The objective of the FASB Consolidation project is to: (1) provide criteria for a reporting entity to evaluate whether a decision maker is using its power as a principle or agent, (2) eliminate inconsistencies in evaluating kick-out and participating rights, and (3) amend the requirements for evaluating whether a general partner controls a limited partnership.
Key developments in the FASB Consolidation project
- In late 2011, the FASB proposed changes to the accounting guidance used to determine whether one entity should consolidate another. The proposal focused primarily on determining whether a party with decision-making power is acting as a principal or an agent for a "variable interest entity" or a partnership that is a "voting interest entity." A principal in this context would consolidate whereas an agent would not. The proposal also would end the deferral of existing guidance on consolidations for certain investment entities.
- Whether the party with decision-making power is acting as a principal or an agent would be determined based on the overall relationship between the decision maker, the entity being managed, and any other interest holders, considering (i) the rights, including kick-out rights, held by others, (ii) how the decision-maker is compensated, with emphasis on whether such compensation is market-based, and (iii) other interests held by the decision maker in the entity.
- For kick-out rights (removal and liquidation), the proposal would align the related guidance for both voting and variable interest entities. Currently, under the variable interest entity model, kick-out rights are only considered when held by a single party, but under the voting interest entity model simple majority kick-out rights are relevant. If kick-out rights are held by more than one party, judgment will be required to determine what impact that right has on the principal versus agent conclusion. Generally the more dispersed the parties that hold the rights, the less indicative those rights would be of an agent in the principal versus agent analysis.
- After the comment period ended early in 2012, the FASB reconsidered some key aspects of the proposal. Perhaps most notable is its decision to align the guidance for participating rights across all consolidation models. Under the current approach for voting interest entities, a noncontrolling shareholder's ability to veto certain decisions could prevent a majority shareholder from consolidating the entity. Under the proposal, a noncontrolling shareholder would have to be able to veto all of the activities that most significantly impact the entity's economic performance to preclude the majority shareholder from being deemed to have control. Another more recent decision would preclude any party, such as an asset manager, from consolidating money market funds that are registered with the SEC and similar unregistered funds.
- Redeliberations were put on hold in 2012 as the FASB turned its attention to other priority projects. However, redeliberations resumed in late 2013 and are expected to continue in 2014. There is no planned effective date at this time and it is unclear whether early adoption will be permitted. A final standard is expected in the second half of 2014.
Why the FASB Consolidation project is important
- The proposal would likely have a significant impact on some asset managers and financial institutions that issue structured products or are general partners in a partnership. For example, managers of collateralized financing entities that currently consolidate solely due to subordinated fee arrangements may be considered agents under the proposal. Also, limited partnership structures − which are common in certain other industries− that are currently consolidated by the general partner because other investors as a group do not have the right to remove the general partner or liquidate the partnership by a simple majority vote may be impacted.
- Aligning the definition of participating rights across all consolidation models could change consolidation conclusions for typical operating entities controlled by voting rights. In particular, consolidation conclusions could change where the existence of participating rights held by the noncontrolling shareholder currently precludes consolidation by the majority shareholder.
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