In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810) – Amendments to the Consolidation Analysis. This ASU affects all companies and is effective for calendar year public companies beginning in 2016 and for nonpublic companies in 2017, with early adoption permitted. This ASU requires companies to reevaluate their consolidation assessments, update their consolidation documentation, and reconsider their conclusion under the revised guidance in the period of adoption.
SUMMARY OF EXISTING GUIDANCE
The overall path to apply the existing consolidation guidance remains unchanged. Companies consolidate other entities that they control, based on the variable interest entity (VIE) model or the voting interest entity (VOE) model. The variable interest entity model is applied when a company holds a variable interest in a legal entity which is a VIE. If so, the VIE model is applied and the primary beneficiary consolidates the legal entity.
OVERVIEW OF AMENDMENT
The primary change of ASU 2015-02 affects the scope of application of the VIE model. Previously, FAS 167 had provided for an indefinite deferral for investment companies from applying the VIE model. This deferral has been rescinded and replaced with a new permanent scope exception for certain registered money market funds and similar unregistered money market funds. The amendment removes the presumption that a general partner should consolidate a limited partnership. For investment companies applying Topic 810 for the first time or for any company participating in limited partnerships, these changes will require a review of their assessment.
The definition of a variable interest has not changed. However, for arrangements with a fee paid to a decision maker, ASU 2015-02 revises the criteria required to conclude that this is not a variable interest, including:
- The fees are commensurate with the level of effort required to provide the services.
- The service arrangement is at arm’s length with only customary terms, conditions, or amounts.
- The service provider does not hold other interests in the VIE that are more than insignificant – related party interests are now included on a proportionate basis instead of in their entirety.
These changes are expected to result in fewer arrangements meeting the definition of a variable interest. Companies with fee arrangements will need to re-perform the analysis of variable interests held as well as begin to track indirect economic interests held through related parties.
VARIABLE INTEREST ENTITY ASSESSMENT
The revised guidance includes the same criterion to assess whether an entity is a VIE, but changes how companies examine equity holder power, or lack thereof, to direct the activities that most significantly impact the entity’s economic performance. Limited partnerships are now required to determine whether the limited partners have power. Limited partners must have either substantive kick-out rights or substantive participating rights over the general partner to be considered to have power. For companies with limited partnerships, this analysis will need to be performed and will likely result in limited partnerships being considered VIEs.
PRIMARY BENEFICIARY DETERMINATION
The primary beneficiary will continue to be the reporting entity that meets both the power and economics criteria. The power criterion remains unchanged, but the economics criterion changed in two respects.
- First, a decision maker is no longer required to include a variable-interest fee arrangement in its economics test if the fees paid are both customary and commensurate.
- Second, if a decision maker has unilateral power but its direct interests do not meet the economics criterion, the ASU has provided a series of steps for that entity to consider the effects of related parties and the application of the related party tiebreaker.
Companies may elect either the modified retrospective approach by recording a cumulative-effect adjustment to equity as of the beginning of the first year of adoption or the full retrospective approach. Under either approach, entities should be consolidated or deconsolidated based on the carrying amounts as if the revised consolidation guidance had always been applied. If it is not practical to determine these carrying amounts, then the fair value as of the date of adoption can be used on an entity by entity basis.
ASSESSING THE IMPACT
While investment companies and companies participating in limited partnerships will be acutely affected, all companies will be required to revise existing documentation, which may result in the consolidation or deconsolidation of an entity for the first time. Consolidation assessments involve the review of nonstandard investment contracts and the aggregation of inputs that many times are not being tracked, such as ownership interests through related parties.
We encourage companies to review their consolidation assessments in order to allow the appropriate time and resources necessary to update documentation, gather newly required inputs and communicate potential changes in consolidation conclusions to management, auditors, and other stakeholders.