Improvements Made in VIE Consolidation Accounting

FASB simplifies guidance for private companies and the business scope exception

IN RECENT YEARS the FASB has been engaged in improving existing standards through amendments to reduce the cost and complexity of financial reporting. This article covers the following two recent improvement amendments to the exceptions to not apply the variable interest entity (VIE) consolidation model:

• ASU 2017-01 Clarifying the Definition of a Business
• ASU 2018-17 Targeted Improvements to Related Party Guidance for Variable Interest Entities

The clarifying definition update became effective after Dec. 15, 2017 for public business entities (e.g., calendar year 2018) and after Dec. 15, 2018 for all other entities (e.g., calendar year 2019 for private companies). This update narrows the breadth of this scope exception.

The targeted improvements update broadens the accounting policy election for a private company to opt-out of the VIE guidance to include all legal entities under common control, not just common control leasing arrangements as previously permitted. The expanded private company election is effective for fiscal years beginning after Dec. 15, 2020 (e.g., calendar year 2021) with early adoption permitted. This update also amends the guidance for determining whether a decision-making fee is a variable interest, but a review of this change is beyond the scope of this article.

Definition of a Business Clarified

One possible way to escape the VIE consolidation rules is to meet the business scope exception. The FASB recently clarified what constitutes a business in the publication of ASU No. 2017-01 and this revision has impacted the business scope exception in the ASC 810 consolidation rules. This 2017 ASU was focused principally on what would qualify as a business for purposes of business acquisition versus asset acquisition accounting. However, the revised definition of a business applies more broadly.

Business Definition

Determining if an entity meets the business scope exception is a two-step process. However, there is an initial screen that can be used to determine when a set is not a business. This may allow some entities to avoid doing the entire analysis if not otherwise needed. When applying the screen, if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or in a group of similar identifiable assets, the set is not a business, and no further assessment is required.

If the screen is not met, an entity then performs an assessment to determine whether the set is a business by using a framework outlined in the ASU. To be considered a business under this framework, a set must include at least one input and one substantive process that together significantly contribute to the set’s ability to create outputs. The guidance narrows the definition of outputs by more closely aligning it with how outputs are described in ASC 606.

Second, the RE must evaluate the entity and its relationship with the entity under paragraph ASC 810-10-15- 17(d). If any of the following apply for the entity and the RE, then the entity does not qualify for the business scope exception.

• The RE has participated significantly in the design or re-design of the entity;
• The activities of the entity have either the RE involved or conducted on behalf of the RE;
• The RE provided more than half of the total of equity, subordinated debt or other forms of subordinated financial support for the entity; or
• The activities of the entity are primarily related to securitizations or other forms of asset-based financings or single-lessee leasing arrangements.

The ASU also includes minor amendments to the definitions of “input” and “process,” the other two elements of a business, to indicate that each has the ability to “contribute to the creation of” outputs. These definitions are in contrast to the existing guidance in ASC 805, which indicates that processes create outputs when applied to inputs. Further, the definition of a process has been revised to indicate that the intellectual capacity of an organized workforce is the attribute that may provide necessary processes toward the creation of outputs.

Private Companies

As noted, the original guidance applied to both public and private companies. However, private companies in particular saw limited benefit in its relevance and usefulness. The Private Company Council (PCC) (www.fasb.org/pcc), which addresses constituents concerns and recommends improvements, helped facilitate feedback which indicated that VIE guidance was difficult to understand, unnecessarily complex and promoted inconsistency in application largely due to lack of clarity in determination of various criteria.

In March 2014, the FASB issued ASU No. 2014-07, Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements, a Consensus of the Private Company Council, which allowed private companies to elect out of the VIE guidance for certain leasing transactions. This was considered to be a step in the right direction, but the consolidation issues remained for transactions not involving leases.

The new standard, ASU No. 2018-17, supersedes the amendments in ASU No. 2014-07 and allows a private company to make an accounting policy election to not apply VIE guidance to legal entities under common control (including common control leasing arrangements) when certain criteria are met. The election covers all current and future legal entities under common control that meet the criteria for applying the alternative option. The company must still apply other GAAP consolidation guidance, specifically, the voting interest entity guidance, and comply with required disclosures concerning its activities with the legal entity under common control. See criteria below:

A legal entity need not be evaluated by a private company (reporting entity) under the VIE model if all of the following are true:

1. The reporting entity and the legal entity are under common control.
2. The reporting entity and the legal entity are not under common control of a public business entity.
3. The legal entity under common control is not a public business entity.

The reporting entity does not directly or indirectly have a controlling financial interest in the legal entity when considering the voting interest model (see ASC 810-10-05; under the voting interest model, the usual condition for a controlling financial interest is ownership by one reporting entity, directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity).

This update to the standard is intended to simplify guidance surrounding consolidations and VIE’s to private companies under common control. It is expected that many private companies will make the applicable election with hopes of improving understanding and consistency in applying VIE guidance. Additional disclosure requirements are aimed to further support communication of relevant financial information to users in a meaningful way. With reduced complexities and therefore reduced cost, the private companies and the users of its financial information should be the beneficiaries of overall enhanced efficiencies and effectiveness into the future.