The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2018-17 Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities (ASU 2018-17), which expands the accounting alternative for private companies' application of variable interest entity (VIE) consolidation guidance and changes the analysis of related party decision maker and service provider fees. The expansion of the private company accounting alternative is expected to reduce the number of entities that must be evaluated under the VIE consolidation guidance, thus reducing the cost of applying U.S. GAAP. The change to the related party decision maker and service provider fees is expected to reduce the instances that a service provider identifies that a variable interest exists in the entity it provides services to, thus reducing the chances of VIE consolidation and disclosure.
Private Company Accounting Alternative
Many private company have used the private company accounting alternative for commonly controlled leasing entities in order to avoid application of the VIE guidance to certain leasing entities. Despite this accounting alternative, the FASB continued to receive feedback that the VIE guidance was difficult to apply to common control arrangements, particularly due to the lack of contractual arrangements among these types of entities. In response to this feedback, the FASB has replaced the accounting alternative for commonly controlled leasing entities with a broader accounting alternative for entities that are under common control.
Upon adoption of ASU 2018-17, the common control leasing alternative is replaced and eliminated. Instead a private company may elect an accounting alternative to not apply the VIE guidance to legal entities under common control (including common control leasing arrangements) if the following conditions are met:
- The reporting entity, legal entity being evaluated, and common control parent are not public business entities
- The reporting entity does not directly, or indirectly, control the legal entity being evaluated if the general subsections of ASC Topic 810, Consolidation (i.e. the voting model) were applied
Although U.S. GAAP does not define control, the FASB did make a requirement that when evaluating the first criterion, only the parent's direct and indirect voting interests in the reporting entity and the legal entity being evaluated should be considered. VIE guidance should not be used in making this determination. This limitation on what constitutes common control under the accounting alternative is new and could, in rare instances, result in a conclusion that an entity that was considered under common control under the prior accounting alternative will not be under common control under the new accounting alternative.
The second criterion above will result in the exclusion of legal entities that would be subsidiaries under the voting model from the accounting alternative. Under the consolidation guidance, a reporting entity always applies the VIE guidance before the voting guidance, and the exclusion of entities that would be voting interest entity subsidiaries from the accounting alternative will result in the retention of the VIE analysis for these entities. The VIE guidance may be relevant for these entities if they are VIEs and there is another entity that is exercising a controlling financial interest through means other than voting interest (i.e. they should not be consolidated by the reporting entity under the VIE guidance) or there are limitations on the use of the assets or recourse of the creditors of the subsidiary that triggers presentation and disclosure requirements under the VIE guidance.
An additional caution for entities seeking to apply the new accounting alternative is that the evaluation of whether an entity is directly or indirectly under the control of another under the voting model may itself be complex. The voting model contains scope exceptions that are considered in concluding if a reporting entity holds a controlling financial interest in another legal entity. Generally, the voting model results in the determination that the party with more than 50 percent of a corporation's voting shares is the party with control, however, substantive noncontrolling rights may prevent the owner of a majority of the voting interest from exercising control. In some cases, a party with less than 50 percent of the voting shares may even be determined to be in control. In addition, limited partnerships and similar entities apply a different methodology. Limited partnerships under the voting model are controlled by a limited partner that has the ownership of a majority of the limited partnership's kick-out rights through voting interests.
Reporting entities that elect to neither consolidate nor apply VIE guidance to a legal entity under common control because it meets the criteria to apply this alternative must make the following disclosures:
- The nature and risks associated with its involvement with the entity under common control;
- How its involvement with the entity under common control affects its financial position, financial performance, and cash flows;
- The carrying amounts and classification of the assets and liabilities in its statement of financial position resulting from its involvement with the entity under common control;
- Its maximum exposure to loss resulting from its involvement with the entity under common control, or if the maximum exposure to loss cannot be quantified, that fact should be disclosed; and
- If its maximum exposure to loss (as required by 4. above) exceeds the carrying amount of the assets and liabilities described in 3. above, qualitative and quantitative information to allow users of the financial statements to understand the excess exposure, including but not limited to the terms of the arrangement that could require the reporting entity to provide financial support to the entity under common control, including events or circumstances that could expose the reporting entity to a loss.
In applying the disclosure requirements in items 4 and 5 above, a reporting entity must consider exposures through implicit guarantees, which are determined by facts and circumstances that include but are not limited to the reporting entity having an economic incentive to act as a guarantor or make funds available, or the reporting entity has acted as a guarantor for or made funds available to the entity in the past. ASU 2018-17 provides examples illustrating arrangements that qualify and do not qualify for the accounting alternative, and provides example disclosures that meet the above requirements.
If elected, a private company should apply the accounting alternative to all legal entities (current and future) under common control that meet the criteria for applying the alternative, continue to apply other consolidation guidance including the voting interest entity guidance, and provide detailed disclosures about its involvement with and exposure to entities under common control.
Adoption of the new alternative may provide flexibility to private companies by enabling them to elect to combine certain common controlled entities together for financial reporting purposes, while excluding others.
For instance, take a scenario where a group of non-public business entities is each owned 100 percent by an individual. The reporting entity manufactures equipment, it has sister entity A that is a downstream retail outlet that sells the equipment and sister entity B that leases space to the reporting entity. Sister entity B and the reporting entity had significant entanglements related to the mortgage for the facility. All three of these entities were previously consolidated under the VIE model, but the financial statements that resulted were provided to the mortgagor that did not desire to have the retail operations included because they did not have an interest in that entity. The financial statement user needs resulted in additional management effort and supporting schedules to the financial statements that showed the bank information without sister entity A. By adopting the new scope accounting alternative for commonly controlled entities, the reporting entity can effectively choose to issue combined financial statements with all three entities, stand-alone financial statements of the reporting entity, or combined financial statements with just sister entity B, consistent with the primary financial statement user's desire.
A private company considering adopting the private company alternative included in this standard should carefully consider the benefits that may result from not applying the VIE consolidation guidance, the needs of its financial statement users, as well as the potential costs that would be incurred if reversal of the election was necessary in the event that it becomes a public business entity.
Decision Making Fees
A second change from ASU 2018-17 relates to how entities evaluate fees paid to a decision maker or service provider. Under the new guidance, indirect interests held through related parties under common control should be considered on a proportional basis for determining whether fees paid to decision makers and service providers are variable interests, which is consistent with how indirect interests held through related parties under common control are considered for determining whether a reporting entity must consolidate a VIE.
For example, if a decision maker or service provider owns 20 percent of a related party, which owns 40 percent of the legal entity being evaluated, the decision maker's or service provider's indirect interest in the entity being evaluated should be considered the equivalent of an 8 percent (20 percent times 40 percent) direct interest for determining whether its fees represent variable interests. Under the existing guidance, a reporting entity is required to consider such indirect interests as the equivalent of a direct interest in its entirety rather than on a proportional basis under the new guidance (i.e. the service provider would have been considered to have equivalent to a 40 percent direct interest in the example above). Therefore, it is likely that this amendment will result in more decision makers not having a variable interest through their decision making arrangements and will reduce the risk that decision makers with insignificant (or no) direct and indirect interests could be deemed the primary beneficiary of a VIE.
A decision maker or service provider that concludes its decision making arrangement no longer qualifies as a variable interest would also not be subject to the VIE disclosure requirements for the entity being evaluated.
Timing and Transition
ASU 2018-17 is effective for fiscal years beginning after Dec. 15, 2020, and interim periods within fiscal years beginning after Dec. 15, 2021, for private companies and for fiscal years beginning after Dec. 15, 2019, including interim periods within those fiscal years, for entities other than private companies. However, early adoption is permitted, including adoption in an interim period. All entities are required to apply these amendments retrospectively with a cumulative-effect adjustment to retained earnings applied at the beginning of the earliest period presented. The amendment also includes guidance on consolidating and deconsolidating entities, as appropriate, upon initial adoption of this ASU.
Seek Help When Needed
Even with the changes to the consolidation guidance ASC Topic 810 Consolidation will continue to be a challenging area of U.S. GAAP that requires knowledge about specialized terminology and significant judgement. An accounting provider that is experienced with the consolidation guidance may be able to help evaluate how adoption will affect you and provide recommendations on how best to design your financial reporting amongst and between commonly controlled entities.
Published on November 06, 2018