what type of entity is permitted to apply accounting alternatives in the codification
The consolidation and reporting of related entities can be a complicated bookkeeping topic, specially for individual companies that utilize carve up legal entities to manage a diverse network of businesses and business interests. Oftentimes, these companies manage and fund a network of legal entities via a unmarried parent company or through a modest group of related entities, which this article refers to as "entities under common control" or "common control entities."
In determining consolidation requirements, private companies that are members of a common control group must use the complex guidance of Accounting Standards Codification (ASC) Topic 810,Consolidation, and its related amendments. This article discusses ASC 810'southward consolidation guidance with a specific focus on the application of that guidance for mutual control entities. Information technology summarizes the history of FASB's consolidation guidance (for list of relevant standards, seeShowroom 1), provides a brief discussion of the relevant amendments, and concludes with a discussion of a recent proposed Accounting Standards Update (ASU),Consolidation (Topic 810): Targeted Improvements to Related Political party Guidance for Variable Involvement Entities.
Exhibit one
Relevant Accounting Standards on Consolidation for Common Control Entities
Overview of Consolidation Guidance
The challenges associated with consolidating controlled companies accept existed for a long fourth dimension. Formal accounting guidance was starting time issued in 1959 with the release of Accounting Research Bulletin (ARB) 51,Consolidated Financial Statements. ARB 51 requires a company to consolidate any chapter for which the visitor retains a direct or indirect controlling financial interest. A controlling financial involvement is defined every bit an investment of 50% or more of the voting equity of another entity (or related group of entities). Therefore, in accord with ARB 51, a company that holds 50% or more of the voting disinterestedness of an affiliate is viewed as the controlling parent company and should include the affiliate (or affiliated group) in its consolidated financial statements.
In accounting jargon, ARB 51 codified the "voting involvement model" (VOE). Under a VOE model, the entity with the majority ownership interest retains significant influence over the way in which the affiliate manages its operations, and the controlled affiliate should therefore be included in the financial statements of its majority interest investor. ARB 51's guidance presumes that the decision-making parent would exercise its voting power to prevent the affiliate from entering transactions that the parent's management views as being opposite to its own best interest or contrary to the best interest of the controlled grouping.
As one might assume, companies have developed very circuitous approaches for financing and administering the activities of their affiliated legal entities. Many of these approaches render the guidance independent in ARB 51 ineffective for ensuring that the controlling investor is properly consolidating affiliates for which it retains significant controlling influence. ARB 51's guidance is particularly ineffective when a parent entity maintains control over its affiliate in an ownership structure different from the VOE arroyo, such as without retaining a straight bulk ownership interest in its affiliate. Therefore, FASB'due south guidance regarding consolidation of affiliated entities has evolved beyond the ARB 51 VOE model.
In consideration of these types of arrangements, FASB, in 2003, issued FASB Interpretation 46 (revised Dec 2003),Consolidation of Variable Interest Entities [FIN 46(R)]. FIN 46(R) provides criteria for classifying an investee/chapter every bit a variable interest entity (VIE), rather than as a VOE, a distinction that must be adamant at the inception of the arrangement. In designating an investee/affiliate equally either a VIE or a VOE, the key considerations are the funding structure arranged for the legal entity and the related rights, risks, and rewards of the disinterestedness investors relative to 1 another and relative to other subordinated financing received by the legal entity.
In addition to developing criteria for classifying the investee/affiliate, FIN 46(R) established guidance for identifying the equity investor responsible for consolidating a VIE. In general, under FIN 46(R), an equity investor consolidates the VIE when that investor retains a majority interest in the VIE's expected losses or a majority involvement in the VIE'southward residual returns. If the equity involvement investor retaining a bulk interest in VIE's residual returns differs from the disinterestedness interest investor retaining a bulk interest in its expected losses, FIN 46(R) requires the latter to consolidate the VIE.
Nether FIN 46(R), the consolidating entity is designated equally the "primary beneficiary," a term that is still used to identify the consolidating entity. In determining the master beneficiary, FIN 46(R) requires equity investors in a VIE to include the equity investments of whatsoever related parties as its ain straight investment: "For purposes of determining it is the primary beneficiary of a VIE, a reporting entity with a variable interest shall treat the variable interest in the same VIE held by its related parties equally its own interests." (par. 16)
In 2009, FASB issued Statement of Fiscal Accounting Standards (SFAS) 167,Amendments to FIN 46(R). SFAS 167 retains the master casher notion but moves abroad from FIN 46(R)'south "risks and rewards"–based consolidation model. Instead, SFAS 167 establishes consolidation requirements for VIEs based on both a qualitative, rather than quantitative, assessment of an equity investor'southward control over significant activities of the VIE and the equity investor's retention of certain rights and obligations that are disproportionate to that investor's investment.
SFAS 167 is codified in ASC 810-10. Therefore, the remainder of this commodity refers to ASC 810-10.
ASC 810-10 and Consolidation of a Variable Interest Entity
ASC 810-ten retains the ARB 51 notion that the investor with the controlling financial interest should consolidate the investee/affiliate. Information technology also retains the FIN 46(R) notion that, for some investor/investee relationships, the traditional voting interest approach may non be sufficient for identifying "the political party with a controlling fiscal interest."
Co-ordinate to ASC 810-10, an investee is identified equally a VIE when "its disinterestedness investors practice not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support or, as a group, the holders of the entity's equity investment at risk lack whatever one of the following three characteristics:
- a. The ability, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity'southward economical performance
- b. The obligation to absorb the expected losses of the entity
- c. The right to receive the expected residuum returns of the entity."
If, after considering the VIE criteria, an equity interest investor determines that the investee/affiliate is not a VIE, the investor should consider using the VOE model.
ASC 810-10 as well establishes consolidation requirements related to investments in a VIE. It says that an equity interest investor consolidates a VIE when information technology retains an investment in the entity, is considered a variable involvement investor in the entity, and is the primary beneficiary of the entity. An investor in a VIE is a "variable interest beneficiary" when, per an organization'southward governing documents, the investor will blot a portion of the VIE's expected losses or volition receive a portion of the entity'due south "residual returns." The variable interest beneficiary retaining a controlling financial involvement in the VIE is designated equally its "primary beneficiary" and must consolidate the VIE.
ASC 810-ten explains that a variable involvement beneficiary retains a "controlling financial involvement" in a VIE when that beneficiary retains the ability to direct the activities of the VIE that take the greatest influence over the VIE's economic performance and retains an obligation to absorb the VIE's pregnant losses or the right to receive benefits from the VIE that could potentially exist significant to the VIE. Investees in a VIE must determine their status equally a variable involvement beneficiary when they enter into their investor human relationship.
ASC 810-x states that but i reporting entity is expected to exist identified as the primary beneficiary. Accordingly, information technology establishes a detailed listing of criteria for identifying and designating the master casher.Exhibit two lists those criteria. In add-on, ASC 810-ten says that when evaluating whether a reporting entity is the primary beneficiary, consideration must be given not only to that entity's involvement in the VIE but also to the variable interests held past its related parties "in the aforementioned VIE … as its own interests." This guidance was retained from FIN 46(R).
EXHIBIT two
ASC 810-x Criteria for Identifying the Primary Beneficiary among a Group of Variable Interest Beneficiaries
Plainly, for common command entities, ASC 810-ten's consolidation model has significant implications for identifying the entity within a mutual control group that might be required to consolidate an interest identified as a VIE.
Common Control Entities and Consolidating a VIE
In determining whether an entity meets its VIE consolidation guidance, ASC 810-10-25 extends the definition of related parties to include those entities or others interim equally "agents or de facto principals" of an disinterestedness investor, including a party that—
- requires subordinated financial support to finance its operations, such as another VIE in which the reporting entity is a primary beneficiary;
- receives its interest via a loan or a contribution from the reporting entity;
- is an officer, employee, or fellow member of the governing board of the reporting entity; or
- maintains either an understanding that it cannot sell, transfer, or otherwise encumber its interest in the VIE without prior blessing from the reporting entity, or maintains a shut business organisation relationship, such as a relationship betwixt a professional service firm or one of its significant clients. ASC 810-10-25-43d states that the "the right of prior approval creates a de facto agency relationship but if that right constrains the other party's power to manage the economical risks or realize the economic rewards from its investment in a VIE through the sale, transfer, or encumbrance of those interests."
Thus, where a VIE is a component of a related party grouping, even if no single reporting entity meets the definition of its primary beneficiary, ane of the related party entities might exist required to consolidate the VIE (i.e., the i with cumulative power, within the group, to direct the activities of the VIE that most significantly impact its economic operation).
In addition, if the reporting entity and its related parties, as a group, see the definition of a primary casher, then the entity within the group that is "nearly closely associated with the VIE" will be classified as the primary casher and volition be required to consolidate the VIE (ASC 810-x-25-44). Determining the entity within the related party grouping that is nearly closely associated with the VIE is subjective and should be based on an analysis of all relevant fact and circumstances, including the post-obit:
- The existence of a principal-agency relationship between parties within the related party group
- The relationship and significance of the VIE's activities to various members within the related party grouping
- A party'south exposure to variability of the VIE's economic performance
- The VIE's pattern.
Amendments to ASC 810
ASU 2014-07.
After establishing the VOE/VIE consolidation model in ASC 810, FASB and the Individual Visitor Quango, a FASB advisory group focusing on awarding of FASB guidance to nonpublic companies, issued several amendments. ASU 2014-07,Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Mutual Control Leasing Arrangements, allows the reporting entity/lessee to elect not to apply VIE guidance to a lessor entity nether mutual command. Under ASC 2014-07, a private company can elect to apply the exception to VIE guidance when—
- the lessee and lessor are private companies and are common control entities,
- the lessee has a lease organisation with the lessor,
- essentially all the activities between the lessee and the lessor are leasing activities, and
- the lessee explicitly guarantees or provides collateral for any obligation of the lessor related to the leased asset, and the main amount of the obligation at inception of such guarantee or collateral arrangement does not exceed the value of that leased nugget.
If the private visitor/lessee elects this exemption, information technology is also exempted from the related VIE disclosures regarding its human relationship with the lessor entity. In that instance, ASU 2014-07 includes carve up disclosure requirements related to the leasing arrangements with its mutual control affiliate.
Those lessees electing the ASU 2014-07 VIE exemption must utilize that election to all current and future lessor entities under common control that meet its criteria. If the exemption is elected, information technology should be practical retrospectively to all periods presented.
ASU 2015-02.
Issued in Feb 2015, ASU 2015-02,Consolidation (Topic 810): Amendments to Consolidation Assay, modified the evaluation of whether legal entities like limited partnerships are VIEs or VOEs, eliminated the presumption that a general partner should consolidate a limited partnership, clarified the implications of fee arrangements and related party relationships when considering the consolidation implications of reporting entities that are involved with VIEs, and provided a scope exception from consolidation guidance for reporting entities with interests in legal entities that are subject field to requirements like those in Rule 2a-vii of the Investment Company Act of 1940 for registered money market funds.
Prior to the issuance of this amendment, ASC 810-10 required a reporting entity to consider the interests in a VIE held by its related parties as though those interests belonged to the reporting entity when determining the VIE'due south primary beneficiary. ASU 2015-02 revised that guidance to let a single determination maker to consider the interest held by its related parties indirectly on a proportionate basis, rather than considering those investments as its own interests.
For the single determination maker, completing this "indirect evaluation" fulfills the chief casher assessment. After considering the interest held by related parties indirectly and on a proportionate basis, if the mutual control group has characteristics of a chief beneficiary, it must consider the related party human relationship in its entirety—that is, determine collectively whether the common command group retains a decision-making financial involvement in the VIE. And then, after because the collective financial interests of the common control group, if the grouping is not classified as the primary beneficiary, it must evaluate whether a single variable involvement holder in that grouping represents the primary beneficiary. And of course, if it determines that substantially all of the VIE's activities are conducted on behalf of a fellow member of the controlled group, that single variable interest holder consolidates the VIE.
Mutual Control Entities and Consolidation of VIEs
After issuing ASU 2015-02, FASB, working with the Private Company Council (PCC), identified some additional difficulties associated with applying the amended guidance of ASC 810-10, particularly for entities nether common control. At public hearings and its periodic meetings, the PCC discussed a common control situation for which applying the VIE accounting can exist challenging. The example involves a three-party related party group:
- Visitor A and its affiliates/subsidiaries Unit B and Unit C.
- Company A holds a 100% equity investment in Unit B and in Unit C.
- Unit of measurement C was established to vertically integrate its production activities with Unit B. It is an operating company that has a bank loan with Local Bank Company.
- Unit B is an operating visitor that has a bank loan with a dissimilar bank, Regional Bank, Inc. In addition, Unit B purchases 90% of Unit C's products.
- Periodically, Unit B has "bailed out" Unit C when it was under financial stress.
In presenting this example, FASB staff asked accountants to answer the following questions: 1) Is Unit C a VIE? 2) Bold Unit of measurement C is a VIE, based on guidance in ASC 810, who is the primary casher—Visitor A or Unit B?
According to a FASB staff memo, in general, respondents classified Unit C as a VIE, mainly considering of its insufficient funding and Unit B'due south periodic bailout of Unit C. Although many respondents agreed that Unit C meets the VIE definition, several other respondents indicated that the data provided was non sufficient to answer the question.
Under the assumption that Unit of measurement C is a VIE, respondents agreed that Unit of measurement B was the primary beneficiary of Unit C. Despite that observation, some argued that, for the given fact pattern, a case could be fabricated that the primary beneficiary is Visitor A, the 100% equity-holder for Unit B and Unit of measurement C. On this indicate, the staff memo states:
Each respondent stated that [Unit B] would likely be the chief casher, simply also acknowledged that some arguments exist for [Visitor A] being the principal beneficiary. Arguments on why [Unit of measurement B] would exist the primary beneficiary differed betwixt practitioners from the large accounting firms and practitioners from regional and midsize accounting firms (Staff Memo, Nov. xx, 2015, page vii).
In general, respondent viewpoints differed over how they reached their decision; those from large firms interpreted and practical the guidance in ASC 810, while their counterparts in regional and mid-sized firms advocated a "mutual sense" approach that focused on which entity retained the risks and rewards associated with the VIE and on their opinions concerning the value of issuing consolidated financial statements in situations involving entities under mutual control. In such situations, these respondents suggested that providing consolidated financial statements represents the default determination, irrespective of the technical nuances of the accounting guidance. (At a 2016 PCC public meeting, the author of this article, along with several other participants, fabricated a similar statement.)
The FASB staff discussed other examples involving application of ASC 810 VIE guidance, after which they concluded that ane) when applied correctly, accountants agree with the reporting results provided by ASC 810; 2) diversity in practice exists in the application of ASC 810 for transactions involving VIEs, especially amidst regional and midsize firms, and iii) in accounting for transactions involving VIEs, particularly for entities under common control, accountants prefer consolidation of subsidiaries with the majority disinterestedness owner, irrespective of the ASC 810 guidance.
After additional outreach, including several boondocks hall style meetings, FASB issued proposed ASU, "Consolidation (Topic 810)—Interest Held Through Related Parties That Are under Common Control," which amends guidance regarding the awarding of VIE rules for entities nether common control. The proposal clarified the evaluation for determining the primary beneficiary of a VIE in situations involving a reporting entity and its related parties, which are entities held nether common control. Nether the proposal's arroyo, one would conclude that Unit C is a VIE, Unit of measurement B is the primary beneficiary and in stand-alone financial statements would consolidate the VIE, and Company A would consolidate both Unit of measurement B and Unit C for consolidated reporting purposes.
FASB received 18 comment letters on the proposal. While offer additional suggestions for improving fiscal reporting for VIEs, most commenters agreed with the proposal. They noted that the clarification in the proposal would crave a reporting entity (i.e., Company A in the example), in evaluating whether information technology is a primary beneficiary of a VIE, to include all its directly variable interests and, on a proportionate basis, the indirect variable interests held past its related parties of that VIE.
Subsequently reviewing comments received on the proposal, and afterwards further deliberations between FASB and the PCC, FASB finalized its guidance in October 2016 in ASU 2016-17,Consolidation (Topic 810): Interests held through Related Parties that are under Mutual Control. ASU 2016-17 apology ASC 810-x to specify that, in determining its fiscal interest in a VIE, an entity should consider its direct interest in the VIE and, "on a proportionate basis, its indirect variable interests in a VIE held through related parties, including related parties that are under common command with the reporting entity."
If the reporting entity concludes that its direct and indirect interest establishes information technology every bit the primary beneficiary, the reporting entity consolidates the VIE. Otherwise, the reporting entity and its related party affiliates held under common command must evaluate their involvement, and if it is adamant that as a grouping they meet the characteristics of a primary casher, they must decide the entity within the common control grouping that "near closely" retains the characteristics of a primary beneficiary.
In substance, by amending the ASU 2015-02 guidance, ASU 2016-17 makes it less likely that a reporting entity will be required to consolidate a VIE when it retains only a minor indirect economical interest in the VIE via a nonconsolidating interest held in a common control affiliate.
Continuing Developments
Clearly, for common control groups with investees that run into the VIE definition, applying the ASC 810-10 guidance is complex and subject to meaning judgment. In because these issues, FASB recently issued a proposed ASU, "Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Involvement Entities." According to the proposed amendment, a individual company would not accept to apply the ASC 810-10 VIE guidance to affiliates nether common control if both the parent and the investee/affiliate being evaluated for consolidation are not public business entities. Instead, the mutual command grouping could apply an bookkeeping alternative allowing the private company to provide detailed disclosures virtually its involvement with and exposure to the investee/affiliate nether common command. To apply the disclosure alternative, both the controlling entity and its investee/affiliate must not exist public business entities. The comment deadline for the proposed ASU was September 5, 2017. Currently, FASB is redeliberating the issue and considering the comments received.
Source: https://www.cpajournal.com/2018/08/15/common-control-entities-and-consolidation-of-variable-interest-entities/
Post a Comment for "what type of entity is permitted to apply accounting alternatives in the codification"