Private companies can elect out of the complex VIE guidance

On Halloween, the Financial Accounting Standards Board (FASB) gave private companies a special treat: long-awaited relief from the variable interest entity (VIE) guidance. Over the years, private companies have described Accounting Standards Codification (ASC) Topic 810, Consolidation, as one of the most complicated areas of U.S. Generally Accepted Accounting Principles (GAAP). Now there’s an easier financial reporting option.

To consolidate or not to consolidate?

The VIE guidance is designed to prevent companies from hiding liabilities in off-balance sheet vehicles. It requires businesses to consolidate (or report on their balance sheets) holdings they have in other entities when they have a controlling financial interest in those entities.

For years, the decision to consolidate was based largely on whether a business had majority voting rights in a related legal entity. In 2003, in the wake of the Enron scandal, the FASB amended the standard to beef up the guidelines on when to consolidate. The new-and-improved standard introduced the concept of VIEs.

“Enron figured out a way within the standard to create off-balance-sheet structures with financing that was completely guaranteed by the host company but yet was off the balance sheet — and the VIE guidance was written to fix that,” said Billy Atkinson, chair of the FASB’s Private Company Council (PCC) from 2012 to 2015.

Under the VIE guidance, a business has a controlling financial interest when it has both the power to direct the activities that most significantly affect an entity’s economic performance and the right to receive significant benefits from the entity, as well as the obligation to absorb its losses.

Reporting alternatives for private companies

Accounting professionals tend to regard the VIE guidance as complicated to follow. And private companies contend that some of their most common business relationships could be considered VIEs under ASC 810 but are set up for tax or estate planning purposes — not to trick investors or pump up stock prices.

The PCC, which keeps the FASB abreast of private company accounting issues, considered the VIE issue a top priority. “We said, ‘Look guys, we’ve had about ten years-plus of application of this guidance. Let’s see if we can untangle it a bit for the impact on private companies that fall prey to the complicated structural guidance,’” said former PCC Chair Atkinson.

Private companies told the FASB that the VIE model forced them to consolidate multiple affiliated and subsidiary businesses onto a parent’s balance sheet. This frustrated lenders and creditors, who wanted cleaner balance sheets. In addition, in companies where ownership is shared among close relatives, determining who holds the power may not always be clear.

In 2014, the FASB responded to these concerns with Accounting Standards Update (ASU) No. 2014-07, Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements (a Consensus of the Private Company Council). The updated standard let private companies ignore the VIE guidance for certain leasing transactions. Private companies applauded this update, but problems persisted with the consolidation guidance for transactions that didn’t involve leases.

Expanding VIE exceptions

The latest FASB move, ASU No. 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities, gives private companies the option to skip the VIE guidance. Instead, they can consider the less complex method provided in the new guidance to assess whether common brother-sister business transactions need to be consolidated.

The updated standard applies to all private company common control transactions that meet certain criteria. And it supersedes the amendments in ASU No. 2014-07. A private company that makes use of the latest amendments to Topic 810 must disclose in its financial statements its involvement with, and exposure to, the legal entity under common control.

“It provides private companies the choice to not apply VIE guidance to their common control arrangements — thereby reducing costs without compromising the relevance of the financial reporting information to financial statement users,” FASB Chairman Russell Golden said in a statement.

Effective dates

For private companies, the amendments in ASU No. 2018-17 are effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. Other organizations must apply the standard for fiscal years beginning after December 15, 2019, and for interim periods within those fiscal years. Early adoption is permitted — and many private companies are expected to opt out of the VIE guidance as soon as possible to simplify financial statement preparation.

Sidebar: Beyond private companies

Accounting Standards Update (ASU) No. 2018-17 does more than provide relief to private companies when applying the consolidation guidance. It also amends the guidance for assessing how fees paid to “decision makers” (or service providers) determine a consolidation decision. The update requires all businesses to consider indirect interests held through related parties in a common control arrangement to be considered on a proportional basis rather than as the equivalent of a direct interest in its entirety.

For example, if a decision maker owns a 20% interest in a related party and that related party owns a 40% interest in the legal entity being evaluated, the decision maker’s indirect interest in the VIE held through the related party under common control should be considered the equivalent of an 8% direct interest (40% × 20%) for determining whether its fees are variable interests.

This amendment will result in more decision makers not having a variable interest through their decision-making arrangements than under the current guidance. In turn, if fewer decision-making fees are considered variable interests, the focus on determining which party within a related party group under common control may have a controlling financial interest will be shifted to the variable interest holders with more significant economic interests. This will substantially reduce the risk that decision makers with insignificant direct and indirect interests could be deemed the primary beneficiary of a VIE.