Considering whether an entity’s business activities with a related entity should result in its consolidation of that related entity under ASC Topic 810, Consolidation (Topic 810), is a very challenging accounting determination for many entities. Applying Topic 810’s often complex guidance, especially with regard to determining the existence of variable interests and whether the reporting entity is the primary beneficiary of a variable interest entity (VIE), is particularly difficult for many smaller, private entities, which often may lack the experience in applying the nuanced rules concerning VIE consolidation.
The FASB’s Private Company Counsel (PCC) has long lobbied for relief for private companies from applying the complex VIE consolidation rules under Topic 810. As a result of these efforts, the FASB passed very limited relief through ASU No. 2014-07, Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements. Through this Update, the FASB exempted a private company from applying the VIE consolidation guidance when it has entered into certain leasing arrangements with a related entity under common control. The FASB recognized that entities often entered into these arrangements for tax, estate planning or legal liability issues and not as an attempt a providing off-balance sheet financing. While addressing a specific concern, ASU No. 2014-07 was very limited in scope and failed to quell the calls for further consolidation relief.
While it took several years, the FASB finally responded to these calls for further relief through the issuance of ASU No. 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities (Update). Through this Update, issued in October 2018, a private company reporting entity, may elect not to apply VIE guidance to legal entities under common control, including common control leasing arrangements, if both the parent and the legal entity being evaluated for consolidation are not public business entities. This broad exemption is exactly what private companies, and the PCC, have been asking for. However, if an entity elects this alternative, it should continue to apply other consolidation guidance, particularly the voting interest entity guidance, unless another scope exception applies. Also, if electing this exemption, the entity must apply it to all current and future legal entities under common control that meet the criteria for applying this alternative.
Lastly, an entity making this election should provide detailed disclosures about its involvement with and exposure to the legal entity under common control.
The FASB expects this accounting alternative to reduce diversity in applying VIE guidance to private companies under common control because it expects that many private companies will elect the alternative. Also, by requiring additional disclosures about these arrangements, the Update will provide additional information about these common control arrangements. However, let’s face it. This alternative will make the financial reporting for many private entities with such arrangements significantly easier.
As with all accounting pronouncements, the devil is in the details. It is vital that entities looking to take advantage of this option to read the new standard, which is available at the FSSB’s website, FASB.org.
Of particular importance in determining the applicability of this option is appropriately applying the concept of “common control.” Per the Update, to determine whether the private company reporting entity and the legal entity being considered for consolidation are under common control of a parent the private company shall consider only the parent’s direct and indirect voting interest in the private company and the legal entity, not factors that may create control through other factors, such as variable interests.
So clearly private entities currently applying the VIE guidance in Topic 810 will want to take advantage of this new election as quickly as possible. This new guidance is effective for a private company for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. Entities should apply the Update on a retrospective basis, with a cumulative-effect adjustment to retained earnings at the beginning of the earliest period presented.
However, early adoption is permitted, meaning consolidation relief is immediately available, even for 2018 financial reporting. So now is the time to see if this consolidation relief makes sense for you.
If you would like a comprehensive review of recent standard setting activities of the PCC, FASB, ASB, and ARSC, Surgent CPE is offering an Annual Accounting and Auditing Update. This course is offered as a webinar or in self-study format with downloadable pdf reference materials.
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