3.3 General Consolidation Scope Exceptions

ASC 810-10

15-12 The guidance in this Topic does not apply in any of the following circumstances:

An employer shall not consolidate an employee benefit plan subject to the provisions of Topic 712 or 715.
Subparagraph superseded by Accounting Standards Update No. 2009-16
Subparagraph superseded by Accounting Standards Update No. 2009-16
Except as discussed in paragraph 946-810-45-3, an investment company within the scope of Topic 946 shall not consolidate an investee that is not an investment company.
A reporting entity shall not consolidate a governmental organization and shall not consolidate a financing entity established by a governmental organization unless the financing entity meets both of the following conditions:
1. Is not a governmental organization
2. Is used by the business entity in a manner similar to a VIE in an effort to circumvent the provisions of the Variable Interest Entities Subsections.
A reporting entity shall not consolidate a legal entity that is required to comply with or operate in accordance with requirements that are similar to those included in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds.
1. A legal entity that is not required to comply with Rule 2a-7 of the Investment Company Act of 1940 qualifies for this exception if it is similar in its purpose and design, including the risks that the legal entity was designed to create and pass through to its investors, as compared with a legal entity required to comply with Rule 2a-7.
2. A reporting entity subject to this scope exception shall disclose any explicit arrangements to provide financial support to legal entities that are required to comply with or operate in accordance with requirements that are similar to those included in Rule 2a-7, as well as any instances of such support provided for the periods presented in the performance statement. For purposes of applying this disclosure requirement, the types of support that should be considered include, but are not limited to, any of the following:
1. Capital contributions (except pari passu investments)
2. Standby letters of credit
3. Guarantees of principal and interest on debt investments held by the legal entity
4. Agreements to purchase financial assets for amounts greater than fair value (for instance, at amortized cost or par value when the financial assets experience significant credit deterioration)
5. Waivers of fees, including management fees.

There are four general exceptions to the requirements for consolidating a legal entity. Broadly speaking, the exceptions apply to (1) employee benefit plans, (2) investment companies, (3) governmental entities, and (4) money market funds. If any of these exceptions are applicable, the reporting entity is not required to consolidate the related legal entity under the VIE model or voting interest entity model. As a result, the reporting entity is not required to determine whether the legal entity qualifies for an exception to the application of the VIE model or meets the definition of a VIE. However, as noted above, ASC 810-10 requires a reporting entity to provide certain disclosures when it does not consolidate a legal entity that must comply with or operate in accordance with requirements that are similar to those for registered money market funds included in Rule 2a-7 of the 1940 Act.

3.3.1 Scope Exception for Employee Benefit Plans

Employee benefit plans (either defined benefit or defined contribution) may have significant investments (e.g., equity or debt securities, other investments) in entities that give them a controlling financial interest in those entities through voting rights or other arrangements.

In accordance with the scope exception in ASC 810-10-15-12(a), employee benefit plans subject to ASC 712 or ASC 715 should not be consolidated by the employer-sponsor. However, other parties involved with employee benefit plans, such as service providers, should apply the VIE model, as warranted by the facts and circumstances.

Nonleveraged employee stock ownership plans (ESOPs), which are defined contribution plans, are within the scope of ASC 718. Since the guidance on such plans is similar to that in ASC 715, we believe that a plan sponsor may apply the employee benefit plan scope exception to them. In addition, even though the accounting for leveraged ESOPs under ASC 718 is not similar to that in ASC 715, because such ESOPs are defined contribution plans, a plan sponsor should apply the employee benefit plan scope exception to them as well.

Note that rabbi trusts do not meet the criteria to qualify for the employee benefit plan scope exception and should be assessed for consolidation under ASC 810-10. Generally, such trusts are VIEs because they have no equity and are only a liability to employees. However, in situations in which these trusts do have equity, they would often still be VIEs because the equity investment was provided by the employer to the employee in exchange for services and therefore was not at risk under ASC 810-10-15-14(a)(3). If the accounts of a rabbi trust are not VIEs, they should be consolidated in the employer’s financial statements under ASC 710-10-45-1.

The guidance on an employee benefit plan’s accounting for its investments in other entities is as follows:

Defined benefit plans — ASC 960-325-35-1 states, “Plan investments — whether equity or debt securities, real estate, or other types (excluding insurance contracts) — shall be presented at their fair value at the reporting date.” Since these investments must be carried at fair value, defined benefit plans should not apply the consolidation requirements in ASC 810-10.
Other employee benefit plans — For other employee benefit plans (defined contribution plans, employee health and welfare benefit plans), the guidance in ASC 962 and ASC 965, respectively, applies. Because that guidance generally requires that investments be carried at fair value (see ASC 962-325-35-1 and ASC 965-325-35-1), the consolidation requirements in ASC 810-10 would not apply to other employee benefit plans.

3.3.2 Scope Exception for Investment Companies

ASC 810-10-15-12(d) prohibits a reporting entity that qualifies as an investment company under ASC 946 from consolidating an investee that is not an investment company unless the investee is an operating entity that provides services to the investment company. (Note that if a reporting entity is exempt from consolidating an investee, it would also be exempt from the disclosure requirements in ASC 810 related to the investments.) Investment companies account for their investments in noninvestment companies (other than those that are providing a service to the investment company) at fair value in accordance with the specialized accounting guidance in ASC 946. It is therefore critical to determine whether a reporting entity meets the definition of an investment company under ASC 946.

Connecting the Dots

At the 2023 AICPA & CIMA Conference on Current SEC and PCAOB Developments, in a discussion of recent consultations, an SEC staff member, Senior Associate Chief Accountant Gaurav Hiranandani, addressed the application of ASC 946, which provides industry-specific guidance for entities that are investment companies as defined in ASC 946-10-15-6(a)(2).3 Assets and liabilities of investment companies are generally recorded at fair value. Mr. Hiranandani described a consultation in which the application of ASC 946 was not appropriate because the legal entity in question did not possess the fundamental characteristics of an investment company under ASC 946. The consultation involved an investment adviser that held an investment in a real estate fund; the limited partner interest was held by a third party. The investment adviser had also formed subsidiaries that participated in development, construction, and property management services provided to the investment properties owned by the real estate fund in question. A simplified illustration of the structure is provided below.

The SEC staff noted that to have the characteristics of an investment company, an entity must make a commitment to its investors that its business purpose and only substantive activities are investing the funds solely for returns from capital appreciation or investment income (or both). In this consultation, the development, construction, and project management activities provided by subsidiaries of the investment adviser for investment properties held by the real estate fund were indistinguishable from the activities performed by the investment adviser as part of its core activities for the real estate fund. Since these collective activities were indistinguishable from the activities of the real estate fund (the investment advisory services), the investment adviser received returns that were incremental to capital appreciation or investment income. Finally, the investment adviser guaranteed the third-party limited partner’s return, shielding the limited partner from development activity risk that would be expected to arise from its respective investment in the fund.

The SEC staff’s view was that development, construction, and property management activities are not investment activities and that the real estate fund did not satisfy the requirements of ASC 946-10-15-6(a)(2) since the fund’s purpose included activities beyond capital appreciation and investment income. As a result, the investment adviser was not eligible to apply ASC 946 to its investment in the real estate fund. Mr. Hiranandani indicated that no single factor in the analysis was determinative in the staff’s conclusion. In addition, the SEC staff reminded registrants that when determining the applicability of ASC 946 to a legal entity, they should perform a robust analysis that takes into account all facts and circumstances.

The interpretive guidance in Volume II of the Reporting Standards Handbook issued by the National Council of Real Estate Investment Fiduciaries’ Pension Real Estate Association discusses two different presentation models for real estate reporting entities that qualify as investment companies under ASC 946: (1) the nonoperating model, which is aligned with the accounting for investments specified in ASC 946 and is based on the amount, measured at fair value, invested by the investment company and (2) the operating model, under which the reporting entity presents the gross fair value of the real estate and the liabilities along with the associated real estate revenues and expenses.

Under the scope exception in ASC 810-10-15-12(d), an investment company technically should not consolidate an investee that is not an investment company unless the investee is an operating entity that provides services to the investment company. However, we believe that a real estate reporting entity that qualifies as an investment company and prepares its financial statements under the operating model should, by analogy, perform a full consolidation analysis under ASC 810, including an evaluation of whether the investee is a VIE, to determine whether it has a controlling financial interest in the investee and therefore whether consolidation under the operating model is appropriate.

The scope exception in ASC 810-10-15-12(d) does not apply to any of the following:

A reporting entity that is not an investment company under ASC 946 that has an interest in an investment company.
A reporting entity that is not an investment company under ASC 946 that applies fair value accounting to its investments.
A reporting entity that is an investment company under ASC 946 that has an interest in an operating entity that provides services to the investment company (e.g., an investment adviser or transfer agent).
A reporting entity that is an investment company under ASC 946 that has an interest in another investment company.

In the situations above, unless the reporting entity qualifies for another exception in ASC 810-10-15-12 or an exception to the application of the VIE model in ASC 810-10-15-17 and as long as the investee is a VIE in accordance with ASC 810-10-15-14, the reporting entity would apply the VIE model in evaluating its accounting for the investee. See further discussion of these situations below.

3.3.2.1 A Reporting Entity That Is Not an Investment Company Under ASC 946 That Has an Interest in an Investment Company

A noninvestment company reporting entity is required to evaluate whether it should consolidate an investee that is an investment company under ASC 946 unless the investment company qualifies for the exception for money market funds in ASC 810-10-15-12(f). If the reporting entity’s interest does not qualify for any of the exceptions to the application of the VIE model, the reporting entity is required to determine whether the investment company is a VIE. If the investment company is a VIE, the reporting entity should apply the VIE model; otherwise, the reporting entity should evaluate the investment company for consolidation under the voting interest entity model in ASC 810-10.

As noted in ASC 810-10-25-15, a noninvestment company parent retains the specialized accounting applied by an investment company subsidiary in consolidation.

Example 3-9

Entity XYZ is a legal entity that was established by Entity A and Entity B (not investment companies) to invest in debt and equity securities of technology startup companies. Entity XYZ intends to own the debt and equity securities for capital appreciation and investment income purposes. Furthermore, A and B do not intend to obtain benefits from XYZ other than capital appreciation or investment income, and XYZ meets the other conditions in ASC 946 to be accounted for as an investment company. In establishing XYZ, A acquired 50 percent of the common equity of XYZ, B acquired 40 percent of the common equity of XYZ, and the remaining 10 percent of common equity of XYZ was sold to other unrelated investors.

Both A and B would have to evaluate whether XYZ is a VIE under ASC 810-10-15-14. Entity XYZ does not qualify for the exception in ASC 810-10-15-12(d) and does not qualify for any of the exceptions to the application of the VIE model in ASC 810-10-15-17 (the business scope exception does not apply).

Note that if either A or B consolidated XYZ under ASC 810-10, its consolidated financial statements should reflect the specialized industry accounting principles that apply to XYZ. That is, in A or B’s consolidated financial statements, XYZ’s investments should be accounted for at fair value with changes in fair value reported in a statement of operations or financial performance.

Example 3-10

Entity X is a general partner in Entity Y, a limited partnership. Entity Y is considered an investment company under ASC 946, and it records its investments at fair value with changes in fair value reported in a statement of operations or changes in net assets. Entity X is not considered an investment company.

Entity X cannot apply the scope exception in ASC 810-10-15-12(d) to its investment in Y because X is not an investment company; X must therefore consider whether it is required to consolidate Y under ASC 810-10.

Note that if X consolidated Y under ASC 810-10, its consolidated financial statements should reflect the specialized industry accounting principles that apply to Y. That is, in X’s consolidated financial statements, Y’s investments should be accounted for at fair value with changes in fair value reported in a statement of operations or financial performance.

3.3.2.2 A Reporting Entity That Is Not an Investment Company Under ASC 946 That Applies Fair Value Accounting to Its Investments

ASC 946 does not address the accounting for reporting entities that are not investment companies. Accordingly, reporting entities that are not investment companies within the scope of ASC 946 (and do not qualify for any other general scope exception) should evaluate their investees to determine whether they are VIEs if they do not qualify for a VIE scope exception under ASC 810-10-15-17. It would not be appropriate for a reporting entity to elect the fair value option in lieu of consolidating a legal entity that requires consolidation under ASC 810-10. As noted in ASC 825-10-15-5(a), the fair value option may not be applied to an “investment in a subsidiary that the entity is required to consolidate.”

3.3.2.3 A Reporting Entity That Is an Investment Company Under ASC 946 That Has an Interest in an Operating Entity That Provides Services to the Investment Company

ASC 946-810-45-3 indicates that when an investment company has a controlling financial interest in an operating entity that provides services to the investment company, the investment company should consolidate the operating entity. The FASB believes that in those cases, “the purpose of the investment is to provide services to the investment company rather than to realize a gain on the sale of the investment.” Accordingly, when an investment company has an interest in an operating entity that provides services to the investment company, the investment company should evaluate whether the investment would qualify for an exception to the application of the VIE subsections of ASC 810-10. If no such exception is appropriate, the investment company is required to determine whether the operating entity is a VIE. If the operating entity is a VIE, the investment company should apply the VIE model; otherwise, the investment company should evaluate the operating entity for consolidation under the voting interest entity model.

3.3.2.4 A Reporting Entity That Is an Investment Company Under ASC 946 That Has an Interest in Another Investment Company

While ASC 946 generally prohibits an investment company from consolidating an operating entity, it does not provide guidance on whether the investment company should consolidate another investment company.

In October 2014, the SEC’s Division of Investment Management released Guidance Update No. 2014-11, which provides the views of the Division’s Chief Accountant’s Office regarding the presentation of consolidated financial statements of certain investment companies registered under the 1940 Act, including feeder funds in a master-feeder structure, funds of funds, and business development companies. The Guidance Update highlights that for feeder funds in master-feeder structures and funds of funds, the staff has generally held the view that unconsolidated financial statement presentation is the most meaningful presentation for users. However, the staff has generally suggested that a business development company should consolidate its wholly owned subsidiaries that have been established to invest in portfolio companies when “the design and purpose of the subsidiary (e.g., a holding company) may be to act as an extension of the [business development company’s] investment operations and to facilitate the execution of the [business development company’s] investment strategy.”

For situations not described in the Guidance Update, we believe that an investment company should consolidate another investment company over which it has a controlling financial interest. Therefore, unless it qualifies for an exception to the application of the VIE subsections of ASC 810-10 under ASC 810-10-15-17, the investment company reporting entity should evaluate whether the investment company investee is a VIE. However, we understand that there may be diversity in practice in these circumstances and that consolidation may not be commonly applied when the nature of the investment is for capital appreciation, investment income, or both. Therefore, consultation with independent accountants is strongly encouraged.

3.3.2.5 ASC 810-10 Disclosures Not Required When Investment Company Qualifies for Exception

ASC 810-10-15-12 indicates that the guidance in ASC 810-10 “does not apply” when a legal entity qualifies for the exception in ASC 810-10-15-12(d). Thus, none of the ASC 810-10 disclosures apply to investment companies that qualify for that exception.

ASC 810-10-15-17(b) states that “[s]eparate accounts of life insurance entities as described in Topic 944 are not subject to consolidation according to the requirements of the Variable Interest Entities Subsections.” In paragraph E11 of FIN 46(R), the FASB clarified its intent to exclude separate accounts from the guidance now codified in ASC 810. Paragraph E11 states:

Separate accounts of life insurance enterprises are excluded from the scope of this Interpretation because existing accounting standards specifically require life insurance enterprises to recognize those accounts and the Board chose not to change those requirements without a broader reconsideration of accounting by [life] insurance enterprises. [Emphasis added]

Although the FASB did not provide similar clarification with respect to investments subject to the specialized accounting guidance in ASC 946, the basis for the two scope exceptions is essentially the same. It is therefore reasonable to conclude that the FASB’s intent was similar for both exceptions (i.e., that when an investment company qualifies for the exception in ASC 810-10-15-12(d), none of the ASC 810-10 disclosures apply to the investee).

3.3.3 Scope Exception for Governmental Organizations

The scope exception in ASC 810-10-15-12(e) states that a reporting entity “shall not consolidate a governmental organization [or] a financing entity established by a governmental organization unless the financing entity [is] not a governmental organization [and is used] in a manner similar to a VIE in an effort to circumvent the provisions” of the VIE model. The exception applies to nongovernmental reporting entities involved with a governmental organization or financing entities established by a governmental organization. In the absence of this scope exception, governmental entities could be considered VIEs because of their lack of equity at risk, and nongovernmental reporting entities could be identified as the primary beneficiary of the governmental entity, which was not the FASB’s intent.

3.3.3.1 Definition of a “Governmental Organization”

The 2023 AICPA Audit and Accounting Guide State and Local Governments and the GASB staff paper Applicability of GASB Standards are helpful in understanding the term “governmental organization” as contemplated in ASC 810-10-15-12(e).

Paragraph 1.01 of State and Local Governments defines governmental organization as follows:

Public corporations and bodies corporate and politic are governmental organizations. Other organizations are governmental if they have one or more of the following characteristics:

Popular election of officers or appointment (or approval) of a controlling majority of the members of the organization’s governing body by officials of one or more state or local governments;
The potential for unilateral dissolution by a government with the net assets reverting to a government [without compensation by that government]; or
The power to enact and enforce a tax levy.

Furthermore, organizations are presumed to be governmental if they have the ability to issue directly (rather than through a state or municipal authority) debt that pays interest exempt from federal taxation. However, organizations possessing only that ability (to issue tax-exempt debt) and none of the other governmental characteristics may rebut the presumption that they are governmental if their determination is supported by compelling, relevant evidence. [Footnote omitted]

Paragraph 3 of Applicability of GASB Standards lists additional factors that should be considered in the determination of whether an entity is a governmental organization, including the following:

Legal decisions that provide the entity with the privileges or responsibilities of government.
Classification as government by the U.S. Bureau of Census.
Evidence of managerial control by a governmental entity (e.g., ability to designate day-to-day operating management, imposition by statute of day-to-day operating requirements).
Possession of other sovereign powers.
Exemption of income from federal taxation through revenue rulings based on the governmental character of the entity.
If acquired rather than created by a government, the purpose of the acquisition and its expected permanence.

3.3.3.2 Whether a Financing Entity Established by a Governmental Organization Was Used to Circumvent the Provisions of the VIE Model

The governmental organization scope exception does not apply if a financing entity established by a governmental organization is being used by a nongovernmental entity to circumvent the consolidation requirements under the VIE model. To determine whether a governmental organization is being used in this way, a reporting entity would apply significant judgment and consider a number of factors related to the purpose and design of the legal entity, including:

Why the potential VIE was created.
The activities of the potential VIE.
The extent of involvement by the reporting entity in the activities of the potential VIE.
The nature of the potential VIE’s interests issued.

In general, if a governmental organization establishes a legal entity to issue tax exempt debt or provide tax subsidies to a reporting entity, the purpose of the legal entity would not have been to circumvent the consolidation requirements under the VIE model, even if the reporting entity is the only party other than the bond holders contracting with the legal entity.

Example 3-11

A U.S. city (considered a governmental organization) establishes and manages a nongovernmental entity to purchase a water treatment plant. The entity issues debt to finance the plant’s acquisition. The debt is purchased by several unrelated third-party private investors, institutional investors, or both. The entity is established on behalf of and for the benefit of the U.S. city, and the investors are not involved in any activities of the entity. In the absence of evidence to the contrary, the investors would be able to apply the scope exception for governmental organizations because (1) the entity was set up on behalf of and for the benefit of the U.S. city, (2) the U.S. city manages the entity, and (3) interests held by the investors do not allow the investors to be involved in the activities of the entity.

Example 3-12

A local governmental entity establishes a trust to issue bonds to finance the construction of a corporate office building for Company A. The bonds are purchased by third parties, the trust enters into a lease with A, and at the end of the lease, the property reverts to A. The sole purpose of the establishment of the trust by the local government is to facilitate tax subsidies for A as an incentive to move its corporate office to the local municipality. Because the trust was established for valid tax purposes, in the absence of evidence to the contrary, A would be able to apply the government scope exception to the trust.

3.3.4 Scope Exception for Money Market Funds and Other Similar Entities

A legal entity that is required to comply with or operate in accordance with requirements that are similar to those included in Rule 2a-7 of the 1940 Act for registered money market funds should not be evaluated for consolidation under either the voting interest entity model or the VIE model. These entities are outside of the scope of the consolidation requirements in ASC 810-10. However, a reporting entity that qualifies for use of this scope exception is required to disclose information about financial support provided to money market funds managed by the reporting entity, regardless of whether such funds were historically consolidated or would be consolidated under the requirements in ASC 810-10. Accordingly, additional disclosures would be required when, for example, a reporting entity has waived its management fees. See Section 11.2.4.2 for further discussion of the disclosure requirements related to money market funds.

3.3.4.1 Nonregistered Money Market Funds

The scope exception in ASC 810-10-15-12(f) may be applied to a legal entity that is not a registered money market fund under the 1940 Act only if the legal entity has requirements similar to those in Rule 2a-7 of the 1940 Act.

While all facts and circumstances need to be considered, unregistered money market funds (either domestic or foreign) that qualified for the money market fund deferral in ASU 2010-10 will generally qualify for the money market scope exception in ASC 810-10-15-12(f). The FASB notes in paragraph BC78 of ASU 2015-02 that its decision to provide an exemption for funds that are required to comply with Rule 2a-7 and those that operate in a manner similar to registered money market funds “in effect, made permanent for certain money market funds the indefinite deferral of Statement 167 provided in the amendments in Update 2010-10.” In addition, paragraph BC81 indicates that while the Board provided additional language in the scope exception to clarify the meaning of the term “similar,” it does not expect this language to change the way the indefinite deferral is currently applied.

When assessing whether a fund is considered to operate in accordance with requirements similar to those in Rule 2a-7, the reporting entity should evaluate the purpose and design of that fund, including the risks that the fund was designed to create and pass along to its investors. This would include evaluating (1) the fund’s investment portfolio quality, (2) the portfolio maturity and diversification, and (3) the ability of investors to redeem their interests. That is, to qualify for the scope exception, the fund would need to invest in a diverse portfolio of high-quality, short-term securities that are a low credit risk.

Footnotes

ASC 946-10-15-6 states, in part:

“An investment company has the following fundamental characteristics:

It is an entity that does both of the following:
1. Obtains funds from one or more investors and provides the investor(s) with investment management services
2. Commits to its investor(s) that its business purpose and only substantive activities are investing the funds solely for returns from capital appreciation, investment income, or both.”

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.