FASB Issues Proposed Improvements to Consolidation Accounting

Jack Humphrey, Regulatory journalist
December 14, 2011 /

The Financial Accounting Standards Board (FASB) has issued a proposed Accounting Standards Update intended to increase transparency and consistency of financial reporting about consolidations.

The proposed amendments would affect all companies that are required to evaluate whether they should consolidate another entity. Specifically, the proposed Update would provide criteria for a reporting entity to evaluate whether a decision maker is using its power as a principal or an agent.

These criteria would affect the evaluation of whether an entity is a variable interest entity and, if so, whether the reporting entity should consolidate the entity being evaluated.

Also, the amendments cover the evaluation of kick-out and participating rights held by noncontrolling shareholders in a consolidation analysis; change the requirements for determining whether a general partner controls a limited partnership and, therefore, could affect reporting entities that are involved with partnerships and similar entities; and rescind the indefinite deferral of the amended guidance about consolidation for reporting entities with interests in certain investment companies and other
similar entities.

In June 2009, the Board issued FASB Statement No. 167 (subsequently codified by Accounting Standards
Update No. 2009-17, Consolidation [Topic 810]: Improvements to Financial Reporting by Enterprises Involved
with Variable Interest Entities).

This guidance amended the evaluation for determining whether a reporting entity should consolidate a variable interest entity from a quantitative analysis to one that is primarily a qualitative evaluation of power and economics.

Some users and preparers of financial statements of investment managers were concerned that the qualitative evaluation in Statement 167 would result in investment managers consolidating certain funds that they manage. Additionally, the International Accounting Standards Board (IASB) was developing a consolidation standard that was expected to result in different conclusions for investment funds that are variable
interest entities (VIEs).

In response to these different conclusions and preparer and user concerns, the Board issued Accounting Standards Update No. 2010-10, Consolidation (Topic 810): Amendments for Certain Investment Funds, which indefinitely deferred the effective date of the consolidation requirements in Statement 167 for certain entities. The deferral’s purpose was to allow the FASB and the IASB to develop converged guidance for evaluating whether a decision maker (e.g., an asset manager, a general partner, a board of directors) is using its decision-making authority (power) as a principal or an agent and whether it should consolidate
another entity.

The amendments in this proposed Update would rescind the indefinite Statement 167 deferral, require
reporting entities to evaluate all VIEs for consolidation under the revised guidance, and clarify whether a decision maker is using its power as a principal or an agent. In addition, the amendments in this proposed Update would reduce inconsistencies among U.S. generally accepted accounting principles (GAAP) related to kick-out and participating rights.

The proposed amendments would affect the evaluation of whether an entity is a VIE and, if so, whether the
reporting entity should consolidate the entity being evaluated. Under current U.S. GAAP, an entity is a VIE if the entity lacks sufficient equity to finance its activities without additional subordinated financial support, or the equity holders, as a group, lack the power to direct the activities of a legal entity that most significantly impact the entity’s economic performance or the obligation and right as equity holders
to absorb the entity’s expected losses or to receive its expected residual returns. The evaluation of whether a decision maker is using its decision-making authority as a principal or an agent would affect the analysis of whether the equity investors, as a group, lack the power to direct the activities of the
entity or have delegated it to an agent.

If the decision maker is determined to be a principal and does not receive its decision-making authority (power) through an equity interest, the entity would be a VIE.

A reporting entity that concludes that it has a variable interest in a VIE would have to evaluate whether it is the entity’s primary beneficiary and, thus, should consolidate the VIE. That determination is based on a qualitative assessment based on whether it has both the power to direct the activities that most significantly impact the entity’s economic performance, and the obligation to absorb losses of the VIE or the right to receive benefits from the VIE.

Under the proposed amendments, a decision maker would apply the principal versus agent analysis to determine whether it uses its power as a principal or an agent. If the decision maker determines that it is a principal
and the primary beneficiary of the VIE, it would consolidate the VIE.

 

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