In the wake of Enron and other scandals involving off-balance-sheet items, variable interest entities (VIEs) have earned a bad reputation as a tool that may be used by unscrupulous owners and managers to manipulate financial results and mislead investors. But most businesses use VIEs for legitimate purposes.
The Financial Accounting Standards Board (FASB) recently proposed changes to the consolidated reporting guidance for entities that are the single decision maker for a VIE. In a nutshell, the updated guidance will modify the evaluation of whether a reporting entity is the primary beneficiary of a VIE by altering how a reporting entity that’s a single decision maker for a VIE would treat indirect interests in the entity held through related parties that are under common control of the reporting entity. Here’s more on this proposal.
Updating an update
On June 23, 2016, the FASB issued Proposed Accounting Standards Update (ASU) No. 2016-260, Consolidation (Topic 810): Interests Held Through Related Parties That Are Under Common Control. It calls for changes to reporting interests in a VIE through affiliated businesses and other related parties.
The proposal is meant to address a provision in ASU 2015-02, which previously amended the accounting guidance for consolidated reporting. This update went into effect on January 1, 2016, for calendar-year public companies, and will become effective for all other calendar-year companies on January 1, 2017.
The 2015 update includes a requirement for reporting entities that are the single decision maker for a VIE to consider indirect economic interests held through related parties when assessing whether they are the VIE’s primary beneficiary.
Before ASU 2015-02 was published, the consolidated reporting requirements for VIEs didn’t prescribe how indirect interests should be considered in the assessment of control. Once the guidance was updated in 2015, some questions were raised about the assessment for indirect interests and whether it led to the consolidation of some VIEs when the reporting entity had no more than a limited interest in the VIE.
Refining the details
The latest round of proposed amendments, among other things, calls on reporting entities making a consolidated reporting assessment to consider all direct variable interests in the VIE and the indirect variable interests in the VIE held through related parties. The proposed amendments also delete the final sentence from FASB Accounting Standards Codification (ASC) Topic 810-10-25-42, which says, “Indirect interests held through related parties that are under common control with the decision maker should be considered the equivalent of direct interests in their entirety.”
If, after performing that assessment, a reporting entity concludes it doesn’t have the characteristics of a primary beneficiary (see “What are the characteristics of a primary beneficiary?”), the latest proposal would require the reporting entity to evaluate whether it and one or more of its related parties under common control, as a group, have the characteristics of a primary beneficiary. If the single decision maker and related parties that are under common control, as a group, have the characteristics of a primary beneficiary, then the primary beneficiary is the party within the related party group that’s most closely associated with the VIE.
Evaluating the feedback
The effective date for the proposed changes will be set after the FASB considers any feedback it received during the comment period, which ended on July 25. If the changes in Proposed ASU 2016-260 are finalized, the FASB will also consider whether any amendments are necessary to ASC Topic 810-10 for fees paid to decision makers or service providers.
In addition, businesses and other organizations that have adopted ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, could adopt the new amendments by adjusting amounts from prior periods using what the board calls a “retrospective transition.” Alternatively, they could use a modified retrospective approach and adjust reported equity to reflect the cumulative effect of the accounting change.
Businesses that haven’t yet adopted ASU 2015-02 will employ the same transition for the proposed amendments (if they’re finalized) once they adopt ASU 2015-02. Contact your accounting professional for help implementing these changes.
Sidebar: What are the characteristics of a primary beneficiary?
Under current U.S. Generally Accepted Accounting Principles (GAAP), a primary beneficiary of a variable interest entity (VIE) has both of the following characteristics:
- The power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, and
- The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.
If a reporting entity satisfies the first characteristic of a primary beneficiary, it’s considered the single decision maker of the VIE. The proposed update by the Financial Accounting Standards Board (FASB) would require that reporting entity, in determining whether it satisfies the second characteristic of a primary beneficiary, to include all of its direct variable interests in a VIE and, on a proportionate basis, its indirect variable interests in a VIE held through related parties, including related parties that are under common control of the reporting entity.
In other words, the proposed amendments would no longer require a single decision maker to consider indirect interests held through related parties that are under common control with the single decision maker to be the equivalent of direct interests in their entirety. Instead, the single decision maker would include such interests on a proportionate basis consistent with indirect interests held through other related parties.