The FASB's consolidation project nears completion with more decisions made at this week's meeting.
The FASB’s consolidation project nears completion with more decisions made at this week’s meeting. Significant changes have been made by the Board to the principal versus agent proposal that was exposed in 2011, making the potential impacts more broad than initially anticipated.
The FASB’s initial goal was to make a surgical fix to one aspect of the consolidation guidance (adding a new principal versus agent step in the VIE model) to avoid asset managers needing to consolidate the funds they manage. Since then, the Board has made decisions that will impact several aspects of the consolidation guidance with applicability to all companies. As discussed further below, the tentative decisions reached will impact, among other items:
(1) how to evaluate control for voting entities;
(2) when an entity is a variable interest entity (VIE);
(3) how to evaluate economics when determining who consolidates a VIE; and
(4) when to apply the related party tiebreaker.
As a result of the current decisions, both the VIE model and voting model for consolidation are expected to change. Consequently, previous consolidation conclusions and disclosures could change, which are likely to impact systems, processes and controls.
The only remaining decisions are around transition and other completion matters, and whether to issue a final standard or re-expose. The remaining decisions are expected to be made in June.
How to evaluate control for voting entities
The current guidance precludes consolidation by a majority owner when a minority owner holds substantive participating rights (such as veto rights on budgets, hiring and firing, and compensation of management) in the ordinary course of business. Under the current decisions, the evaluation of the minority owner rights would change to align with the concept of the “most significant activities” in the VIE model. Therefore, different consolidation conclusions could result if the veto rights held by the minority owner are not “the most significant activities”. This change would raise the bar on when minority rights preclude consolidation and cause more majority shareholders to consolidate than under today’s guidance. Many industries are expected to be impacted by this change.
When an entity is a VIE
Today, a limited partnership would typically be a VIE if the general partner has not invested a substantive amount of equity. However, under the tentative decisions, a limited partnership would be a VIE unless substantive kick-out, liquidation or participating rights are exercisable by either a single limited partner or a vote of majority of all partners. A different consolidation conclusion may be reached under the VIE model than under the voting model and additional disclosures would also apply. This change would result in more entities being VIEs and have broad application, since limited partnership structures are utilized extensively in the asset management sector and also in a number of other sectors such as oil & gas, transportation, and real estate development sectors.
How to consider economics and the related party tiebreaker
The criteria for determining which party should consolidate would remain broadly consistent – i.e., based on who has both power over the most significant activities and exposure to potentially significant economics, with a few notable exceptions. First, fees paid to a decision-maker that are “at market” and “commensurate with services provided” would be excluded in determining whether the decision maker’s economics are “potentially significant”. In addition, how related parties and de facto agents of a decision maker are considered in the consolidation assessment would change. Further, the circumstances when the related party tiebreaker applies would be reduced. These changes individually and in the aggregate could change who consolidates an entity.
The Board has yet to determine if these changes merit re-exposure of the proposed model. If the Board decides to issue a final standard (that decision could be made as early as June), companies will not have an opportunity to formally comment on the new standard. Therefore, companies, particularly those outside of asset management who may not have been following this project, should familiarize themselves with the proposed model now and consider sharing perspectives with the FASB and its staff.
PwC clients who have questions about this In brief should contact their engagement partner. Engagement teams who have questions should contact the Business Combinations team in the National Professional Services Group (1-973-236-7801).
Stephanie L. Stewart