Chapter 1 — Overview of the Consolidation Models
Chapter 1 — Overview of the Consolidation Models
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.
1.2 The VIE Model
The VIE model requires a reporting entity to identify whether it holds a
controlling financial interest when voting
interests may not
appropriately indicate which party should
consolidate a legal entity. Accordingly, if a
determination is made that a legal entity is a
VIE, the reporting entity will consolidate the VIE
if the reporting entity has both (1) the power to
direct the activities of the VIE that most
significantly affect the VIE’s economic
performance and (2) 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. In addition, even if it is
apparent that an equity owner would be required to
consolidate a legal entity under the voting
interest entity model, it must still evaluate
whether the legal entity is a VIE and whether it
would be required to consolidate the legal entity
under the VIE requirements, because there are
different measurement requirements for VIEs and
additional presentation and disclosure
requirements under the VIE model if certain
criteria are met. While determining whether the
power and economics criteria have been satisfied
might appear straightforward, it is often
difficult in practice. The reporting entity must
exercise significant judgment in making its
determination.
Further, as discussed in detail in Chapter 7, the consolidation analysis will
vary when, among other factors, (1) there is a single decision maker, (2) power is
shared between related parties as opposed to
unrelated parties, (3) different parties direct the same significant activity, (4)
different parties direct different significant activities, (5) related parties are
under common control, and (6) substantially
all the activities involve or are conducted on behalf of a single related party.
1.3 The Voting Interest Entity Model
Under the voting interest entity model, a reporting entity consolidates a legal
entity when it has a controlling financial
interest in the legal entity through its ownership
of voting interests. The voting interest entity
model is codified entirely in ASC 810-10.
1.3.1 Limited Partnerships (and Similar Entities)
For limited partnerships (and similar entities) that are not VIEs, the
identification of a controlling financial interest
focuses on (1) whether any limited partner holds
substantive kick-out rights
that give it the unilateral right to remove the
general partner or dissolve the partnership
without cause and (2) whether the noncontrolling
limited partners do not have substantive participating rights. Under ASC
810-10, a general partner will not consolidate a
limited partnership under the voting interest
entity model. Rather, only a limited partner that
has the unilateral right to remove the general
partner or dissolve the partnership would do so.
1.3.2 Legal Entities That Are Not Limited Partnerships (or Similar Entities)
For legal entities that are not limited partnerships (and not VIEs), the identification of a controlling financial interest focuses on whether the reporting entity has voting interests that give it control over the financial and operating policies of the legal entity. A controlling financial interest typically exists when a reporting entity owns more than 50 percent of the outstanding voting shares of another entity and the noncontrolling shareholders do not have substantive participating rights. However, there are exceptions to this general principle, including when control exists without a majority voting interest and control does not exist with a majority voting interest.
See Appendix D for a discussion of the voting interest entity model.
1.3.3 Control by Contract
In addition to the VIE and voting interest entity models, ASC 810-10 contains
guidance on evaluating entities that are
controlled by contract and are not deemed to be
VIEs. With the introduction of the VIE model, the
relevance of the contract-controlled entity model
has diminished. This is because a legal entity
that is controlled by contract would most likely
be a VIE since one of the conditions to qualify as
a voting interest entity is that the equity
investors at risk must control the most
significant activities of the legal entity.
See Section D.3.4 for further discussion of the contract-controlled entity model.
1.4 Key Differences Between the Voting Interest Entity Model and the VIE Model
The following table compares key concepts under
the voting interest entity model and the VIE model:
Table
1-1 Differences Between the Voting Interest Entity Model and the VIE
Model
Concept
|
Voting Interest Entity Model
|
VIE Model
|
---|---|---|
Definition of a controlling financial
interest
|
For legal entities other than limited
partnerships (and similar entities), the usual condition for
consolidation is ownership of a majority voting interest.
For limited partnerships (and similar
entities), the usual condition for consolidation is
ownership of a majority of the limited partnership’s
kick-out rights.
However, for all legal entities, control may
not rest with the majority owner if certain conditions
exist.
|
A reporting entity has a controlling
financial interest if it has both of the following
characteristics: (1) the power to direct the activities of
the entity that most significantly affect the entity’s
economic performance and (2) the obligation to absorb losses
of the entity that could potentially be significant to the
entity or the right to receive benefits from the entity that
could potentially be significant to the entity.
Under the VIE model (unlike the voting
interest entity model), a broader list of activities is
typically considered in the determination of which party, if
any, should consolidate.
|
Impact of related parties
|
Related parties and de facto agents are not
considered.
|
Related parties, including de facto agents,
must be considered. The identification of related parties
can have a significant impact on the consolidation analysis,
including potentially requiring one of the related parties
to consolidate even though the reporting entity, on its own,
does not have a controlling financial interest. See
Section 8.3 for a discussion of how related
parties affect the analysis under the VIE model.
|
Participating rights — definition
|
Participating rights allow the limited
partners or noncontrolling shareholders to block or
participate in certain significant financial and operating
decisions of the limited partnership or the corporation that
are made in the ordinary course of business.
An owner of a majority voting interest will
be precluded from consolidating if a noncontrolling
shareholder or limited partner has a substantive
participating right in certain (but not all) significant
financial and operating decisions that occur as part of the
ordinary course of the investee’s business.
In addition, the voting interest definition
is used for limited partnerships (and similar entities) in
the determination of whether the partnership is a VIE.
|
Participating rights provide the ability to
block or participate in the actions through which an entity
exercises the power to direct the activities of a VIE that
most significantly affect the VIE’s economic performance. To
have a substantive participating right in determining
whether a limited partnership or similar entity is a VIE,
the limited partners must participate in certain significant
financial and operating decisions that occur as part of the
ordinary course of the limited partnership’s business in a
manner similar to their participation under the voting
interest entity model.
However, to be a substantive participating
right and preclude another party from controlling, the right
must be held by a single reporting entity and unilaterally
exercisable relative to the activities that most
significantly affect the economic performance of the VIE.
|
Forward starting rights and potential voting
rights
|
Only existing voting rights are considered
in the analysis of which party has a controlling financial
interest.
Potential voting rights are not considered
until they are currently held unless they are deemed to be
held because of a nonsubstantive exercise or purchase price
and there are no significant decisions in the ordinary
course of business that will be made before the potential
voting right is exercisable. See Section D.1.4.
|
Since the evaluation of economic
performance, and therefore determining which reporting
entity has power over the activities that most significantly
affect the VIE’s economic performance, takes into account
the life of the legal entity, forward starting rights are
considered in the primary-beneficiary determination.
In addition, forward starting rights as a
result of a contingent event should be evaluated in the
determination of whether the contingency initiates or
results in a change in power and, for the latter, whether
the contingency is substantive. See Section
7.2.9.
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Disclosures
|
The required disclosures for consolidated
subsidiaries are limited, including disclosures related to
consolidated subsidiaries that are not wholly owned.
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In addition to the general disclosures
required for consolidated voting interest entities, there
are specific VIE disclosures for consolidated and
unconsolidated VIEs. See Section 11.2.
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