1.1 Which Consolidation Model to Apply
Under U.S. GAAP, there are two primary consolidation models: (1) the voting interest entity model and (2) the VIE model. Both accounting models require the
reporting entity1 to identify whether it has a “controlling financial
interest” in a legal entity2 and is therefore required to consolidate the legal entity. This requirement is
not limited to legal entities that are VIEs — a reporting entity must consolidate
any legal entity in which it has a controlling financial interest.
Under the voting interest entity model, a reporting entity with ownership of a majority of the voting interests of a legal entity is generally considered to have a controlling financial interest in the legal entity (see Section 1.3 for information about the voting interest entity model). However, the VIE model (see Section 1.2) was established for situations in which control may be demonstrated other than by the possession of voting rights in a legal entity. Accordingly, the evaluation of whether a reporting entity has a controlling financial interest in a VIE focuses on “the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance” and “the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.”
The flowchart segment above illustrates the relevant questions (a series of
“scope” questions) for determining which consolidation model a reporting entity
should apply. The analysis begins with the reporting entity’s evaluation of whether
the legal entity is a VIE3 and therefore subject to the consolidation requirements under the VIE model.
Only if a legal entity does not meet the definition of a VIE, or the reporting
entity qualifies for a VIE scope exception, would the reporting entity apply the
voting interest entity model or other applicable GAAP.
1.1.1 Is There a Legal Entity?
The scope of the consolidation guidance in ASC 810-10 is limited to a reporting
entity’s involvement with another legal entity. The Codification defines “legal
entity” broadly; therefore, almost any legal structure that is used to own
assets, issue debt, or otherwise conduct activities would meet the definition of
a legal entity. The particular legal form of the entity (e.g., corporation,
partnership, limited liability company, grantor trust, or other trust) is not
relevant to the determination of whether the structure is a legal entity.
Divisions, departments, branches, and pools of assets are examples of components
that are typically not separate legal entities. See Section 3.2.
If the reporting entity is involved with a legal entity, the reporting entity must continue its consolidation analysis.
1.1.2 Does a Scope Exception Apply?
A reporting entity may be exempt from analyzing a legal entity for consolidation as a result of a general scope exception (see Section 3.3) or from analyzing a legal entity for consolidation under only the VIE requirements if the legal entity qualifies for a VIE scope exception (see Section 3.4). The general scope exceptions are designed to prevent consolidation of a legal entity by a reporting entity that applies other guidance under U.S. GAAP on (1) employee benefit plans, (2) investment companies, (3) governmental entities, or (4) certain money market funds. If any of these exceptions are applicable, the reporting entity should not consolidate the legal entity under ASC 810. In addition, in developing the VIE model, the FASB determined that certain reporting entities should be exempt from analyzing whether a legal entity is a VIE.
If a scope exception does not apply, the reporting entity must continue its consolidation analysis. If a scope exception applies only to the VIE model, the voting interest entity model must be applied.
1.1.3 Does the Reporting Entity Hold a Variable Interest in the Legal Entity?
The VIE model created the concept of a “variable
interest.” If a reporting entity does not hold a variable
interest in a legal entity, it can stop its consolidation analysis. While there
are many forms of variable interests, all variable interests will absorb portions of a VIE’s variability (changes in the
fair value of the VIE’s net assets exclusive of variable interests) that the
legal entity was designed to create. An interest that creates variability would not be considered a variable interest.
It is often easy to identify whether an arrangement is a variable interest. A
good rule of thumb is that most arrangements that are on the credit side of the
balance sheet (e.g., equity and debt) are variable interests because they absorb
variability as a result of the performance of the legal entity, while items on
the debit side of the balance sheet are typically not variable interests because
they create variability for the legal entity. However, identifying whether other
arrangements (e.g., derivatives, leases, and decision-maker and other service-provider contracts) are
variable interests can be more complex. See Chapter 4 for further discussion of
variable interests.
If a reporting entity holds a variable interest, the reporting entity must continue its consolidation analysis.
1.1.4 Is the Legal Entity a VIE?
Consolidation conclusions under the VIE model can be different from those under the voting interest entity model (and additional disclosures are required for VIEs). Therefore, it is important to determine which model to apply. The difference between a VIE and voting interest entity can be subtle, and the reporting entity needs to completely understand all contractual arrangements (explicit and implicit) as well as the design and purpose of the legal entity. In addition, the criteria for determining whether a limited partnership (or similar entity) is a VIE are different from the criteria for any other legal entity (see Chapter 5 for a complete description of these differences).
ASC 810 provides several characteristics to consider in determining whether an entity is a VIE. Only one of the following characteristics needs to be met (i.e., one characteristic cannot be overcome by consideration of the others) for a conclusion to be reached that the legal entity is a VIE:
- The legal entity does not have sufficient equity investment at risk.
- The equity investors at risk, as a group, lack the characteristics of a controlling financial interest.
- The entity is structured with disproportionate voting rights, and substantially all of the activities are conducted on behalf of an investor with disproportionately few voting rights.
Footnotes
1
Throughout this Roadmap, “reporting entity” refers to the
party performing the consolidation analysis (i.e., the party potentially
consolidating a legal entity).
2
Throughout this Roadmap, “legal entity” refers to the entity
that is analyzed for potential consolidation.
3
It is assumed in this evaluation that no scope exception under ASC
810-10-15-12 or ASC 810-10-15-17 applies to the legal entity.