A Look at ASC 810: To Consolidate or Not To Consolidate
Companies tasked with determining whether to consolidate the financial statements of potential variable interest entities (VIEs) face challenges that can significantly change the presentation of their financial statements. Properly assessing whether to consolidate VIEs is crucial for accurate financial reporting. Failure to properly assess potential VIEs can jeopardize regulatory compliance, which could have a rippling effect on investor and stakeholder confidence. BDO’s Blueprint: Control and Consolidation Under ASC 810 provides essential guidance to help organizations navigate these complex accounting standards effectively.
This overview introduces some of the fundamental concepts covered by the Blueprint, helps define the characteristics of VIEs, and explains when a VIE analysis is required.
ASC 810 and Today’s Business Relationships
The Financial Accounting Standards Board (FASB) established Accounting Standards Codification Topic 810 (ASC 810), Consolidation. ASC 810 describes how to determine whether an entity controls other entities and prescribes guidance on when and how an entity should consolidate with another entity for financial reporting. Our Blueprint contains a flowchart that summarizes ASC 810 and can be used in situations where consolidation may be required.
Understanding the complex relationships between entities is vital for determining whether one entity is required to consolidate another. Unique contractual arrangements and complex legal structures can often present challenges when navigating VIE guidance. Such information is critical when identifying whether reporting entities are required to consolidate other entities (for example, investees or counterparties to contractual relationships).
The decision process is not always straightforward, in part because of the judgment required. Additionally, a consolidation assessment is not a one-time event; the result can change as the facts and circumstances evolve. Professional assistance can be useful when applying ASC 810.
Scope of the VIE Model
Before diving into an analysis under the VIE model, an entity must first determine whether a scope exception to ASC 810 applies. The following entities are excluded from the scope of ASC 810:
- Employee benefit plans
- Certain investments accounted for at fair value
- Most governmental organizations and governmental financing entities
- Money market funds
Entities that fall within the scope of ASC 810 may still be subject to a scope exception to the VIE guidance. The VIE scope exceptions are as follows:
- Most not-for-profit (NFP) entities
- Separate accounts of life insurance entities
- Some legal entities created before December 31, 2003
- A legal entity under common control with a private company (determined using only the voting model) that elects the private company accounting alternative
Businesses (as defined in ASC 805, Business Combinations) that meet specific conditions may qualify for a scope exception. However, the business scope exception is often misinterpreted as suggesting that the VIE guidance does not apply to any entity that is a business. Rather, additional criteria also must be analyzed to determine if this scope exception applies, which may be challenging.
Despite the scope exceptions listed above, many entities are within the scope of the VIE guidance. Chapter 1 of our Blueprint further describes the entities that fall within the scope of ASC 810, as well as those that do not.
Identifying a VIE
The VIE model and voting interest model have distinct requirements. The VIE model was written to address fact patterns where not all equity investors bear the typical economic risks and rewards of owning a legal entity. Whereas the voting interest model follows a general premise that majority of voting interests dictates control. When assessing consolidation companies are required to first determine if the entity is a VIE before assessing consolidation under the voting interest model. Determining the proper model to follow can critically affect the consolidation outcome.
Legal entities are VIEs if they exhibit any of the following characteristics:
- The entity needs additional subordinated financial support from other parties to finance its activities (for example, it is thinly capitalized).
- The holders of the equity at risk collectively lack the power, through voting rights or similar rights, to direct the activities that most significantly impact the legal entity’s economic performance.
- The holders of the equity at risk collectively lack the obligation to absorb the legal entity’s expected losses.
- The holders of the equity at risk collectively lack the right to receive the legal entity’s expected residual returns.
- The legal entity fails the anti-abuse test, which means that the voting rights are deemed nonsubstantive.
The VIE analysis must thoroughly consider the entity’s purpose and design when evaluating the characteristics listed above. Chapter 3 of our Blueprint further describes these characteristics.
Answering the Consolidation Question
After concluding that the entity is a VIE, the entity must identify the primary beneficiary (if any); the primary beneficiary has a controlling financial interest in the VIE. The reporting entity is the primary beneficiary of a VIE if it has both power and the economics.
The process of determining whether an entity has power and economics often requires judgment, as discussed in Chapter 4 of our Blueprint. Due to the complex nature of such assessments, entities should consider consulting with professionals who have the experience and skill to consider all pertinent facts and circumstances.
As noted in ASC 810 and Chapter 5 of our Blueprint, other facts and circumstances can affect the consolidation analysis, including the existence of “related parties” and “de facto agents.” Examples of related parties include affiliates, principal owners, and management of the entity, as well as their immediate family members. ASC 810 also describes five different categories of “de facto agents” that must be considered when applying ASC 810 .
Conducting Timely, Required Analysis
Any entity may be a VIE. Therefore, when a company first becomes involved with another entity, it is required to assess whether the other legal entity is a VIE. Applying the voting model without first analyzing whether the other entity is a VIE may lead to incorrect financial reporting. Instead, comprehensive analysis can help start out on the right foot, as detailed in Chapter 2 of the blueprint.
A VIE analysis is not one-and-done. As facts and circumstances evolve, the status of an entity may switch from VIE to voting interest entity or vice versa. Additionally, the primary beneficiary may also change over time. When such changes occur, timely professional judgment is needed to understand the intricacies of the contracts and relationships and to apply the accounting standards. Failing to address these changes can lead to misstated financial statements as a result of inappropriate consolidation or failure to consolidate of subsidiary entities.
Other Consolidation Models
If an entity is within the scope of ASC 810 but is not a VIE (or is outside the scope of the VIE model), the voting interest model applies. Under the voting interest model, the entity that owns more than 50% of the voting rights (or kick-out rights) generally controls the other entity. Further analysis may be required depending on the facts and circumstances (for example, when other entities, having less than 50% of the voting rights, can exercise substantive participating rights over the entity).
VIE Analysis Is Challenging. We Can Help.
When companies fail to appropriately assess consolidation under the VIE guidance, the risk of materially misstated financial statements increases. Conducting timely VIE analyses is essential for preparing financial reports in accordance with U.S. GAAP.
Our Blueprint offers comprehensive guidance on the application of ASC 810, and our professional advisors can walk you through the complicated process of determining the appropriate financial reporting for VIEs. Contact BDO’s Accounting & Reporting Advisory Services to learn more.
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