Chapter 2 — Glossary of Selected Terms
Chapter 2 — Glossary of Selected Terms
In constructing the concept of a VIE, the FASB invented a new
language of sorts. At times, its nomenclature has proven difficult to understand
because many of the terms are esoteric and do not appear in other areas of GAAP. The
purpose of this chapter is to briefly explain some of the key terminology introduced
by the consolidation models and to indicate where the related concepts are more
fully discussed in this Roadmap.
2.1 Controlling Financial Interest
ASC 810-10
Objectives — General
10-1 The purpose of consolidated financial statements is to present, primarily for the benefit of the
owners and creditors of the parent, the results of operations and the financial position of a parent and
all its subsidiaries as if the consolidated group were a single economic entity. There is a presumption that
consolidated financial statements are more meaningful than separate financial statements and that they are
usually necessary for a fair presentation when one of the entities in the consolidated group directly or indirectly
has a controlling financial interest in the other entities.
A reporting entity that consolidates another legal entity holds a “controlling financial interest” in that legal entity. Such legal entities are not limited to VIEs — the party that consolidates any legal entity is said to have a controlling financial interest in that legal entity.
Under the voting interest entity model, a reporting entity with ownership of a majority of the voting interests is generally considered to have a controlling financial interest (see Appendix D for information about the voting interest entity model). However, as discussed in Chapter 1, the VIE model 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 reporting entity that has a controlling financial interest in a VIE is sometimes the same party that holds a majority of the voting interests. See Chapter 7 for guidance on how a reporting entity should assess whether it has a controlling financial interest in a VIE.
2.2 Decision Maker
ASC 810-10 — Glossary
Decision Maker
An entity or entities with the power to direct the activities of another legal entity that most significantly impact
the legal entity’s economic performance according to the provisions of the Variable Interest Entities Subsections
of Subtopic 810-10.
A legal entity may have multiple decision makers, examples of which include
equity owners, asset managers, servicers of asset backed securitizations, real
estate property managers, hotel operators, oil and gas plant operators, and utility
plant operators.
Until the FASB issued ASU 2015-02, the concept of a “decision maker” was never
formally defined. Many of ASU 2015-02’s amendments
to ASC 810-10 focus on the evaluation of whether a
reporting entity has the first characteristic of a
controlling financial interest in a VIE (i.e., the
power to direct the activities that most
significantly affect the VIE’s economic
performance). Paragraph BC76 of ASU 2015-02 states
that if the conditions in ASC 810-10-55-37 through
55-38 are met, the decision maker is deemed to be
acting as a fiduciary on behalf of the legal
entity and its variable interest holders. Fees
paid to such a decision maker would therefore not
represent a variable interest in the legal entity,
and the decision maker would not need to continue
with its consolidation assessment of the legal
entity. Conversely, if a decision maker does not
meet all of the conditions in ASC 810-10-55-37
through 55-38, the fees paid to the decision maker
would be considered a variable interest and
further consideration under the VIE model would be
required. See Section 4.4 for
a detailed discussion of whether fees paid to an
entity’s decision maker are considered a variable
interest.
2.3 Expected Losses, Expected Residual Returns, and Expected Variability
ASC 810-10 — Glossary
Expected Losses
A legal entity that has no history of net losses and expects to continue to be profitable in the foreseeable future
can be a variable interest entity (VIE). A legal entity that expects to be profitable will have expected losses. A
VIE’s expected losses are the expected negative variability in the fair value of its net assets exclusive of variable
interests and not the anticipated amount or variability of the net income or loss.
Expected Residual Returns
A variable interest entity’s (VIE’s) expected residual returns are the expected positive variability in the fair value
of its net assets exclusive of variable interests.
Expected Losses and Expected Residual Returns
Expected losses and expected residual returns refer to amounts derived from expected cash flows as described
in FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements.
However, expected losses and expected residual returns refer to amounts discounted and otherwise adjusted
for market factors and assumptions rather than to undiscounted cash flow estimates. The definitions of
expected losses and expected residual returns specify which amounts are to be considered in determining
expected losses and expected residual returns of a variable interest entity (VIE).
Note: The following definition is Pending Content; see
Transition Guidance in 105-10-65-9.
Expected losses and expected residual returns refer to
amounts derived from expected cash flows. However, expected
losses and expected residual returns refer to amounts
discounted and otherwise adjusted for market factors and
assumptions rather than to undiscounted cash flow estimates.
The definitions of expected losses and expected residual
returns specify which amounts are to be considered in
determining expected losses and expected residual returns of
a variable interest entity (VIE). A computation of expected
losses, expected residual returns, and expected variability
is illustrated in paragraphs 810-10-55-42 through 55-49.
Expected Variability
Expected variability is the sum of the absolute values of the expected residual return and the expected loss.
Expected variability in the fair value of net assets includes expected variability resulting from the operating
results of the legal entity.
While the terms “expected losses,” “expected residual returns,” and “expected
variability” can be difficult to understand, the
concepts underlying them are critical to
comprehending many of the VIE model’s other terms
and concepts. The expected losses and expected
residual returns of the VIE do not represent GAAP
losses or gains of the VIE; rather, they represent
the variability from the VIE’s mean cash flows.
See Appendix C for a
detailed discussion of these terms as well as a
history of the purpose of the quantitative
calculations inherent in them.
2.4 Kick-Out Rights
ASC 810-10 — Glossary
Kick-Out Rights (VIE Definition)
The ability to remove the entity with the power to direct the activities of a VIE that most significantly impact the
VIE’s economic performance or to dissolve (liquidate) the VIE without cause.
Kick-Out Rights (Voting Interest Entity Definition)
The rights underlying the limited partner’s or partners’ ability to dissolve (liquidate) the limited partnership or
otherwise remove the general partners without cause.
In the determination of whether a legal entity is a VIE, two different definitions of kick-out rights apply depending on whether the legal entity is (1) a limited partnership (or similar entity) that uses the voting interest entity definition or (2) other than a limited partnership (or similar entity) that uses the VIE definition. Both definitions have a similar theme (i.e., whether the party that is making decisions about a legal entity can be removed without cause). In the evaluation of whether a legal entity is a VIE, a decision maker does not have control over a legal entity if another party or parties have the substantive right to remove the decision maker without cause.
In the analysis of a legal entity other than a limited partnership, the VIE definition should be applied. For these types of legal entities, a kick-out right is substantive if a single equity holder at risk (including its related parties and de facto agents) is able to exercise the kick-out right (see Section 5.3.1.1.3.4). If the single equity holder has a substantive kick-out right, the equity investors at risk, as a group, would possess the power to direct the most significant activities of the legal entity.
The definition of kick-out rights in the evaluation of whether a limited partnership (or similar entity) is a VIE is the same as the definition that applies under the voting interest entity model. For a kick-out right to be substantive for a limited partnership (or similar entity), a simple majority (or lower threshold) of the limited partner interests (excluding those held by the general partner, entities under common control with the general partner, and entities acting on behalf of the general partner) must be able to remove the general partner without cause (see Section 5.3.1.2.2).
For kick-out rights to affect the consolidation analysis under either definition, the rights must be substantive (i.e., there can be no significant barriers to exercising those rights). See Section 5.3.1.2.4 for guidance on determining whether kick-out rights are substantive.
2.5 Legal Entity
ASC 810-10 — Glossary
Legal Entity
Any legal structure used to conduct activities or to hold assets. Some examples of such structures are
corporations, partnerships, limited liability companies, grantor trusts, and other trusts.
Throughout this Roadmap, we refer to the entity that is analyzed for potential consolidation as the “legal entity.” Both the VIE model and the voting interest entity model require a reporting entity to evaluate its involvement with any legal entity to establish whether consolidation of the legal entity is required. The assessment of whether a structure is a legal entity is a critical first step in the overall consolidation analysis. A common misconception is that a legal entity has to be incorporated or registered with some type of governmental agency or regulatory body. The definition of a legal entity is meant to be extensive and depends on specific facts and circumstances. See Section 3.2 for more details.
2.6 Participating Rights
ASC 810-10 — Glossary
Participating Rights (VIE Definition)
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 impact the VIE’s economic performance. Participating rights do not
require the holders of such rights to have the ability to initiate actions.
Participating Rights (Voting Interest Entity 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 corporation that are made in the
ordinary course of business. Participating rights do not require the holders of such rights to have the ability to
initiate actions.
Participating rights give a party or a group of parties the ability to either participate in or block the actions that are most significant to a legal entity’s economic performance. Decision makers do not have a controlling financial interest if another party has the substantive right to participate in their decisions. Holders of participating rights are not required to have the ability to initiate actions for their rights to be substantive. Like kick-out rights, participating rights must be substantive to be considered in the VIE analysis.
As described in Sections 5.3.1.1.3.5 and 5.3.1.2.7, in determining whether a legal entity is a VIE, a reporting entity analyzes the impact of the existence of substantive participating rights differently depending on whether the legal entity is a limited partnership (or similar entity). That is, the evaluation of participating rights under the voting interest entity model focuses on whether the holder of such rights can participate in certain significant financial and operating decisions of the entity, while the evaluation of such rights under the VIE model focuses on whether the holder can participate in the most significant activities of the entity. The evaluation of whether a limited partnership is a VIE is based on the voting interest entity definition of a participating right. Accordingly, it is important to determine which activities the limited partners can participate in.
2.7 Protective Rights
ASC 810-10 — Glossary
Protective Rights (VIE Definition)
Rights designed to protect the interests of the party holding those rights without giving that party a controlling
financial interest in the entity to which they relate. For example, they include any of the following:
- Approval or veto rights granted to other parties that do not affect the activities that most significantly impact the entity’s economic performance. Protective rights often apply to fundamental changes in the activities of an entity or apply only in exceptional circumstances. Examples include both of the following:
- A lender might have rights that protect the lender from the risk that the entity will change its activities to the detriment of the lender, such as selling important assets or undertaking activities that change the credit risk of the entity.
- Other interests might have the right to approve a capital expenditure greater than a particular amount or the right to approve the issuance of equity or debt instruments.
- The ability to remove the reporting entity that has a controlling financial interest in the entity in circumstances such as bankruptcy or on breach of contract by that reporting entity.
- Limitations on the operating activities of an entity. For example, a franchise agreement for which the entity is the franchisee might restrict certain activities of the entity but may not give the franchisor a controlling financial interest in the franchisee. Such rights may only protect the brand of the franchisor.
Protective Rights (Voting Interest Entity Definition)
Rights that are only protective in nature and that do not allow the limited partners or noncontrolling
shareholders to participate in significant financial and operating decisions of the limited partnership or
corporation that are made in the ordinary course of business.
While protective rights protect the interests of the holder, they do not allow
the holder to participate in the significant financial and operating decisions made
in a voting interest entity’s ordinary course of business or to participate in the
most significant activities of a VIE. Unlike participating rights, protective rights
do not preclude another entity from having the power to direct the most significant
activities of a legal entity.
Both protective rights and participating rights are approval or veto rights. The key to differentiating between the two types of rights is the underlying activity or action to which the rights relate. Protective rights often apply to fundamental changes in the activities of a legal entity or apply only in extraordinary circumstances. Participating rights involve the ability to approve or veto the significant financial and operating decisions for a voting interest entity and the activities that most significantly affect a legal entity’s economic performance for a VIE, and would generally be expected to occur in an entity’s normal course of business.
ASC 810-10-25-10 lists protective rights (not all-inclusive) that are often
provided to the noncontrolling shareholder or limited partner of a voting interest
entity. The rights pertain to the following:
Determining whether rights are protective or participating may require
significant judgment. Depending on the facts and circumstances, rights that are
protective in one instance may be participating in another.
-
Amendments to articles of incorporation or partnership agreements of the investee
-
Pricing on transactions between the owner of a majority voting interest or limited partner with a majority of kick-out rights through voting interests and the investee and related self-dealing transactions
-
Liquidation of the investee in the context of Topic 852 on reorganizations or a decision to cause the investee to enter bankruptcy or other receivership
-
Acquisitions and dispositions of assets that are not expected to be undertaken in the ordinary course of business (noncontrolling rights relating to acquisitions and dispositions of assets that are expected to be made in the ordinary course of business are participating rights; determining whether such rights are substantive requires judgment in light of the relevant facts and circumstances [see paragraphs 810-10-25-13 and 810-10-55-1])
-
Issuance or repurchase of equity interests.
2.8 Primary Beneficiary
ASC 810-10 — Glossary
Primary Beneficiary
An entity that consolidates a variable interest entity (VIE). See paragraphs
810-10-25-38 through 25-38J for guidance on determining the
primary beneficiary.
A reporting entity that consolidates (i.e., has a controlling financial interest in) a VIE is the “primary beneficiary” of the VIE. See Chapter 7 for a detailed discussion of how a reporting entity should assess whether it has a controlling financial interest and is therefore the primary beneficiary of the VIE.
2.9 Private Company
ASC 810-10 — Glossary
Private Company
An entity other than a public business entity, a not-for-profit entity, or an employee benefit plan within the
scope of Topics 960 through 965 on plan accounting.
If certain criteria are met, a reporting entity that meets the definition of a
private company can elect the accounting alternative in ASC 810-10-15-17AD and not
apply the VIE guidance to legal entities under common control. See Section 3.5 for details.
2.10 Public Business Entity
ASC 810-10 — Glossary
Public Business Entity
A public business entity is a business entity meeting any one of the criteria below. Neither a not-for-profit entity
nor an employee benefit plan is a business entity.
- It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing).
- It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC.
- It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.
- It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
- It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including notes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion.
An entity may meet the definition of a public business entity solely because its financial statements or financial
information is included in another entity’s filing with the SEC. In that case, the entity is only a public business
entity for purposes of financial statements that are filed or furnished with the SEC.
Whether a reporting entity can elect to apply the accounting alternative in ASC
810-10-15-17AD to a private company (as defined in Section 2.9) depends, in part, on whether the
reporting entity is a public business entity. See Section
3.5 for a discussion of the criteria a reporting entity must meet to
use the private-company accounting alternative.
2.11 Related Parties, De Facto Agents, and Common Control
ASC 810-10 — Glossary
Related Parties
Related parties include:
- Affiliates of the entity
- Entities for which investments in their equity securities would be required, absent the election of the fair value option under the Fair Value Option Subsection of Section 825-10-15, to be accounted for by the equity method by the investing entity
- Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management
- Principal owners of the entity and members of their immediate families
- Management of the entity and members of their immediate families
- Other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests
- Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.
2.11.1 De Facto Agents
ASC 810-10
25-43
For purposes of applying the guidance in the Variable
Interest Entities Subsections, unless otherwise
specified, the term related parties includes
those parties identified in Topic 850 and certain other
parties that are acting as de facto agents or de facto
principals of the variable interest holder. All of the
following are considered to be de facto agents of a
reporting entity:
-
A party that cannot finance its operations without subordinated financial support from the reporting entity, for example, another VIE of which the reporting entity is the primary beneficiary
-
A party that received its interests as a contribution or a loan from the reporting entity
-
An officer, employee, or member of the governing board of the reporting entity
-
A party that has an agreement that it cannot sell, transfer, or encumber its interests in the VIE without the prior approval of the reporting entity. The right of prior approval creates a de facto agency relationship only if that right could constrain the other party’s ability to manage the economic risks or realize the economic rewards from its interests in a VIE through the sale, transfer, or encumbrance of those interests. However, a de facto agency relationship does not exist if both the reporting entity and the party have right of prior approval and the rights are based on mutually agreed terms by willing, independent parties. . . .
-
A party that has a close business relationship like the relationship between a professional service provider and one of its significant clients.
In initially introducing the VIE model, the FASB identified various structures in the marketplace that involved a reporting entity’s transaction with another party that would not have been identified as a related party under the traditional GAAP definition. In some instances, the FASB believed that the nature of the structure or the relationship with these other parties was significant enough to warrant additional scrutiny in a consolidation analysis. Consequently, for certain aspects of the VIE model, the FASB requires a reporting entity to identify related parties and de facto agents to prevent the reporting entity from avoiding consolidation of a VIE by protecting its interests or indirectly expanding its holdings through other entities that are effectively acting on its behalf. The identification of related parties and de facto agents is critical because those relationships have the potential to affect the consolidation analysis in multiple ways. For example, they can affect:
- Whether the potential VIE qualifies for the business scope exception.
- Whether an entity’s decision-maker or service-provider arrangement is a variable interest.
- Whether the potential VIE is, in fact, a VIE.
- The determination of the primary beneficiary of a VIE.
See Chapter 8 for more details.
2.11.2 Common Control
A reporting entity’s determination of whether related parties are under common
control may be critical to its consolidation conclusion because the effects of interests
held by such parties depend on this determination. While the Codification does not define
common control, paragraph BC69 of ASU 2015-02 states that entities under common control
include “subsidiaries controlled (directly or indirectly) by a common parent, or a
subsidiary and its parent.” In this context, a parent includes any party that has a
controlling financial interest in a subsidiary, and that party does not need to be a
separate legal entity.
Oftentimes, entities will exhibit a high degree of common ownership. However, such ownership is not the same as common control, and a reporting entity therefore should not apply those terms synonymously in its consolidation analysis.
See Section 8.2.2 for further discussion.
2.12 Reporting Entity
Although not specifically defined in ASC 810-10-20, a “reporting entity” as used in ASC 810 (and therefore as used in this Roadmap) is the entity performing the consolidation analysis (i.e., the party potentially consolidating a legal entity).
2.13 Subordinated Financial Support
ASC 810-10 — Glossary
Subordinated Financial Support
Variable interests that will absorb some or all of a variable interest entity’s (VIE’s) expected losses.
Subordinated financial support refers to a variable interest that absorbs a portion of a legal entity’s expected losses. If the terms of the arrangement cause the variable interest to absorb expected losses before or at the same level as the most subordinated interests (e.g., equity, subordinated debt), or the most subordinated interests are not large enough to absorb the entity’s expected losses, the variable interest would generally be considered subordinated financial support. Examples may include non-investment-grade debt, contracts with terms that are not normal or customary, guarantees, derivatives, or a commitment to fund losses. The determination of whether a variable interest is subordinated financial support will be based on how that interest absorbs expected losses compared with other variable interests in a legal entity.
Understanding which variable interests constitute subordinated financial support can help a reporting entity determine the following in its evaluation under the VIE model:
- Which party has provided a potential VIE’s subordinated financial support in the evaluation of whether the potential VIE qualifies for the business scope exception (see Section 3.4.4.9).
- Whether the potential VIE’s total equity investment at risk is sufficient to permit the legal entity to finance its activities without additional subordinated financial support (see Section 5.2.3).
-
Whether a de facto agency relationship exists (see Section 8.2.3.1).
2.14 Variable Interests
ASC 810-10 — Glossary
Variable Interests
The investments or other interests that will absorb portions of a variable
interest entity’s (VIE’s) expected losses or receive
portions of the entity’s expected residual returns are
called variable interests. Variable interests in a VIE are
contractual, ownership, or other pecuniary interests in a
VIE that change with changes in the fair value of the VIE’s
net assets exclusive of variable interests. Equity interests
with or without voting rights are considered variable
interests if the legal entity is a VIE and to the extent
that the investment is at risk as described in paragraph
810-10-15-14. Paragraph 810-10-25-55 explains how to
determine whether a variable interest in specified assets of
a legal entity is a variable interest in the entity.
Paragraphs 810-10-55-16 through 55-41 describe various types
of variable interests and explain in general how they may
affect the determination of the primary beneficiary of a
VIE.
A reporting entity cannot consolidate a legal entity if it does not hold a variable interest in that legal entity. Variable interests exist in many different forms and will absorb portions of the variability that the VIE was designed to create. An interest that creates an entity’s variability is not a variable interest.
As a rule of thumb, most arrangements 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 entity. However, identifying whether other arrangements, such as those involving derivatives, leases, or decision-maker and other service-provider contracts, are variable interests can be more complex. See Chapter 4 for additional details.
2.15 Variable Interest Entity
ASC 810-10 — Glossary
Variable Interest Entity
A legal entity subject to consolidation according to the provisions of the Variable Interest Entities Subsections of
Subtopic 810-10.
A VIE is a legal entity that is outside the scope of the traditional voting
interest entity model. Specifically, a VIE does not qualify for any of the scope
exceptions under ASC 810-10-15-12 or ASC 810-10-15-17 and meets one of the following
three conditions:
-
The equity investment at risk is not sufficient for the legal entity to finance its activities without additional subordinated financial support. Said differently, the equity investors do not have sufficient “skin in the game.”
-
The equity investors at risk, as a group, lack the characteristics of a controlling financial interest. Equity investors do not have the attributes typically expected of an equity holder.
-
The voting rights of some equity investors at risk are disproportionate to their obligation to absorb losses or right to receive returns, and substantially all of the activities are conducted on behalf of an equity investor at risk with disproportionately few voting rights. This is an anti-abuse provision designed to prevent structuring opportunities to circumvent consolidation under the voting interest entity model.
2.16 Voting Interest Entity
The Codification does not define “voting interest entity,” but, in practice, the
term has evolved to mean any entity that is not a
VIE as defined in the previous section. Throughout
this Roadmap, we refer to the analysis of a voting
interest entity as the voting interest entity
model. For guidance on applying the voting
interest entity model, see Appendix
D.
2.17 Collateralized Financing Entity
ASC 810-10 — Glossary
Collateralized Financing Entity
A variable interest entity that holds financial assets, issues beneficial interests in those financial assets, and has
no more than nominal equity. The beneficial interests have contractual recourse only to the related assets of
the collateralized financing entity and are classified as financial liabilities. A collateralized financing entity may
hold nonfinancial assets temporarily as a result of default by the debtor on the underlying debt instruments
held as assets by the collateralized financing entity or in an effort to restructure the debt instruments held
as assets by the collateralized financing entity. A collateralized financing entity also may hold other financial
assets and financial liabilities that are incidental to the operations of the collateralized financing entity and have
carrying values that approximate fair value (for example, cash, broker receivables, or broker payables).
A collateralized financing entity (CFE) is an asset-backed financing or
securitization entity typically with no substantive business purpose other than to
issue beneficial interests in the financial assets it holds. Most securitization
entities and other asset-backed financing vehicles, such as collateralized loan
obligation entities (CLOs) and collateralized debt obligation entities(CDOs) are
CFEs. These entities are typically VIEs because their capital structure
qualitatively demonstrates that there is insufficient equity investment at risk. See
Sections E.1 and E.2 for consolidation considerations related to
securitization structures and collateralized investment vehicles (CIVs),
respectively. CLOs and CDOs are examples of entities that are referred to in this
Roadmap as CIVs. Some reporting entities that consolidate a CFE elect to carry all
of the financial assets and financial liabilities at fair value. Note that the FASB
has provided a measurement alternative for consolidated CFEs (see Sections 10.1.3 and 10.2.2).