorite topic, and presentation of some of the historical equity accounts, including cumulative translation adjustment.
11:47
SPEAKER_03: Um, I will give a plug here.
11:49
SPEAKER_03: We have a PWC Carve Out Financial Statements Guide.
11:52
SPEAKER_03: It's a great resource if you want more detail on how to prepare carve out financial statements for the spinny.
11:57
SPEAKER_03: And it's also a quick read compared to some of our other publications.
12:00
SPEAKER_02: All right, that is a very good plug.
12:02
SPEAKER_02: So uh I think carve outs could be its whole own episode.
12:05
SPEAKER_02: In fact, I think we may have done an episode in the past on this topic.
12:08
SPEAKER_02: So maybe for today, then focusing on the accounting by the spin or.
12:12
SPEAKER_02: So the company that is is completing the spin-off, what are sort of the high-level accounting considerations then, Katie?
12:18
SPEAKER_03: Sure.
12:19
SPEAKER_03: So when you're dealing with a spin-off, as Matt mentioned, the guidance is specific to understanding that you are transferring a business.
12:25
SPEAKER_03: Um, and it's based on the already recorded carrying amounts of those assets and liabilities.
12:29
SPEAKER_03: There is no gain or loss recognized in earnings, which is different compared to when you're looking at a sales transaction.
12:35
SPEAKER_03: In that situation, when you've you know lost control of that business, you are comparing your carrying value of your assets and liabilities against the consideration that was received in the sale.
12:45
SPEAKER_03: Um, and so in this situation, you would have a gain or loss to be determined.
12:49
SPEAKER_03: It just doesn't apply in a spin-off transaction.
12:52
SPEAKER_03: And then one, I think we touched on this a little bit, but the assets and liabilities related to the spin-e entity are accounted for under a held and used impairment model up until when the spin-off occurs.
13:02
SPEAKER_03: Um, but if there is an impairment loss to be recognized at the time of spin-off, if the carry amount of the business to be spun off exceeds its fair value, you would need to take that impairment loss.
13:11
SPEAKER_02: So, Katie, the thing that caught my ear there is the fact that you're saying that you actually could wind up, even in a spin transaction, recording impairment loss.
13:19
SPEAKER_02: Because if I think of a spin transaction, then I'm a company and spinning off some of my business and I'm, you know, giving uh shares pro rata, as as Matt said, to my existing shareholders.
13:32
SPEAKER_02: So it's hard to see where the impairment comes in.
13:34
SPEAKER_03: So how does that work?
13:36
SPEAKER_03: So it's a great question, Heather.
13:37
SPEAKER_03: I would say that when you're talking about a spin-off transaction, at the time that the spin goes effective, you're looking at the carrying amount of this disposal group, the business that's being disposed of through the spin-off.
13:47
SPEAKER_03: And if that carrying amount of the business in its entirety exceeds its fair value, an impairment loss would need to be recognized immediately prior to the spin-off at the spin-off level.
13:56
SPEAKER_02: So basically, is this right that you're writing down the assets and liabilities before you complete the spinoff?
14:02
SPEAKER_01: That's right.
14:02
SPEAKER_02: And you're required to do this.
14:04
SPEAKER_01: That's right.
14:04
SPEAKER_01: Okay.
14:05
SPEAKER_01: And it's uh it seems counterintuitive to you because you're not you're not receiving proceeds.
14:09
SPEAKER_01: So you don't have a third-party indication of what the value is.
14:11
SPEAKER_02: Yes.
14:11
SPEAKER_01: Right, which is what you have in a sales situation.
14:13
SPEAKER_01: So that's why it's it always takes a minute.
14:16
SPEAKER_02: Yes, or maybe more than a minute.
14:18
SPEAKER_02: So all right, so that's helpful.
14:20
SPEAKER_02: So then putting aside this impairment, which is required.
14:23
SPEAKER_02: So let's assume in in this particular case, we don't have an impairment.
14:27
SPEAKER_02: So now I've I've spun this business.
14:30
SPEAKER_02: Is it you just take all the assets and liabilities off your books?
14:33
SPEAKER_02: I assume it's not that easy.
14:35
SPEAKER_01: It's not, you know, in an ideal world, it would be that easy.
14:38
SPEAKER_01: Um so we'll just hit a couple of highlights at some of the things that we hear uh questions on most often.
14:43
SPEAKER_01: The first is goodwill, right?
14:44
SPEAKER_01: So, and again, goodwill, derecognition, and a spin-off can be straightforward if the business that you are spinning off happens to be a reporting unit.
14:53
SPEAKER_01: Because in that situation, you basically just take all of the goodwill that was residing in that reporting unit and it goes with the spun business from the spin-over's perspective, right?
15:02
SPEAKER_01: So that gets derecognized.
15:03
SPEAKER_01: Uh it becomes a little bit more complicated when the business that you're spinning is a component or a piece of a reporting unit, because then you have to allocate, uh, similar to the way you would in a sell of a business.
15:12
SPEAKER_01: So you basically do it based on relative fair values of the piece of the reporting unit that's being spun versus what's staying behind.
15:18
SPEAKER_01: One one complicating factor, right, or one question that comes up a lot is the way I just described the allocation of goodwill and um for the spin or is not necessarily the same as the way the spin-e would record uh goodwill in their carve-out financial statements.
15:33
SPEAKER_01: So again, we're not going to go into too much detail on that, but it's a call-out for people to be aware that there might not always be symmetry on the on the goodwill uh side of things.
15:41
SPEAKER_01: The other thing that comes up a lot is um what do I do with equity accounts?
15:44
SPEAKER_01: Um, most importantly, AOCI, right?
15:47
SPEAKER_01: Because usually for AOCI, when it reverses itself or it recycles out, it comes through the income statement, right?
15:53
SPEAKER_01: So that's how, because usually AOCI represents a deferral of something that otherwise would have gone through the income statement.
15:58
SPEAKER_01: Um so in a sale transaction, again, which we talked about in our other podcast, um, if you're releasing anything from from AOCI, it would go through the PL.
16:06
SPEAKER_01: But remember, Katie talked about spin transactions, we don't have a PL impact.
16:10
SPEAKER_01: We don't have a gain or loss.
16:11
SPEAKER_01: So typical AOCI uh accounts will be split between the spin-E and spin or anything that gets derecognized on the spin or side is really just going to go as a reclass through equity, not through a gain or loss.
16:22
SPEAKER_01: CTA is is is fairly consistent with that concept, but the only thing I'll call out there is that you can only release CTA if you're disposing of or substantially liquidating a foreign entity in its entirety.
16:34
SPEAKER_01: And I know you probably have podcasts on foreign.
16:36
SPEAKER_01: We do.
16:37
SPEAKER_02: This is actually a very interesting point we've talked about in some podcasts with John Haran.
16:40
SPEAKER_02: Right.
16:41
SPEAKER_01: So as long as the spinoff includes an entire foreign entity, the CTA is going to be derecognized or recycled, right?
16:46
SPEAKER_01: But again, not through earnings.
16:48
SPEAKER_01: It's going to be reclassed through equity because there's no gain or loss.
16:51
SPEAKER_01: Um, it becomes a lot more complicated when you're spinning off a portion of a foreign entity.
16:56
SPEAKER_02: Okay, so it's very helpful, Matt.
16:57
SPEAKER_02: So definitely, I'm sure that's only hitting the tip of the iceberg of some of the things to think about.
17:02
SPEAKER_02: But I want to go back to Katie because Katie, you mentioned taxes and the complexity of taxes.
17:07
SPEAKER_02: Now, I think our tax colleagues would say this is probably the most interesting part of the spin.
17:12
SPEAKER_02: But what are some of the things that companies should be thinking about when they think about the county for their deferred tax assets and liabilities?
17:18
SPEAKER_03: I did want to give a specific call out to the preparation and the carve-out financial statements, just because there are multiple approaches that could be used.
17:26
SPEAKER_03: Um, for example, a separate return approach.
17:28
SPEAKER_03: It's just complicated in trying to reconstruct the tax information for these historical carve out financial statements that are, you know, based on, again, allocations and attributions of specific assets.
17:38
SPEAKER_03: At the spin or level, um, the deferred taxes that are associated with the assets and liabilities that will be transferred as part of the spin should be in the carrying out of the disposal group when the spin goes effective.
17:48
SPEAKER_03: So identification of the specific assets and liabilities is going to be critical for this particular piece.
17:53
SPEAKER_02: Yeah.
17:54
SPEAKER_02: So you're saying basically you have to make sure you know exactly which assets and liabilities are in the business being spun off and then the related, all of the related taxes, which may not be so easy to always identify.
18:04
SPEAKER_03: Yeah, you may not have had it split out at that level in the past, but you'll need to drill down into that information to appropriately represent the deferred tax balances associated with those assets and liabilities that are in the spin.
18:15
SPEAKER_02: Okay, that's helpful.
18:16
SPEAKER_02: So then let me move on to another topic.
18:18
SPEAKER_02: So again, in last week's episode, after we talked about the fact that you have, um, if you're disposing of a business by sale, that you could, once you're held for sale, you could get into discontinued operations.
18:31
SPEAKER_02: So we're in when we're doing a spin-off, what do we need to consider from a disc ops perspective?
18:37
SPEAKER_01: Excellent.
18:38
SPEAKER_01: So, and this is where we talked about uh in last week's podcast, things get a little bit confusing in terms of what the differences between held for sale and disc ops.
18:45
SPEAKER_01: For for a spin transaction, up until the spin date, there's like you said earlier, there's really no accounting to do for the spin or you can't meet the held for sale criteria because you're not selling the business, right?
18:56
SPEAKER_01: So you wait until the spin date.
18:57
SPEAKER_01: And at the spin date, you make an assessment as to whether or not the business that you've spun qualifies for discontinued operations.
19:04
SPEAKER_01: And we talked about the two things that have to happen to qualify, right?
19:07
SPEAKER_01: It has to be a strategic shift with a major impact.
19:10
SPEAKER_01: And there's again a podcast from last week that that goes into a little bit more detail.
19:14
SPEAKER_01: If the spin-off does qualify for discontinued operations, you're really following the guidance in AAC205 for both the income statement and the balance sheet, which is a little bit different than what we talked about last week.
19:24
SPEAKER_01: But it really kind of gets to the same place where you're recharacterizing the business that you've spun as a discontinued operations for purposes of presenting it in the income statement and for purposes of the assets and liabilities on the balance sheet, which again would require, because we're in disc ops, recasting prior years balance sheets to show all of the periods in a consistent way.
19:46
SPEAKER_01: If you don't meet the criteria for disc ops, you're actually not allowed to recharacterize either your income statement or your balance sheet after the spin date.
19:54
SPEAKER_02: Wow.
19:55
SPEAKER_02: So I can see for some companies that would result in some mGNA disclosure that they may want to be talking about then of the impact because yeah, because it just explained the business before the spin-off and after the business.
20:07
SPEAKER_01: Yeah, or or more reliance on you know pointing folks to performas or other.
20:11
SPEAKER_01: Yes.
20:11
SPEAKER_02: Okay.
20:11
SPEAKER_02: That's a helpful perspective.
20:13
SPEAKER_02: So I think the other point then, Matt, that's important there is that you can't just assume, oh, I'm doing a spin-off.
20:18
SPEAKER_02: It must be discontinued operations.
20:20
SPEAKER_02: You still have to go through the criteria to make sure that you've you've met them.
20:25
SPEAKER_02: Okay.
20:25
SPEAKER_02: So it's important, and again, I'd remind people to go listen to last week's podcast for more discussion on that.
20:30
SPEAKER_02: All right.
20:31
SPEAKER_02: So, Katie, let me go back to you and anything specific that you would say on the income statement if you've met the criteria for discontinued operations.
20:40
SPEAKER_03: Sure.
20:40
SPEAKER_03: Um, and I will highlight here a little bit of the difference between what may be presented in the spin-off's discontinued operations disclosures when compared to what's in the spinny's carve out financial statements.
20:51
SPEAKER_03: There is a distinction between the objectives for the presentation on both.
20:54
SPEAKER_03: And so conceptually, you may think, okay, I'm backing out the business that's carved out, therefore I'd nut it down.
20:59
SPEAKER_03: That's what's semi-disc ops.
21:00
SPEAKER_03: That's not going to be the case all the time.
21:03
SPEAKER_03: So wanted to highlight some of those differences.
21:05
SPEAKER_03: So when you're thinking about the PL, revenues and costs that are directly attributable to the spinny are are required to be presented within discontinued operations.
21:14
SPEAKER_03: And they should also be things that are not expected to continue.
21:17
SPEAKER_03: That's kind of a good test in terms of assessing those direct uh revenues and costs.
21:22
SPEAKER_03: Um, as an example, the spinny entity might have had its own dedicated revenue streams and specific operating costs associated with that, that would be going into discontinued operations.
21:32
SPEAKER_03: So any direct and attributable costs that may have been uh incurred as part of executing the spin itself, for example, advisory or legal fees, you would also put through discontinued operations as well.
21:42
SPEAKER_03: So just touching on this carve out financial statements concept, when you think about the balance sheets, it's an attribution approach where you'd include them in the carve out balance sheet if they are directly benefiting the business and are attributable to the business being carved out.
21:55
SPEAKER_03: But on the income statement, a carve out may include both direct expenses and And income numbers as well as allocations.
22:02
SPEAKER_03: So shared corporate overhead and costs.
22:05
SPEAKER_03: Carve out financial statements are intended to represent the standalone business.
22:08
SPEAKER_03: And so it's supposed to give you the full picture from a financial information standpoint.
22:12
SPEAKER_03: And this is going to drive a big difference between what you may see in the carve out financial statements compared to disc ops because discontinued operations is very specific only to direct revenues and expenses.
22:22
SPEAKER_03: It would not include items such as allocations of corporate overhead or other general costs.
22:26
SPEAKER_01: Right.
22:26
SPEAKER_01: This is similar to the concept I brought up where on the allocation of goodwill, right?
22:30
SPEAKER_01: So when you're thinking about the spin or versus the spin-e financial statements, remember for the spin or we're relying on disc ops guidance and things like that.
22:38
SPEAKER_01: For the spin-e, we're really relying on concepts around Carvat financial statements and they're not always aligned.
22:42
SPEAKER_02: Yeah, definitely a lot of complexity here.
22:45
SPEAKER_02: Uh and again, something you're going to need to be planning ahead to think through some of this before you get to the date.
22:51
SPEAKER_02: I guess other areas that you would highlight as something that companies should be focused on is potential complexities, Katie.
22:57
SPEAKER_03: Sure.
22:58
SPEAKER_03: Uh one point on employee arrangements.
23:00
SPEAKER_03: So this concept of is it an ongoing expense?
23:02
SPEAKER_03: If an employee goes with the spinny entity and the compensation expense going forward is going to be with that entity, any of their historical compensation expense would be in part or be part of your discontinued operations at the spin or level.
23:16
SPEAKER_03: But sometimes you may have bonuses that are intended to incentivize those employees to help complete the spin-off successfully.
23:22
SPEAKER_03: That would remain in continuing operations.
23:24
SPEAKER_03: It's not tied to the spinny's ongoing business.
23:26
SPEAKER_03: And so it would not be appropriate to reflect that in discontinued operations.
23:30
SPEAKER_03: And one other item we wanted to highlight is specific to out debt, outstanding debt arrangements.
23:35
SPEAKER_03: You may have debt that goes with the spinny.
23:37
SPEAKER_03: They legally assume it from the parent entity, or it was something that was within that business itself that would be part of discontinued operations.
23:45
SPEAKER_03: And from an income statement perspective, debt that was legally assumed by the spinny, or if it was required to be repaid as part of the spin, the interest associated with that debt would be allocated to discontinued operations as well.
23:56
SPEAKER_02: All right.
23:56
SPEAKER_02: A lot to think about.
23:57
SPEAKER_02: And I know there's more to think about after you've completed the spin.
24:01
SPEAKER_02: So, Katie, again, going back to you, what are some of the key things that you see is coming up as considerations in the spin or financial statements once the spin is complete?
24:11
SPEAKER_03: So this is a great example of understanding this concept that the spin E used to be a consolidated subsidiary and now is its own separate standalone company.
24:20
SPEAKER_03: Oftentimes you'll see transition service arrangements executed between the spin or and the spinny, where the spin or is going to be providing certain ongoing services for a period of time to help transition the new company.
24:30
SPEAKER_03: Could be IT, it could be payroll, finance, that type of thing.
24:34
SPEAKER_03: That income and the associated expenses for the spin-or are going to be happening on an ongoing basis.
24:40
SPEAKER_03: So the income related to that you would just put in the normal expense line items.
24:46
SPEAKER_03: It's part of your ongoing business and would not be something that you would put into discontinued operations.
24:51
SPEAKER_03: And another thing is any guarantees that may exist between the spinor and the spin-e entity.
24:56
SPEAKER_03: Historically, it may have fallen under apparent subsidiary exception.
24:59
SPEAKER_03: It's not something you would have to reflect in consolidated financial statements and you would not have a related liability.
25:04
SPEAKER_03: After that spin, you're dealing with a completely separate company and that exemption would not apply.
25:09
SPEAKER_03: So you may have to recognize a guarantee liability if the related recognition criteria are met.
25:13
SPEAKER_03: Any you would add, Matt?
25:15
SPEAKER_01: Yeah, yeah.
25:16
SPEAKER_01: We can kind of do a lightning round of things that happen in conjunction with the spin, right?
25:20
SPEAKER_01: That maybe aren't part of the actual spin itself, right?
25:23
SPEAKER_01: So a lot of times we see indemnifications between the spinny and the spin spin oar.
25:27
SPEAKER_01: So that so that would attract accounting for the spinor's financial statements, particularly if the spinny indemnifies the spinor to certain risks, but only at the time that the spinor recognizes a liability related to that exposure, right?
25:39
SPEAKER_01: So it kind of tracks asset can only be recorded as a liability is recorded, kind of like insurance accounting or guarantee accounting, right?
25:45
SPEAKER_01: Um a lot of times we'll see lease transactions between the two.
25:47
SPEAKER_01: So if there happens to be a sale lease back where the spinny is leasing property back to the spin or that arrangement needs to be evaluated under AAC 42 to make sure you get the accounting right on the sale lease back.
25:58
SPEAKER_01: Um the impact on segments, right?
26:01
SPEAKER_01: So um it maybe seems straightforward that for the spinny, you have to figure out what the segments are of the new entity.
26:06
SPEAKER_01: But for the spin or there also may be an impact in terms of how management is now evaluating the performance of the company, right?
26:12
SPEAKER_01: Things might change because you've just done a strategic transaction.
26:15
SPEAKER_01: So make sure you're tracking how the reporting packages of the C that the CODM receives has changed as a result of the spin and what that impact could be.
26:23
SPEAKER_01: Um a lot of times we see uh stock compensation arrangements modified as a result of the spin.
26:28
SPEAKER_01: Sometimes they have to be because the employees were receiving stock uh options of the spin or now they need to be receiving it of this of the spin-e.
26:35
SPEAKER_01: So just be cognizant of how modifications work under AC718 and make sure you're accounting for that the right way.
26:42
SPEAKER_01: So a lot of times um a company will hold a retained interest in the spun entity, you know, a lot of times it's 10% or 19.9%, very specific percentages for regulatory reasons.
26:52
SPEAKER_01: Um, the spin or is going to have to figure out how to account for that investment, you know, on the spin date.
26:57
SPEAKER_01: It's going to need to be on their balance sheet.
26:58
SPEAKER_01: And then on a go-forward basis, right?
27:00
SPEAKER_01: Either under ASE 323 if there's significant influence, or ASE 321, if not.
27:05
SPEAKER_02: Yeah.
27:05
SPEAKER_02: And I guess we would presume because uh because it's under 20%, you wouldn't have significant influence, but obviously you have to go through and do the evaluation at that date.
27:14
SPEAKER_01: Yeah, that's right.
27:15
SPEAKER_01: I would make sure, yeah, you can look at that as a starting point and then make sure that, you know, check out how many boards he takes.
27:20
SPEAKER_01: Yes, exactly.
27:21
SPEAKER_02: Because your point being that given the unique relationship, it might not be so straightforward as to just say, oh, it's under 20%.
27:28
SPEAKER_02: Correct.
27:28
SPEAKER_02: I'm done.
27:29
SPEAKER_02: Correct.
27:29
SPEAKER_01: There could be nuance.
27:30
SPEAKER_01: Yep.
27:30
SPEAKER_02: Okay, that's a helpful reminder.
27:32
SPEAKER_02: So definitely a lot to think about and many considerations.
27:35
SPEAKER_02: It sounds like both before you complete the spinoff, dealing with your carve-out financial statements and otherwise, and then at the point of spinoff, there's accounting.
27:42
SPEAKER_02: And then after the spinoff, there also could be accounting.
27:45
SPEAKER_02: And so really understanding all the relationships and what's involved is going to be critically important.
27:50
SPEAKER_02: But I know Matt and Katie, you guys both have dealt with a lot of these transactions.
27:54
SPEAKER_02: So just curious, taking a step back, if you think about advice you would give to the company conjecting the spin-off, what you know, sort of what you would tell them to do or focus on, or any tips and tricks.
28:07
SPEAKER_02: So, Matt, I'll start with you.
28:08
SPEAKER_01: Yeah.
28:09
SPEAKER_01: So for me, the most important thing is kind of comes from a question you asked earlier, which is what why are folks are doing this and what's really driving the strategy behind a spinoff.
28:17
SPEAKER_01: Again, it's it's mostly a tax-driven transaction to kind of be able to achieve this tax-free spin to your shareholders to unlock that value.
28:25
SPEAKER_01: Um, a lot of times it's the tax professionals and the business development professionals kind of orchestrating the early steps in the spin-off strategy.
28:32
SPEAKER_01: Make sure the accounting folks and the financial reporting folks are involved early on, because the worst thing that can happen is we learn late late in the game that it's not per rata or that it was a reciprocal transaction and actually gets split-off accounting, right?
28:45
SPEAKER_01: Because that that could have ramifications on both tax, but also, you know, financial reporting and accounting, right?
28:50
SPEAKER_01: It's a very different transaction.
28:51
SPEAKER_01: Yeah.
28:51
SPEAKER_01: If you're spinning and it's carrying value, which seems a little bit easier, comes with complexities, versus wow, we've done a split-off transaction now, everything's at fair value and we're gonna have a gain or loss for accounting.
29:00
SPEAKER_02: Yeah.
29:01
SPEAKER_02: And even without that, I was just thinking if the accounting is brought in late and then they have to suddenly get these carve-out financials done quickly and think through all this other accounting.
29:10
SPEAKER_02: I mean, the more time, the smoother the transaction's going to be.
29:14
SPEAKER_02: Okay.
29:14
SPEAKER_02: And Matt and Katie are both nodding.
29:15
SPEAKER_02: So okay, Katie, how about from your point of view?
29:18
SPEAKER_03: I would just say uh there's always gonna be an emphasis on disclosures.
29:21
SPEAKER_03: There's a lot of judgment involved with executing a spinoff, and estimation is really involved in all of that.
29:27
SPEAKER_03: So making sure that you're being transparent in your disclosures is gonna be really important.
29:30
SPEAKER_02: All right.
29:30
SPEAKER_02: Well, definitely an interesting topic.
29:32
SPEAKER_02: This has been very helpful and insightful.
29:34
SPEAKER_02: So, Matt, Katie, thanks so much for joining me today.
29:36
SPEAKER_02: Thank you.
29:37
SPEAKER_01: Thank you.
29:39
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29:41
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30:01
SPEAKER_02: From Thought Leadership at PwC, I'm Heather Horn.
30:05
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