Chapter 3 — Scope | DART – Deloitte Accounting Research Tool

Chapter 3 — Scope

3.1 Introduction

3.2 Legal Entities

3.2.1 Evaluating Portions of Legal Entities or Aggregations of Assets Within a Legal Entity as Separate Legal Entities

3.2.2 Multitiered Legal-Entity Structures

3.2.3 “Looking Through” a Holding Company to the Underlying Legal Entity

3.3 General Consolidation Scope Exceptions

3.3.1 Scope Exception for Employee Benefit Plans

3.3.2 Scope Exception for Investment Companies

3.3.3 Scope Exception for Governmental Organizations

3.3.4 Scope Exception for Money Market Funds and Other Similar Entities

3.4 Scope Exceptions From the VIE Model

3.4.1 Scope Exception for NFPs

3.4.2 Scope Exception for Separate Accounts of Life Insurance Entities

3.4.3 Scope Exception for Exhaustive Efforts for Entities Created Before December 31, 2003

3.4.4 Scope Exception for Entities That Meet the Definition of a Business

3.5 Private-Company Alternative

3.1 Introduction

ASC 810-10

15-3 All reporting entities shall apply the guidance in the Consolidation Topic to determine whether and how to consolidate another entity and apply the applicable Subsection as follows:

If the reporting entity has an interest in an entity, it must determine whether that entity is within the scope of the Variable Interest Entities Subsections in accordance with paragraph 810-10-15-14. If that entity is within the scope of the Variable Interest Entities Subsections, the reporting entity should first apply the guidance in those Subsections. Paragraph 810-10-15-17 provides specific exceptions to applying the guidance in the Variable Interest Entities Subsections.
If the reporting entity has an interest in an entity that is not within the scope of the Variable Interest Entities Subsections and is not within the scope of the Subsections mentioned in paragraph 810-10-15-3(c), the reporting entity should use only the guidance in the General Subsections to determine whether that interest constitutes a controlling financial interest.
If the reporting entity has a contractual management relationship with another entity that is not within the scope of the Variable Interest Entities Subsections, the reporting entity should use the guidance in the Consolidation of Entities Controlled by Contract Subsections to determine whether the arrangement constitutes a controlling financial interest.

15-4 All legal entities are subject to this Topic’s evaluation guidance for consolidation by a reporting entity, with specific qualifications and exceptions noted below.

15-5 The application of this Topic by not-for-profit entities (NFPs) as defined in Topic 958 is subject to additional guidance in Subtopic 958-810.

15-6 The guidance in this Topic applies to all reporting entities, with specific qualifications and exceptions noted below.

The determination of whether a legal entity should be consolidated by a reporting entity begins with an evaluation of whether the legal entity is subject to a general exception to the consolidation requirements in ASC 810-10. If a legal entity is not subject to a general exception, the evaluation should focus on whether the legal entity is subject to an exception to the VIE model. The voting interest entity model is applied only if it is determined that the legal entity qualifies for a VIE scope exception, the legal entity is not a VIE, or the legal entity is not subject to the guidance on consolidation of entities controlled by contract.1 Evaluating whether a legal entity qualifies for a scope exception or is subject to the VIE model is therefore a critical step in the determination of which consolidation model to apply (i.e., the VIE model or the voting interest entity model; see Section 1.1 for a summary of the consolidation model objectives).

This chapter provides an overview of considerations related to the initial scope determination and focuses on the general exceptions to the consolidation requirements as well as the VIE scope exceptions. Chapter 5 provides guidance on whether a legal entity is subject to the VIE model (i.e., the legal entity is a VIE).

The VIE model applies to all legal entities that do not qualify for either a general exception to the consolidation requirements or an exception to the application of the VIE model. Accordingly, application of the VIE model is not limited to SPEs. Rather, reporting entities must evaluate all legal entities in which they have an interest to determine whether the legal entities are subject to the VIE subsections. If a scope exception does not apply to a legal entity (SPE or otherwise), reporting entities would be required to evaluate whether the legal entity meets the definition of a VIE. Only if the legal entity qualifies for an exception to the application of the VIE subsections, or does not meet the definition of a VIE, would consolidation of the legal entity be evaluated under the voting interest entity model.

Footnotes

While ASC 810-10 primarily focuses on the voting interest entity model and the VIE model, it also discusses the consolidation of entities that are controlled by contract. Although the guidance in the ASC 810-10 subsections on the consolidation of contract-controlled entities applies to all entities (except those that are deemed VIEs), the context of that guidance is physician practice management entities. See Section D.3.4 for a discussion of the contract-controlled entity model.

3.2 Legal Entities

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.

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” relatively 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., a corporation, a partnership, a limited liability company, a grantor trust, or other trust) is not relevant to the determination of whether the entity is a legal entity. Divisions, departments, branches, and pools of assets are examples of entities that are typically not separate legal entities.

A collaborative arrangement that is not conducted via a separate entity is not in itself a legal entity. However, if a separate entity was formed to conduct the activities of a collaborative arrangement, that entity would typically represent a legal entity.

A reporting entity may consider the following factors when evaluating whether a legal entity exists, which will help it determine whether the structure has separate legal standing or identity:

Do third parties view the structure as a legal entity?
Does the structure invoice its customers under its own name?
Do the vendors invoice the structure under its own name?
Does the structure file a tax return or have a unique identification in any tax jurisdiction?
Does the structure have separate financial statements?
Does the structure have any regulatory filing requirements?
Does the structure have the ability to enter into contracts and agreements?
Is the structure able to open bank accounts?
Can the structure be sued or sue others?
Is the structure able to obtain financing?

Certain industries (such as the asset management industry) commonly use series trusts (referred to herein as a “series”) to permit (1) distinct sets of activities to be legally isolated and conducted separately from one another and (2) each series to benefit from the sharing of administrative and organizational costs. Although there is technically only one umbrella legal entity, each series fund issues its own share class(es) and has characteristics that are substantially the equivalent of operating as a separate entity. Other industries may also use a series or similar legal structure (e.g., segregated cell structures in the insurance industry).

Paragraph BC38 of ASU 2015-02 provides some insight into relevant considerations in the determination of whether an individual series fund is a legal entity. Although the example in the paragraph is specific to an individual series fund, it lists factors that are similar to those above. The FASB noted that it is reasonable to treat an individual series fund as a separate legal entity if the fund is required to comply with the requirements of the Investment Company Act of 1940 (the “1940 Act”) for registered mutual funds, which have the following characteristics:

Has its own investment objectives and policies.
Has its own custodial agreement.
Has its own shareholders separate from other series funds.
Has a unique tax identification.
Files separate tax returns with the Internal Revenue Service.
Has separate audited financial statements.
Is considered a separate investment company in virtually all circumstances for purposes of investor protection afforded by the Investment Company Act of 1940 by the Securities and Exchange Commission (SEC) staff’s Division of Investment Management (IM), in accordance with the June 2014 SEC IM staff’s Guidance Update No. 2014-06 titled “Series Investment Companies: Affiliated Transactions.”

The relative weight given to the above characteristics should be based on the relevant facts and circumstances. Reporting entities may need the assistance of legal counsel in determining whether a structure is a legal entity.

3.2.1 Evaluating Portions of Legal Entities or Aggregations of Assets Within a Legal Entity as Separate Legal Entities

ASC 810-10

15-15 Portions of legal entities or aggregations of assets within a legal entity shall not be treated as separate entities for purposes of applying the Variable Interest Entities Subsections unless the entire entity is a VIE. Some examples are divisions, departments, branches, and pools of assets subject to liabilities that give the creditor no recourse to other assets of the entity. Majority-owned subsidiaries are legal entities separate from their parents that are subject to the Variable Interest Entities Subsections and may be VIEs.

Proper identification of the legal entity being evaluated is critical since it affects all aspects of the consolidation analysis, including whether the legal entity is a VIE or voting interest entity and the nature and extent of any activities that will ultimately be consolidated. For example, before ASU 2015-02, a series was typically not considered a separate legal entity but rather a silo within the broader legal entity (i.e., the umbrella). In many instances, the umbrella would be considered a VIE, and a series (i.e., the silo2) would be consolidated by the asset manager during the period that the manager’s initial seed capital exceeds 50 percent of the economic interests in the series. The asset management industry initially expressed concerns that the ASU would require them to consolidate a series (the silo) at a lower threshold of economic interest (“potentially significant”). Conversely, if a series were to be considered its own legal entity that is evaluated for consolidation under the voting interest entity model, it would be possible for the asset manager to conclude that each series is a separate voting interest entity and that consolidation is required only to the extent that the asset manager has more than 50 percent of the voting interests.

Generally, a series should be considered its own legal entity under ASC 810-10 if the following three conditions are met:

Condition 1 — Essentially all the assets, liabilities, and equity of the larger legal structure reside in individual series, and essentially none of these items reside in the larger legal structure itself.
Condition 2 — The assets, liabilities, and equity of each series are legally isolated from the assets, liabilities, and equity of the other series.
Condition 3 — Each series presents itself, in all material respects, as a separate legal entity with respect to its dealings with its interest holders and third parties.

The third condition is consistent with the series fund structure discussed by the FASB in paragraphs BC38 and BC39 of ASU 2015-02 (see the introduction to Section 3.2).

Although the Board’s observations in paragraphs BC38 and BC39 are specific to series funds that are registered under the 1940 Act, the requirements under the 1940 Act for such funds (as articulated in paragraph BC38) provide a useful framework for evaluating whether the third condition is present in other structures (e.g., segregated cell companies, unregistered series funds, legal structures in other legal jurisdictions or industries). In many cases, the evaluation of international series structures may result in a different conclusion from series funds that are registered under the 1940 Act (i.e., that a separate international series should not be considered its own legal entity). A reporting entity should carefully evaluate the characteristics of international funds and use judgment in applying the above factors. For example, although an individual characteristic might not apply to another type of structure (e.g., the entity does not have a unique tax identification because it is located in a nontaxable jurisdiction), the reporting entity should evaluate the relevant factors in the framework in paragraph BC38 to determine whether the series, in substance, represents a separate legal entity.

3.2.1.1 SEC Staff Views on International Series Funds as Separate Legal Entities

The Asset Management Accounting Policy Committee of the Securities Industry and Financial Markets Association (SIFMA) and the Asset Management Industry Accounting Policy Group (AMIAPG) formally discussed international series funds with the SEC staff. After those discussions, SIFMA and AMIAPG sent a letter in January 2016 to the SEC staff to confirm the staff’s views on determining whether an international series fund would be considered a separate legal entity under the consolidation models. The letter stated, in part:

The SEC Staff would not object to the view that the considerations listed in ASU 2015-02, paragraph BC38, be considered indicators as to whether an individual series fund is a legal entity; rather than a prescribed list of criteria that must all be met.

The SEC Staff believes the determination as to whether an individual series fund is a separate legal entity for consolidation purposes requires the application of reasonable judgment and includes, but is not limited to, consideration of the following:

The definition of a legal entity as defined in the Master Glossary,
The considerations in paragraph BC38 in the Basis for Conclusions of ASU 2015-02,
The purpose, objective and strategy of each of the series funds within the umbrella,
The legal isolation of the assets, liabilities, and equity (i.e., segregation of assets and liabilities) of each of the individual series funds,
Whether the shareholders of an individual series fund have substantive decision-making rights related to the individual series fund; such rights include, but are not limited to, the ability to directly remove and replace the asset management company for the individual series fund or liquidate the individual series fund, approve the compensation of the asset management company for the individual series fund, and vote on changes to the fundamental investment strategy of the individual series fund, and
Other relevant jurisdictional characteristics.

The SEC Staff believes that legal isolation of the assets, liabilities and equity of each of the individual series funds and the existence of substantive shareholder decision-making rights at the series fund level can be viewed as relevant and significant considerations in the context of the asset management industry and, as a result, the SEC Staff would expect that in many series fund structures where these two considerations are present, the individual series fund would qualify as a separate legal entity for purposes of the consolidation analysis.

If the individual series fund is considered a legal entity for accounting purposes, the consolidation analysis is performed at the individual series fund level. The SEC Staff would also expect that in such situations, where the shareholders of the individual series fund have substantive decision-making rights, the individual series fund would generally meet the criteria to be classified as a voting interest entity, although such a conclusion would require analysis based on individual facts and circumstances.

It is our understanding that most international series funds are not designed with the substantive decision-making rights listed in the fifth bullet above. If the governance of an international series fund is amended to meet the definition of a separate legal entity, a reporting entity should determine whether substantive decision-making rights are at the series-fund level. We generally expect that a reporting entity’s conclusion that a separate legal entity exists would be based on the presence of all the substantive decision-making rights listed by the SEC staff. We believe all of these rights are required in substance but not necessarily in form. For example, if the shareholders could set compensation of the asset manager as low as zero, it may not be relevant that the shareholders do not have an explicit ability to remove and replace the asset manager since setting the compensation to zero may force the asset manager to resign. Therefore, in determining whether a separate legal entity exists, a reporting entity should carefully evaluate the facts and circumstances.

3.2.2 Multitiered Legal-Entity Structures

In a multitiered legal-entity structure, a reporting entity should generally begin its evaluation at the lowest-level entity. Each entity within the structure should then be evaluated on a consolidated basis. The attributes and variable interests of the underlying consolidated entities should generally become those of the parent company upon consolidation.

When a reporting entity applies the VIE model to a consolidated entity, it should analyze the design of the consolidated entity, including an analysis of the risks of the entity, why the entity was created (e.g., the primary activities of the entity), and the variability the entity was designed to create and pass along to its interest holders.

Note that there are situations in which a reporting entity may “look through” a holding company and therefore would not be required to examine the structure on a consolidated basis. For more information, see Section 3.2.3.

Example 3-1

Two investors each hold 50 percent of the ownership interests in Company H. Company H has 100 percent of the ownership interests in Entity X and consolidates X. Entity X is a business as defined in ASC 805 and represents substantially all of H’s consolidated activities and cash flows. Company H, on a stand-alone basis, does not meet the definition of a business in ASC 805. There are no other relationships or agreements between the investors, H, or X.

As noted above, the attributes of a consolidated entity become the attributes of the parent company. In this example, X’s attributes become those of H. When the investors are evaluating their ownership interests, they should consider H’s design on a consolidated basis. Because X meets ASC 805’s definition of a business, and its activities and cash flows represent substantially all of H’s consolidated activities and cash flows, H also meets ASC 805’s definition of a business. Therefore, the investors in H may be eligible for the business scope exception in ASC 810-10-15-17(d) (see Section 3.4.4). In determining whether any of the four conditions in ASC 810-10-15-17(d) are met, the investors in H should evaluate H’s consolidated activities and cash flows, inclusive of X.

Example 3-2

Two investors each hold 50 percent of the ownership interests in a holding company. The holding company has 100 percent of the ownership interests in Entity E and consolidates E. Entity E meets ASC 805’s definition of a business and represents substantially all of the holding company’s consolidated activities and cash flows. The holding company also consolidates Entity N, which does not meet ASC 805’s definition of a business. Other than its investments in E and N, the holding company has no assets, liabilities, or activities. There are no other relationships or agreements between the investors, the holding company, E, or N.

As in the example above, the attributes of the consolidated entities become those of the parent company. In this example, the attributes of E and N become those of the holding company.

When the investors are evaluating their ownership interests, they should consider the holding company’s design on a consolidated basis. Because substantially all of the holding company’s consolidated activities and cash flows are derived from E, the holding company meets ASC 805’s definition of a business. As in the example above, before applying the business scope exception, the investors must determine whether any of the four conditions in ASC 810-10-15-17(d) have been met regarding the holding company’s consolidated activities and cash flows. If so, the business scope exception cannot be applied (see Section 3.4.4).

Example 3-3

An investor holds 50 percent of the ownership interests in a holding company. The holding company consolidates the following two entities, both of which meet ASC 805’s definition of a business:

Entity J, an operating entity.
Entity L, whose activities are primarily related to securitizations or other forms of asset-backed financings.

Entity L’s activities and cash flows represent substantially all of the holding company’s activities and cash flows. Other than its investments in J and L, the holding company has no assets, liabilities, or activities. There are no other relationships or agreements between the investor, the holding company, J, or L.

As in both examples above, the attributes of the consolidated entities become those of the parent company. In this example, the attributes of J and L become those of the holding company.

When the investor is evaluating its ownership interests, it should consider the holding company’s design on a consolidated basis. While J and L both meet ASC 805’s definition of a business, the investor would not be able to apply the business scope exception because the holding company is designed primarily to facilitate activities that are primarily related to securitizations or other forms of asset-backed financings, which is a scenario in which the business scope exception cannot be applied (see ASC 810-10-15-17(d)(4); also see Section 3.4.4).

Example 3-4

A group of investors establishes a holding company that is 100 percent funded by the equity of the investors. The design and purpose of the company is to hold all the equity of an operating company. The operating company is capitalized as follows: 3 percent by the equity investment from the holding company and 97 percent by non-investment-grade debt. Accordingly, assume that the operating company is a VIE due to insufficiency of equity investment at risk (see Section 5.2). In addition, assume that the holding company consolidates the operating company.

When the investors evaluate whether the holding company is a VIE, they should consider the holding company’s design on a consolidated basis. Because the sole purpose of the holding company was to aggregate investors to control the operating company, the holding company should be considered a VIE due to insufficiency of equity investment at risk (even if the operating company’s debt is nonrecourse to the holding company). That is, it would be inappropriate to ignore the substance of the significant debt at the operating company level and conclude that the holding company is a voting interest entity. The holding company is simply a pass-through for the investors to form the operating company.

Example 3-5

A group of investors establishes a collateralized manager vehicle (CMV) that is funded 100 percent by the equity of the investors. The CMV’s design and purpose is to sponsor, manage, and hold subordinated interests in various CLOs. The CLOs issue debt to third parties on a nonrecourse basis (i.e., the investors in the CLO only have recourse to the performance of the respective CLO). The CLOs are VIEs because they do not have sufficient equity investment at risk. The CMV consolidates the CLOs because the CMV has the power to direct the most significant activities and a potentially significant variable interest through the subordinated interests held.

When the investors are evaluating whether the CMV is a VIE, they should consider the CMV’s design on a consolidated basis. In contrast to the previous example, it would not be appropriate to consider the CLOs’ debt in the determination of whether the CMV has sufficient equity investment at risk. The CMV’s design and purpose was to sponsor and manage CLOs rather than to capitalize CLOs, and the CLOs’ debt is nonrecourse to the CMV. That is, despite the CMV’s consolidation of the CLOs (which are VIEs due to insufficient equity investment at risk), we do not believe that the debt issued at the subsidiary CLOs should affect whether the CMV has equity sufficient to finance its activities. Therefore, the equity that is needed to support the activities of the CMV is not at the same level as that needed to capitalize a financing vehicle.

3.2.3 “Looking Through” a Holding Company to the Underlying Legal Entity

Holding companies are frequently established (often for legal or tax purposes) to hold some or all of the ownership interests in a legal entity. In many cases, reporting entities have ownership interests in these holding companies for the sole purpose of investing in an underlying legal entity. Questions can arise about whether a reporting entity with an interest in a holding company can “look through” (i.e., ignore) a holding company and apply the provisions of the VIE model directly to the underlying legal entity as if the holding company does not exist. This is particularly relevant to the business scope exception discussed in Section 3.4.4.

For example, assume that an investor has a 40 percent ownership interest in HoldCo, a holding company that is not a joint venture. HoldCo was designed for the sole purpose of acquiring 100 percent of the ownership interests in Entity X, a preexisting single legal entity that is a business as defined in ASC 805. The investor was involved in the design of HoldCo but was not involved in the design or redesign of X. If the investor cannot look through HoldCo, it cannot apply the business scope exception because the investor was involved in the design of HoldCo (see ASC 810-10-15-17(d)(1)). If the investor can look through HoldCo, it can apply the business scope exception (provided that the investor, X, and HoldCo do not meet any of the other business scope exception conditions) because the investor was not involved in the design or redesign of X.

In limited circumstances, it may be necessary or appropriate for an investor to look through a holding company and apply the VIE model directly to a single underlying legal entity. The investor can only do this when (1) the holding company is a nonsubstantive entity because it does not have any substantive identity separate from that of the underlying legal entity and (2) the economics of the arrangement do not change as a result of the holding company’s insertion between the investors and the underlying legal entity.

A holding company is considered to have no substantive identity separate from its investment in the legal entity when all variable interests in the holding company represent indirect variable interests of the reporting entity in the underlying legal entity because they are virtually indistinguishable from direct variable interests of the holding company in the underlying legal entity (i.e., the reporting entity’s variable interests in the holding company are essentially “back-to-back” with the holding company’s variable interests in the underlying legal entity, and the holding company represents a pass-through entity). When looking through a holding company is deemed to be appropriate, in general, the conclusions reached under a VIE evaluation (regarding (1) whether a legal entity is a VIE and (2) who consolidates the legal entity as its primary beneficiary) with respect to looking through a holding company should be the same conclusions that would be reached if the analysis were performed separately for the holding company and the underlying legal entity. All facts and circumstances should be considered, including (1) the design of both the holding company and the underlying legal entity and (2) the nature of the relationships with the variable interest holders and their related parties.

Satisfaction of all the following conditions may indicate that a reporting entity can look through a holding company to a single underlying legal entity when applying the VIE model:

Other than its ownership interests in the single underlying legal entity, the holding company is restricted by its governing documents from holding any assets, issuing debt, or engaging in any operating activities on its own behalf.
The governing documents of the holding company and the underlying legal entity are substantively the same.
The governing documents associated with the holding company and the underlying legal entity require that both entities have the same individuals on the board of directors or other bodies that determine the financial and operating policies of the entity.
Other than tax implications of the holding company, the risks and rewards of the interest holders (including their interests in profits and losses and in liquidation) would be identical if their interests were directly in the underlying legal entity instead of in the holding company.

Example 3-6

An investor holds 40 percent of the ownership interests in a holding company. The holding company has 100 percent of the ownership interests in a single legal entity and consolidates that legal entity. The legal entity is a business as defined in ASC 805. Other than its ownership interests in the legal entity, the holding company has no assets, liabilities, or activities. There are no other relationships or agreements between the investor, the holding company, and the legal entity. Assume that the four conditions described above have been met in this arrangement.

The investor can look through the holding company and apply the VIE model directly to the underlying legal entity because the holding company is a nonsubstantive entity under the VIE subsections. To apply the business scope exception, the investor must determine whether any of the four conditions in ASC 810-10-15-17(d) have been met for either the investor or the single underlying legal entity. If any of the conditions have been met, the business scope exception cannot be applied.

Example 3-7

Assume the same facts as in the example above except that the holding company takes out a loan from a third-party bank. In this scenario, the investor would not be able to look through the holding company to the underlying legal entity because the holding company’s loan precludes the investor from doing so since it has not satisfied the first condition described above (i.e., the holding company is not restricted by its governing documents from holding any assets, issuing debt, or engaging in any operating activities on its own behalf).

Example 3-8

An investor has 40 percent of the ownership interests in a holding company, which holds 100 percent of the ownership interests in a legal entity. The legal entity takes out a loan from a third-party bank. The investor has guaranteed repayment of the loan in the event of default. There are no other relationships or agreements between the investor, the holding company, and the legal entity. Assume that the four conditions described above have been met in this arrangement.

Although not required to do so, the investor would be able to look through the holding company since the investor’s guarantee represents a direct variable interest in the legal entity (i.e., the guarantee has no impact on the holding company).

Footnotes

See Chapter 6 for a discussion of silos.

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.

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.

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.

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.

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 2021 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.

3.4 Scope Exceptions From the VIE Model

ASC 810-10

15-17 The following exceptions to the Variable Interest Entities Subsections apply to all legal entities in addition to the exceptions listed in paragraph 810-10-15-12:

Not-for-profit entities (NFPs) are not subject to the Variable Interest Entities Subsections, except that they may be related parties for purposes of applying paragraphs 810-10-25-42 through 25-44. In addition, if an NFP is used by business reporting entities in a manner similar to a VIE in an effort to circumvent the provisions of the Variable Interest Entities Subsections, that NFP shall be subject to the guidance in the Variable Interest Entities Subsections.
Separate 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.
A reporting entity with an interest in a VIE or potential VIE created before December 31, 2003, is not required to apply the guidance in the Variable Interest Entities Subsections to that VIE or legal entity if the reporting entity, after making an exhaustive effort, is unable to obtain the information necessary to do any one of the following:
1. Determine whether the legal entity is a VIE
2. Determine whether the reporting entity is the VIE’s primary beneficiary
3. Perform the accounting required to consolidate the VIE for which it is determined to be the primary beneficiary.
This inability to obtain the necessary information is expected to be infrequent, especially if the reporting entity participated significantly in the design or redesign of the legal entity. The scope exception in this provision applies only as long as the reporting entity continues to be unable to obtain the necessary information. Paragraph 810-10-50-6 requires certain disclosures to be made about interests in VIEs subject to this provision. Paragraphs 810-10-30-7 through 30-9 provide transition guidance for a reporting entity that subsequently obtains the information necessary to apply the Variable Interest Entities Subsections to a VIE subject to this exception.
A legal entity that is deemed to be a business need not be evaluated by a reporting entity to determine if the legal entity is a VIE under the requirements of the Variable Interest Entities Subsections unless any of the following conditions exist (however, for legal entities that are excluded by this provision, other generally accepted accounting principles [GAAP] should be applied):
1. The reporting entity, its related parties (all parties identified in paragraph 810-10-25-43, except for de facto agents under paragraph 810-10-25-43(d)), or both participated significantly in the design or redesign of the legal entity. However, this condition does not apply if the legal entity is an operating joint venture under joint control of the reporting entity and one or more independent parties or a franchisee.
2. The legal entity is designed so that substantially all of its activities either involve or are conducted on behalf of the reporting entity and its related parties.
3. The reporting entity and its related parties provide more than half of the total of the equity, subordinated debt, and other forms of subordinated financial support to the legal entity based on an analysis of the fair values of the interests in the legal entity.
4. The activities of the legal entity are primarily related to securitizations or other forms of asset-backed financings or single-lessee leasing arrangements.
A legal entity that previously was not evaluated to determine if it was a VIE because of this provision need not be evaluated in future periods as long as the legal entity continues to meet the conditions in (d).

A reporting entity that has an interest in a legal entity should first evaluate whether it qualifies for a general scope exception to the consolidation requirements in ASC 810-10-15-12 (see Section 3.3). If it does not, it should determine whether it qualifies for any of the following four scope exceptions to application of the VIE model:

Not-for-profit entities (NFPs).
Separate accounts of life insurance entities.
Exhaustive efforts.
Business entities.

3.4.1 Scope Exception for NFPs

Like the governmental organization scope exception in ASC 810-10-15-12(e), a for-profit entity is exempt from consolidating an NFP under the VIE model unless the NFP is used in a manner similar to a VIE and the intent is to circumvent the provisions of the VIE model (see Section 3.4.1.2 for guidance on identifying circumvention of the VIE model). However, a for-profit entity should evaluate an NFP under the voting interest entity model. Under the voting interest entity model (see Appendix D), a for-profit entity would generally consolidate an NFP if (1) it holds an economic interest in the NFP and (2) the for-profit entity is the sole corporate member or controls the board of directors. All facts and circumstances should be considered, including the existence of kick-out or participating rights.

In addition, an NFP is not required to determine, under the VIE model, whether to consolidate any legal entity in which it holds an interest. However, the NFP may be a related party of a for-profit entity that must be analyzed pursuant to the guidance in ASC 810-10 on related parties (see Chapter 8). See Section 3.4.1.3 for additional guidance on the consolidation model for NFPs.

3.4.1.1 Certain Situations in Which an Entity Does Not Qualify for the NFP Scope Exception

The ASC master glossary defines an NFP as:

An entity that possesses the following characteristics, in varying degrees, that distinguish it from a business entity:

Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return
Operating purposes other than to provide goods or services at a profit
Absence of ownership interests like those of business entities.

Entities that clearly fall outside this definition include the following:

All investor-owned entities
Entities that provide dividends, lower costs, or other economic benefits directly and proportionately to their owners, members, or participants, such as mutual insurance entities, credit unions, farm and rural electric cooperatives, and employee benefit plans.

Only entities that meet the Codification’s definition of an NFP can qualify for the NFP scope exception in ASC 810-10-15-17(a). Accordingly, an entity that presents its financial statements in a manner similar to an NFP, but does not meet the Codification’s definition of an NFP, does not qualify for the NFP scope exception. Further, an entity that qualifies as an NFP for regulatory purposes (e.g., under state law), but does not meet the Codification's definition of an NFP, does not qualify for the NFP scope exception.

Example 3-13

Company A (a for-profit organization) sells properties to a common interest realty association (CIRA) in exchange for time-share memberships, which A then sells to consumers. The CIRA presents its financial statements similarly to an NFP pursuant to ASC 972 but does not meet the Codification’s definition of an NFP.

We understand that the SEC staff does not believe that a CIRA is an NFP because typically it does not meet part (a) or part (c) of the Codification’s definition as follows:

Part (a) — The investors (consumers who purchase the time-share units) expect the CIRA to use their contributions to maintain the properties, which maintains (or increases) the value of their time-share units.
Part (c) — The investors have a residual claim on the properties and voting rights with respect to the activities of the CIRA, and the units are exchangeable. These attributes are characteristics of “ownership interests like those of business entities.”

The CIRA, therefore, would not meet the scope exception for NFPs in ASC 810-10-15-17(a).

Note that the next steps in applying the VIE model are to determine whether A has a variable interest and whether the CIRA entity is a VIE.

3.4.1.2 Use of an NFP in Circumvention of the VIE Model

ASC 810-10-15-17(a) states that if a business reporting entity uses an NFP to circumvent the provisions of the VIE model, the NFP is subject to the VIE model. The determination of whether an NFP has been established to circumvent the VIE model requires significant judgment. As part of this analysis, a reporting entity should consider all facts and circumstances associated with the creation and design of the NFP as well as the NFP’s relationship with business entities. For example, a reporting entity should consider the following:

Whether the party (the sponsor) who will transact with the NFP created or designed the legal entity.
Why the legal entity was formed as an NFP.
The nature of the NFP’s operations (e.g., whether substantially all of its activities are on behalf of the sponsor).

Example 3-14

Enterprise A, a business enterprise, establishes Entity B, an NFP whose sole purpose is to lease a building to A. To purchase this building, B uses the proceeds of various tranches of senior and subordinated debt it has issued. The terms of the lease are designed so that A can attain operating lease treatment. The terms include a first-loss residual value guarantee from A (the guarantee is capped to meet the operating lease criteria), and A has a fixed-price purchase option at the end of the lease term (the option is not considered to be a bargain purchase option). It is expected that all of the lease payments (including those from the residual value guarantee) and the proceeds from final sale of the property will be sufficient to redeem the debt. Although no excess funds are expected after the debt is redeemed, any excess funds must be contributed to a local foundation.

In the absence of a valid business purpose, A cannot use the NFP scope exception in analyzing whether it must consolidate B because the form of B as an NFP was used simply to circumvent the provisions of the VIE model. Therefore, A would need to analyze its arrangement with B under the VIE model.

3.4.1.3 Accounting Guidance for NFPs That Are Outside the Scope of ASC 810-10

NFPs that qualify for the scope exception in ASC 810-10-15-17(a) should apply ASC 958 and ASC 954 instead of ASC 810-10. See Section E.6 for detailed guidance and interpretations for NFPs.

3.4.1.4 Retention of a For-Profit Reporting Entity’s Accounting Policies in the Consolidated Financial Statements of an NFP Reporting Entity

For-profit reporting entities that are owned by NFP reporting entities must apply the VIE model to a legal entity in which it holds an interest. That guidance does not change as a result of consolidation of the for-profit entity by the NFP reporting entity. This position is supported by analogy to ASC 810-10-25-15, which states:

For the purposes of consolidating a subsidiary subject to guidance in an industry-specific Topic, an entity shall retain the industry-specific guidance applied by that subsidiary.

Example 3-15

Company N, a not-for-profit health care company that applies the guidance in ASC 954, has a wholly owned subsidiary, W, a for-profit holding company that directly operates several for-profit businesses. Company W has a variable interest in Company V and consolidates V under the provisions of the VIE model. While ASC 810-10-15-17(a) exempts N from the provisions of the VIE model, W’s accounting for V should be retained in the consolidated financial statements of N (a not-for-profit reporting entity).

3.4.2 Scope Exception for Separate Accounts of Life Insurance Entities

ASC 810-10-15-17(b) exempts life insurance entities and the investors in the separate accounts of life insurance entities from applying the VIE model to a separate account of the life insurance company. However, a separate account must nevertheless apply the VIE model to a legal entity in which it holds a variable interest. That is, when financial statements of a separate account are separately prepared in accordance with GAAP, the financial statements of the separate account are not exempt from the guidance in the VIE subsections.

The scope exception in ASC 810-10-15-17(b) applies to investors in assets held by a separate account of an insurance company. The insurance company would apply the guidance in ASC 944-80-45-1, which states, in part, that “[s]eparate account assets and liabilities shall be included in the financial statements of the insurance entity.” The FASB included this scope exception because it did not intend to change the accounting under ASC 944.

In April 2010, the FASB issued ASU 2010-15, which addresses, among other things, whether an insurance company is required to consolidate a majority-owned investment when such investment is held through the insurance company’s separate accounts (as described in ASC 944-80-25-2) or through a combination of investments in the insurance company’s separate and general accounts. The ASU states that “an insurance entity should not consider any separate account interests held for the benefit of policy holders in an investment to be the insurer’s interests and should not combine those interests with its general account interest in the same investment when assessing the investment for consolidation, unless the separate account interests are held for the benefit of a related party policy holder.” In addition, ASU 2010-15 specifies that in the determination of whether specialized accounting for investments in consolidation should be retained (note that separate accounts that issue stand-alone financial statements are generally considered investment companies), a separate account should be viewed to be the equivalent of a subsidiary (i.e., separate legal entity) even though separate accounts are generally not set up as separate legal entities by the insurance company. Since ASC 810-10-15-12(d) precludes investment companies from consolidating noninvestment companies (with certain exceptions), viewing the separate account as an investment company would generally prevent the insurance company from consolidating an investment in which a separate account holds a controlling financial interest.

3.4.3 Scope Exception for Exhaustive Efforts for Entities Created Before December 31, 2003

In determining whether the exception in ASC 810-10-15-17(c) may be applied, a reporting entity should consider all facts and circumstances associated with its ability to obtain information from a legal entity in which it has an interest. ASC 810-10-15-17(c) states, in part, that the “inability to obtain the necessary information is expected to be infrequent, especially if the reporting entity participated significantly in the design or redesign of the legal entity.”

Therefore, a reporting entity that concludes it is subject to this exemption should compile documentation demonstrating that it has made a significant effort to obtain the information (e.g., date, time, and nature of requests; evidence that the appropriate parties at the legal entity have been contacted; copies of requests for written information; evidence that other holders of similar variable interests are also unable to obtain the information; the nature of any responses from the legal entity). A reporting entity is not required to resort to legal action to obtain information if it does not have a contractual right to obtain the information.

The reporting entity should make an exhaustive effort, supported by appropriate documentation, for each legal entity to which it is unable to apply the VIE model. As long as the reporting entity has an interest in the legal entity in question, the reporting entity should continue to make exhaustive efforts to obtain the necessary information no less frequently than each reporting period.

At the 2004 AICPA Conference on Current SEC and PCAOB Developments, the SEC staff emphasized that management should be prepared to support how it has satisfied the exhaustive-effort requirements.

Note that reporting entities can apply this scope exception only for legal entities created before December 31, 2003.

At the 2003 AICPA Conference on Current SEC Developments, the SEC staff stated the following:

[T]he staff has begun to contemplate the meaning of “an exhaustive effort” in applying this limited scope exception. Consistent with the thoughts of the FASB, as expressed in the modifications to FIN 46 [codified in ASC 810-10], the staff anticipates that the use of the exception will be infrequent. We plan to deal with instances where the information scope exception is being applied on a case-by-case basis, considering all of the relevant facts and circumstances. In assessing those facts and circumstances, the staff can be expected to consider whether registrants operating in the same industry with similar types of arrangements were able to obtain the requisite information.

ASC 810-10-50-6 requires that certain disclosures be made about interests in VIEs that apply this provision. (See Section 11.2.4.1 for further discussion of the disclosure requirements related to the exhaustive-efforts scope exception.) ASC 810-10-30-7 provides transition guidance for a reporting entity that subsequently obtains the information necessary to apply the VIE model to an entity previously subject to this exception.

3.4.3.1 Application of the Exhaustive-Efforts Scope Exception to an Inactive Entity Created Before December 31, 2003

The exhaustive-efforts scope exception in the VIE model applies only when (1) a legal entity was created before December 31, 2003, and (2) the reporting entity meets the other requirements of ASC 810-10-15-17(c). A legal entity may have been created before December 31, 2003, remained inactive for a number of years, and then been activated after December 31, 2003, to carry out new activities and issue new variable interests. In these situations, the exhaustive-efforts scope exception may not be applied. At the 2003 AICPA Conference on Current SEC Developments, the SEC staff stated the following:

For instance, in making a determination whether to apply the scope exception, registrants should carefully consider whether the entity was really created prior to December 31st or was merely in existence prior to that date and re-configured in such a way that the “creation date” of the legal entity is not relevant. For instance, if an entity was inactive for a number of years and then re-activated after December 31st to carry out new activities and issue new variable interests, the staff would consider the use of the information scope exception abusive.

3.4.4 Scope Exception for Entities That Meet the Definition of a Business

The FASB has indicated that determining whether a legal entity is a business is not, in and of itself, relevant to the VIE model’s consolidation objective. The VIE model focuses on the identification of entities for which an analysis of voting interests is not effective in the determination of whether a controlling financial interest is held by a reporting entity. The business scope exception is thus intended to specify conditions that would help identify legal entities in which voting interests would be effective in the determination of whether a controlling financial interest in the legal entity is held by the reporting entity. Accordingly, the FASB created conditions that, if none are met, would obviate the need for further analysis of whether the legal entity should be consolidated pursuant to the VIE model.

The business scope exception is two-pronged and premised on both (1) the legal entity’s characteristics (i.e., whether it is a business, and its activities) and (2) the reporting entity’s relationship with the legal entity (i.e., the extent of involvement by the reporting entity in the design or redesign of the legal entity, whether the legal entity is designed so that substantially all of its activities either involve or are conducted on behalf of the reporting entity and its related parties, and whether the reporting entity and its related parties provided more than half of the subordinated financial support). A common oversight in evaluating the applicability of the business scope exception is merely assessing whether a legal entity meets the definition of a business and failing to determine whether any of the four conditions in ASC 810-10-15-17(d) are met.

The first three conditions in ASC 810-10-15-17(d) focus on the reporting entity’s relationship with the legal entity and can help reporting entities identify whether legal entities have relationships that are so intertwined with the reporting entity that it would be inappropriate to exclude them from the VIE model merely because they meet the definition of a business. In the fourth condition, the activities of the legal entity itself are considered. If the legal entity does not meet the definition of a business, or is a business but meets any of the following four conditions, the legal entity would not qualify for the business scope exception. ASC 810-10-15-17(d) states, in part:

The reporting entity, its related parties (all parties identified in paragraph 810-10-25-43, except for de facto agents under paragraph 810-10-25-43(d)), or both participated significantly in the design or redesign of the legal entity. However, this condition does not apply if the legal entity is an operating joint venture under joint control of the reporting entity and one or more independent parties or a franchisee.
The legal entity is designed so that substantially all of its activities either involve or are conducted on behalf of the reporting entity and its related parties.
The reporting entity and its related parties provide more than half of the total of the equity, subordinated debt, and other forms of subordinated financial support to the legal entity based on an analysis of the fair values of the interests in the legal entity.
The activities of the legal entity are primarily related to securitizations or other forms of asset-backed financings or single-lessee leasing arrangements.

3.4.4.1 Applying the Business Scope Exception on a Reporting-Entity-by-Reporting-Entity Basis

The business scope exception should be evaluated on a reporting-entity-by-reporting-entity basis. Each reporting entity involved with the legal entity must evaluate whether the legal entity (or reporting entity) meets any of the conditions in ASC 810-10-15-17(d) and thus fails to qualify for the scope exception. It is possible that one reporting entity with an interest in a legal entity will fail to qualify for this scope exception while another reporting entity with an interest in the same legal entity will qualify.

A determination of whether the following conditions have been met should be based on an analysis of the legal entity (and thus the same analysis should be used for all holders of interests in the legal entity):

Whether the legal entity is a business as defined in ASC 805 (see Section 3.4.4.2).
Whether the activities of the legal entity are primarily related to securitizations or other forms of asset-backed financings or single-lessee leasing arrangements (see ASC 810-10-15-17(d)(4); also see Section 3.4.4.11 for more information about single-lessee leasing activities).

A determination of whether the following conditions have been met should be based on an analysis of the relationship each interest holder (reporting entity) and its related parties have with the legal entity (the results of the analysis may, therefore, be different for different holders of interests in the legal entity):

Whether the reporting entity, its related parties (for this purpose includes all related parties in ASC 810-10-25-43, except for de facto agents under ASC 810-10-25-43(d)), or both participated significantly in the design or redesign of the legal entity, unless the legal entity is an operating joint venture under joint control of the reporting entity and one or more independent parties or a franchisee (ASC 810-10-15-17(d)(1)).
Whether the legal entity is designed so that substantially all of its activities either involve or are conducted on behalf of the reporting entity and its related parties (ASC 810-10-15-17(d)(2)).
Whether the reporting entity and its related parties provide more than half the total of the equity, subordinated debt, and other forms of subordinated financial support to the legal entity (ASC 810-10-15-17(d)(3)).

Example 3-16

A joint venture (Entity A) is formed by two enterprises. Entity A meets the definition of a business in ASC 805 and does not meet the condition in ASC 810-10-15-17(d)(4). Enterprise 1 provides 50 percent of the equity and a subordinated loan to A. Enterprise 2 provides the other 50 percent of the equity. Other than the equity and the subordinated loan, no other forms of subordinated financial support exist. Enterprise 2’s interests in A would be outside the scope of the VIE model because it did not provide more than half the subordinated financial support. However, Enterprise 1 must analyze its interest under the VIE model because it provided more than half the total subordinated financial support to the joint venture.

3.4.4.2 Definition of a Business

ASC 805-10-55-3A defines a business as follows:

[A]n integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants. To be considered a business, an integrated set must meet the requirements in paragraphs 805-10-55-4 through 55-6 and 805-10-55-8 through 55-9.

In January 2017, the FASB issued ASU 2017-01, which narrowed the pool of assets or net assets that are considered a business by providing a “screen” for determining when a set of assets and activities qualifies as a business. The screen ensures that if substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business.

However, a legal entity that gets through the screen (i.e., substantially all of the fair value is not concentrated in a single identifiable asset or group of similar identifiable assets) cannot be considered a business unless it possesses an input and a substantive process that together significantly contribute to the ability to create an output. ASC 805 provides a framework to help entities evaluate whether both an input and a substantive process are present, and it removes the need to assess whether a market participant could potentially replace any missing elements. For further guidance on how to determine whether a legal entity meets the definition of a business, see Deloitte’s Roadmap Business Combinations.

Note that the business scope exception indicates that even if a potential VIE meets the definition of a business, a reporting entity would analyze its interest in that potential VIE if any of the four conditions in ASC 810-10-15-17(d) are met.

3.4.4.3 [Reserved]

3.4.4.4 When a Reporting Entity Should Assess Whether It Qualifies for the Business Scope Exception

ASC 810-10-15-17(d) states, in part:

A legal entity that previously was not evaluated to determine if it was a VIE because of this provision need not be evaluated in future periods as long as the legal entity continues to meet the conditions in (d).

Each reporting entity should continually evaluate a legal entity to determine whether the reporting entity still qualifies for the business scope exception. A reporting entity should perform this evaluation (1) on the date it becomes involved with the legal entity, (2) when events occur that would require reconsideration under ASC 810-10-35-4 (see Chapter 9) or other events that cause a change in the design of the legal entity occur, and (3) as of each reporting date (see note below). Further, the reassessment of whether a legal entity continues to qualify for the business scope exception is limited to the four conditions specified in ASC 810-10-15-17(d). Therefore, unless a legal entity is fundamentally redesigned and its entire purpose has changed (e.g., all of the operations are spun off and the remaining legal entity represents a single real estate asset), a reporting entity applying the business scope exception is not required to reassess whether the legal entity is a business. If a reporting entity determines that the legal entity qualifies for the business scope exception, the VIE model does not apply and consolidation should be evaluated under the voting interest entity model.

This reassessment could result in a reporting entity’s inability to claim the business scope exception in subsequent periods.

Conversely, a reporting entity that has not been able to claim the business scope exception should reassess whether it meets the scope exception only if one of the following types of events occurs:

Reconsideration events under ASC 810-10-35-4 regarding whether a legal entity is a VIE (see Chapter 9).
Events that cause a change in the design of the legal entity.

Note that ASC 810-10-15-17(d), read literally, requires a reporting entity to evaluate all the business scope exception factors in each reporting period. The condition in ASC 810-10-15-17(d)(3) indicates that the reporting entity cannot provide more than half the subordinated financial support to the legal entity. However, in performing the ASC 810-10-15-17(d)(3) evaluation, the reporting entity should not conclude that operating losses incurred by the legal entity would, by themselves, cause it to fail to qualify for the scope exception (if it did qualify in previous periods). That is, losses that have reduced the legal entity’s equity such that, on a fair value basis, the reporting entity now provides more than half of the subordinated financial support do not cause a reporting entity to no longer be able to apply the business scope exception. This view is supported by ASC 810-10-35-4, which states, in part:

A legal entity that previously was not subject to the Variable Interest Entities Subsections shall not become subject to them simply because of losses in excess of its expected losses that reduce the equity investment. [Emphasis added]

Connecting the Dots

As discussed in further detail in Section 3.4.4.2, ASU 2017-01 narrowed the definition of a business and consequently reduced the number of legal entities deemed businesses. We do not believe that a reporting entity is generally required upon adoption of ASU 2017-01 to reassess whether a legal entity that previously applied the business scope exception continues to meet the definition of a business. As discussed above, the reassessment of whether a legal entity qualifies for the business scope exception is limited to the four conditions specified in ASC 810-10-15-17(d). Therefore, unless a legal entity is fundamentally redesigned and its entire purpose has changed (e.g., all of the operations are spun off and the remaining legal entity represents a single real estate asset), a reporting entity applying the business scope exception is not required to reassess whether the legal entity is a business.

Example 3-17

Enterprise A and Enterprise B, two unrelated parties, form a joint venture, Entity C. The two venturers contribute an equal amount of equity and have joint control of the joint venture. Entity C sells all of its manufactured product to an unrelated third party. At inception, C is determined to be a business under ASC 805 and neither C nor A or B meet any of the four conditions in ASC 810-10-15-17(d). Therefore, both A and B rely on the business scope exception.

Subsequently, C loses its customer and no longer sells to an unrelated third party. Enterprise A enters into a contract to purchase the entire output of the joint venture. Because the new contract results in a change to “[t]he legal entity’s . . . contractual arrangements . . . in a manner that changes the characteristics or adequacy of the legal entity’s equity investment at risk” in accordance with ASC 810-10-35-4 (a), the determination of whether A is a VIE should be reconsidered. As a result of the reconsideration, A now meets the condition in ASC 810-10-15-17(d)(2) that the “legal entity is designed so that substantially all of its activities either involve or are conducted on behalf of the reporting entity.” As of the date this condition is met, A must apply the VIE model to C.

Note that because B does not meet any of the conditions in ASC 810-10-15-17(d), it can still rely on the scope exception.

Example 3-18

Assume the same facts as in the example above before Entity C loses its customer and enters into a purchase contract with Enterprise A, except that A also loans C an additional amount to fund the venture. The loan has a bullet maturity of 20 years. Because A has provided more than half the total equity and additional subordinated financial support to C via the loan, and there are no other forms of subordinated financial support, A meets the condition in ASC 810-10-15-17(d)(3) and therefore must apply the VIE model to C. Five years after the inception of the entity, C determines that its cash flows have exceeded original expectations and decides to repay A the entire principal on the debt. Early repayment of the debt results in a change to a contractual arrangement that may change the adequacy of C’s equity investment at risk (which is a reconsideration event under ASC 810-10-35-4(a)); therefore, A should reassess whether it qualifies for the business scope exception. As of that date, A may qualify for the scope exception because the condition in ASC 810-10-15-17(d)(3) no longer applies — the remaining variable interests are two 50-50 equity interests from A and B. On a fair value basis as of the reconsideration date, the reporting entity (A) is no longer providing more than half the total equity and financial support.

3.4.4.5 Whether the Reporting Entity Participated Significantly in the Design or Redesign of the Legal Entity

A reporting entity must consider all relevant facts and circumstances in determining whether it or its related parties participated significantly in the design or redesign of the legal entity. For this determination, related parties include all parties identified in ASC 810-10-25-43 (see Section 8.2 for a list of related parties and de facto agents) except for the de facto agency relationship that results from the transfer restrictions described in Section 8.2.3.4. The following are situations (not all-inclusive) in which the reporting entity would be presumed to have participated significantly in the design or redesign of the legal entity:

The reporting entity’s interest in the legal entity was obtained at the inception of the legal entity or shortly thereafter. This presumption may be overcome in certain circumstances, such as when the interest is not significant to the legal entity. However, if the lack of participation by a reporting entity would have prevented the creation of the legal entity, that reporting entity always will be deemed to have participated significantly in the design of the legal entity.
The reporting entity was involved in the execution of the legal entity’s initial or amended governing documents or contractual arrangements (if the amendment to the governing documents or contractual arrangements effectively redesigns the legal entity).
The legal entity was initially formed, or subsequently restructured, by others on behalf of the reporting entity or its related parties.
The reporting entity participated significantly (or, via protective or participating rights, had the opportunity to participate regardless of whether these rights were exercised) in significant changes to the legal entity’s operations.

Example 3-19

Entity 1 is a corporation formed with investments by two equity holders and an unrelated debt holder. All of the enterprises were involved in determining the amount of equity and debt financing necessary to fund the entity. The equity holders and the debt holder would be deemed to have participated significantly in the design of Entity 1 because all parties were involved in the legal entity’s design (i.e., establishing the funding requirements of the entity) and in executing the contractual arrangements that established the design.

Example 3-20

Entity 2 is a real estate partnership that entered into a service contract with Enterprise D, a developer, concurrently with Entity 2’s formation. The service contract is determined to be a variable interest. According to the terms of the service contract, Enterprise D will construct and manage a majority of Entity 2’s assets and has advised Entity 2 about the type of assets to construct for its operations. Because the service contract is negotiated and executed concurrently with the formation of Entity 2 and allows Enterprise D to significantly influence its activities, Enterprise D would be deemed to have participated significantly in the legal entity’s design.

3.4.4.6 Definition of a Joint Venture and Joint Control

As noted in ASC 810-10-15-17(d)(1), to qualify for the business scope exception, the reporting entity and its related parties (other than de facto agents under ASC 810-10-25-43(d)) cannot have been involved in the design or redesign of the legal entity unless the legal entity is an operating joint venture under joint control of the reporting entity and one or more independent parties or a franchisee. (See ASC 952-10 for guidance on identifying franchisees.)

ASC 323-10 — Glossary

Corporate Joint Venture

A corporation owned and operated by a small group of entities (the joint venturers) as a separate and specific business or project for the mutual benefit of the members of the group. A government may also be a member of the group. The purpose of a corporate joint venture frequently is to share risks and rewards in developing a new market, product or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities. A corporate joint venture also usually provides an arrangement under which each joint venturer may participate, directly or indirectly, in the overall management of the joint venture. Joint venturers thus have an interest or relationship other than as passive investors. An entity that is a subsidiary of one of the joint venturers is not a corporate joint venture. The ownership of a corporate joint venture seldom changes, and its stock is usually not traded publicly. A noncontrolling interest held by public ownership, however, does not preclude a corporation from being a corporate joint venture.

ASC 805-10 — SEC Materials — SEC Staff Guidance

SEC Observer Comment: Accounting by a Joint Venture for Businesses Received at Its Formation

S99-8 The following is the text of SEC Observer Comment: Accounting by a Joint Venture for Businesses Received at Its Formation.

The SEC staff will object to a conclusion that did not result in the application of Topic 805 to transactions in which businesses are contributed to a newly formed, jointly controlled entity if that entity is not a joint venture. The SEC staff also would object to a conclusion that joint control is the only defining characteristic of a joint venture.

ASC 845-10 — SEC Materials — SEC Staff Guidance

SEC Observer Comment: Accounting by a Joint Venture for Businesses Received at Its Formation

S99-2 The following is the text of SEC Observer Comment: Accounting by a Joint Venture for Businesses Received at Its Formation.

The ASC master glossary defines a corporate joint venture and provides specific characteristics of a joint venture within that definition. In addition to those characteristics, there is a consensus that venturers must have joint control over an entity for it to be considered a joint venture, as evidenced by the codified comments from the SEC staff observer captured originally in EITF Issue 98-4. Further, the Accounting Standards Executive Committee (AcSEC) indicated in the advisory conclusion of its July 17, 1979, AICPA Issues Paper, “Joint Venture Accounting,” that the element of “joint control” of major decisions should be the central distinguishing characteristic of a joint venture. The AcSEC recommended that the definition in Section 3055 of the Canadian Institute of Chartered Accountants Handbook (subsequently amended) be adopted in substance as the definition of a joint venture. The Handbook defines a joint venture as:

An arrangement whereby two or more parties (the venturers) jointly control a specific business undertaking and contribute resources towards its accomplishment. The life of the joint venture is limited to that of the undertaking which may be of short or long-term duration depending on the circumstances. A distinctive feature of a joint venture is that the relationship between the venturers is governed by an agreement (usually in writing) which establishes joint control. Decisions in all areas essential to the accomplishment of a joint venture require the consent of the venturers, as provided by the agreement; none of the individual venturers is in a position to unilaterally control the venture. This feature of joint control distinguishes investments in joint ventures from investments in other enterprises where control of decisions is related to the proportion of voting interest held.

Although joint control is a joint venture’s most distinguishing feature, it is not the only characteristic of a joint venture, and as indicated in ASC 805-10-S99-8 and ASC 845-10-S99-2, the SEC staff “would object to a conclusion that joint control is the only defining characteristic of a joint venture.”

On the basis of the definition of a corporate joint venture in ASC 323-10-20, we believe that a joint venture has all3 the following characteristics:

It is a separate legal entity. It is owned by a small group of entities.
Its operations are for the mutual benefit of the venturers.
Its purpose is to share risks and rewards in developing a new market, product, or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities.
It allows each venturer to participate, directly or indirectly, in the overall management. The members have an interest or relationship other than that of passive investors.
It is not a subsidiary of one of the members (commonly referred to as the “joint control” provision).

See Section 7.2 of Deloitte’s Roadmap Equity Method Investments and Joint Ventures for additional details.

3.4.4.7 Whether Substantially All of the Activities Either Involve or Are Conducted on Behalf of the Reporting Entity

A reporting entity should base its determination of whether substantially all of a legal entity’s activities either involve or are conducted on behalf of the reporting entity and its related parties on the design of the legal entity and should compare the nature and extent of the activities between the reporting entity and the legal entity with the entire set of the legal entity’s activities. For this determination, related parties include all parties identified in ASC 810-10-25-43 except for de facto agents as described in ASC 810-10-25-43(d). Generally, if 90 percent or more of the legal entity’s activities are conducted on behalf of a reporting entity and its related parties, it is presumed to be “substantially all” of the legal entity’s activities. However, less than 90 percent is not a safe harbor. The evaluation should not necessarily be based on the reporting entity’s economic interest(s) in a legal entity. However, significant economic interests in a legal entity may indicate that substantially all of the legal entity’s activities either involve, or are conducted on behalf of, the reporting entity and its related parties.

The following conditions may indicate (depending on their relative significance) that substantially all of a legal entity’s activities are conducted on behalf of a reporting entity and its related parties:

The reporting entity has entered into an agreement to purchase the output of the legal entity.
The legal entity purchases the inputs for its products, services, or both from the reporting entity, and the activities of the legal entity are an extension of the reporting entity’s activities.
The legal entity acts as a reseller of the reporting entity’s finished products or services.
The legal entity was designed or redesigned to provide goods, services, or both exclusively to the reporting entity’s customers.
The legal entity’s assets are leased to or from the reporting entity.
The legal entity depends on the reporting entity when conducting its ongoing business activities (without a similar level of dependency on other parties).
The legal entity enters into an outsourcing or tolling arrangement in which the reporting entity agrees to (1) provide raw materials, other inputs, or both and (2) purchase all of the related finished product from the legal entity.
The legal entity enters into a technical service agreement in which the reporting entity provides the legal entity with a variety of technical, consulting, and administrative services.
The legal entity is dedicated to developing pharmaceutical, biotech, software, or other in-process technology, and the reporting entity has rights to the resulting product.
The reporting entity holds options or other securities to acquire the other investors’ interests in the legal entity.
The other investors in the legal entity hold options or other securities that allow them to put their interests to the reporting entity.
The reporting entity is obligated to provide additional funding when operating losses occur, current funding is insufficient, or both.
The economics of the legal entity are designed or redesigned to be heavily weighted toward the reporting entity.
The reporting entity’s employees act as management for the legal entity.
The legal entity’s employees receive incentive compensation that depends on the financial results of the reporting entity.

Note that these conditions are also important to the determination of whether a legal entity is a VIE under ASC 810-10-15-14(c). See Section 5.4.2 for additional examples.

Example 3-21

Enterprise A owns an equity interest in Entity B, a public utility company that meets the definition of a business in ASC 805. Entity B provides electricity to unrelated third parties. There are no other interests or agreements between A and B. Because B conducts activities (i.e., producing electricity) on behalf of third-party customers, it does not conduct its activities on behalf of A. Therefore, substantially all of B’s activities neither involve nor are conducted on behalf of A. However, A would still need to determine whether the other conditions in ASC 810-10-15-17(d) are met.

Conversely, assume that A enters into a long-term power purchase agreement (PPA) for 100 percent of B’s output. In this case, A would not be able to apply the business scope exception because substantially all of B’s activities are conducted on A’s behalf.

Example 3-22

Entity G is created solely to lease diagnostic equipment to hospitals. Enterprise H owns several hospitals and enters into an agreement to exclusively lease its diagnostic equipment from G. This arrangement represents 40 percent of G’s total leasing activities. Assume that there are no other arrangements between G and H and that G is a business as defined in ASC 805.

Although H leases 100 percent of its diagnostic equipment from G, the exclusive leasing arrangement does not, in itself, represent substantially all of G’s activities because G conducts the remaining 60 percent of its leasing activities with unrelated parties. However, H would still need to determine whether the other conditions in ASC 810-10-15-17(d) are met.

Example 3-23

A joint venture entity (Entity C) is formed by two unrelated parties, Enterprises A and B. Each investor has a 50 percent equity interest. Entity C’s activities consist solely of purchasing a product from A and selling and distributing it to third-party customers.

Because of its current design, C represents another distribution or sales channel for A’s merchandise. Entity C appears to be an extension of A’s business because it is so closely aligned in appearance and purpose. Therefore, substantially all of C’s activities either involve or are conducted on A’s behalf and, accordingly, the business scope exception cannot be applied by A.

Example 3-24

A joint venture entity (Entity C) is formed by two unrelated parties, Enterprises A and B. Each investor has a 50 percent equity interest in C. Entity C has contracted to purchase all of its raw materials from A. Entity C uses these raw materials to manufacture finished goods to sell to third-party customers.

In this example (unlike the previous example), C does not appear to be an extension of A’s business. Even though A provides all of C’s raw materials, C uses those raw materials to manufacture finished goods as opposed to just selling, without modifying, the raw materials purchased from A. Thus, C has not been designed so that substantially all of its activities either involve or are conducted on A’s behalf. However, A would still need to determine whether the other conditions in ASC 810-10-15-17(d) are met.

Example 3-25

An investment hedge fund is established by a 99 percent limited partner and a 1 percent general partner. The fund has no other activities, and profits and losses are allocated according to ownership interests. In this scenario, the only activity of the fund is to invest its money and to provide returns to the general partner and limited partner. As currently designed, the fund’s activities, as well as its economics, are heavily weighted toward the limited partner. Therefore, substantially all of the fund’s activities involve or are conducted on behalf of the limited partner and, accordingly, the business scope exception cannot be applied by the limited partner.

3.4.4.8 Whether a Financing Represents Subordinated Financial Support

ASC 810-10-20 defines subordinated financial support as “[v]ariable interests that will absorb some or all of a [legal entity’s] expected losses” (see also Section 2.13). In general, all forms of financing are “subordinated financial support” unless the financing is the most senior class of liabilities and is considered “investment-grade.” Standard & Poor’s and Moody’s categorize investment-grade debt as that rated BBB or higher and Baa or higher, respectively. If the debt is not rated, it should be considered investment-grade only if it possesses characteristics that warrant such a rating. Evaluating whether a nonrated instrument possesses the same characteristics to be considered investment-grade requires careful consideration.

The determination that non-investment-grade debt is subordinated is based on the view that the debt holder is exposed to a more than remote chance of experiencing a credit loss. Therefore, unless the financing is investment-grade or, if the debt is not rated, possesses the same characteristics as investment-grade debt, the financing should be considered subordinated. This conclusion is consistent with ASC 810-10-55-23, which states, in part, that the “return to the most subordinated interest usually is a high rate of return (in relation to the interest rate of an instrument with similar terms that would be considered to be investment grade)” (emphasis added).

Example 3-26

Two unrelated parties, Enterprise A and Enterprise B, form a joint venture, Entity C, that meets the definition of a business in ASC 805. Enterprises A and B each contribute equity with a fair value of $20 and share equally in all voting matters. In addition, A lends $10 to C. The fair value of the loan is $10 and it is not considered investment-grade. Enterprise A has provided subordinated financial support with a fair value of $30 ($20 in equity and $10 in debt), which is more than half the total subordinated financial support of C ($50). Therefore, A cannot apply the business scope exception. However, if none of the other conditions in ASC 810-10-15-17(d) are met, B should apply the business scope exception because it does not provide more than half of the subordinated financial support.

3.4.4.9 Whether More Than Half of the Total of Equity, Debt, and Other Subordinated Financial Support Has Been Provided by the Reporting Entity and Its Related Parties

Under ASC 810-10-15-17(d)(3), a reporting entity must identify all forms of subordinated financial support that it or its related parties have provided to the legal entity. Related parties would include all parties identified in ASC 810-10-25-43 except for the de facto agency relationship that results from the transfer restrictions described in Section 8.2.3.4. (See the previous section for a discussion of how to determine whether the financing is subordinated.)

In determining whether the reporting entity or its related parties have provided more than half of the equity, debt, and other forms of subordinated financial support to a legal entity, the reporting entity should aggregate the fair value of the total equity, subordinated debt, and other forms of subordinated financial support that it (and its related parties) provides to the legal entity. If that amount is greater than half the fair value of the total equity, subordinated debt, and other forms of subordinated financial support of the legal entity, the reporting entity would meet this condition and therefore should not be able to apply the business scope exception.

A reporting entity must consider whether any variable interests that it (or its related parties) holds (in addition to equity or subordinated debt) constitute additional subordinated financial support. Many of the examples of variable interests cited in Table 4-1 in Section 4.3 (such as certain guarantees, put options, and agreements to provide services to the legal entity) will be considered a form of subordinated financial support if there is more than a remote chance that they absorb some or all of the expected losses of a legal entity.

Example 3-27

Company A contributes $5 million cash, and a guarantee of debt with a fair value of $1 million, in exchange for 67 percent of the equity of Entity X. Other equity holders contribute $3 million in cash to the entity in exchange for the remaining 33 percent of the equity in X, and X raises additional funds via a $2 million note payable (guaranteed by A) to a financial institution that is considered additional subordinated financial support. The guarantee absorbs expected losses of the entity and is therefore also considered to be additional subordinated financial support. Since the aggregate fair value of A’s equity and the guarantee ($6 million) is more than half of the total equity, debt, and other forms of subordinated financial support of X, A would not be able to avail itself of the business scope exception.

3.4.4.10 Additional Subordinated Financial Support — Put and Call Options

A put or call option between equity owners in a legal entity (e.g., between joint venture partners) can have an impact on whether a reporting entity meets the condition in ASC 810-10-15-17(d)(3) and, therefore, on whether it can apply the business scope exception. The examples below illustrate situations in which (1) a put option (purchased by one investor from the reporting entity) results in the reporting entity’s ineligibility for the business scope exception since the reporting entity effectively provides more than half of the total equity, subordinated debt, and other forms of subordinated financial support to the legal entity and (2) a call option would not have the same impact.

Example 3-28

Put Options

Investor A and Investor B form Entity X with equal contributions of equity. Investor B purchases a put option from A that permits it to put its interest in X to A at a fixed price.

The fair value of the fixed-price put option should be considered additional subordinated financial support provided by A to X because A will absorb expected losses of X upon exercise of that put option (i.e., it meets the definition of subordinated financial support in ASC 810-10-20). Therefore, A would consider the fair value of the fixed-price put option (presumably the price paid) in determining whether the condition in ASC 810-10-15-17(d)(3) is met. If the fair value of the put option is greater than zero, A would meet this condition and therefore would not be able to use the business scope exception since the fair value of the equity provided by A and the fair value of the put option written by A would constitute more than half the total of the equity, subordinated debt, and other forms of subordinated financial support to the legal entity.

Example 3-29

Call Option

Investor A and Investor B form Entity X with equal contributions of equity. Investor A purchases a call option from B that permits it to call B’s interest at a fixed price (the call option’s strike price is at or above the fair value of the equity interest at inception of the option).

The fair value of the fixed-price call option should not be considered additional subordinated financial support to X because A will not absorb expected losses of X upon exercise of that call option (i.e., the option does not meet the definition of subordinated financial support in ASC 810-10-20). Investor A can exercise its call and obtain additional residual returns of X, but the call option does not expose it to additional expected losses. Therefore, A would not consider the fair value of the fixed-price call option in determining whether it meets the condition in ASC 810-10-15-17(d)(3). Investors A and B would not meet this condition since the fair value of the equity provided by each investor would not constitute more than half of the total of the equity, subordinated debt, and other forms of subordinated financial support to the legal entity. To use the business scope exception, A and B must determine whether the other conditions in ASC 810-10-15-17(d) are met.

3.4.4.11 Single-Lessee Leasing Activities

The business scope exception in ASC 810-10-15-17(d) may not be applied to legal entities whose activities are primarily related to single-lessee leasing arrangements, regardless of whether the leasing arrangements are accounted for as operating leases or finance leases. Lessee reporting entities sometimes question whether it is necessary to evaluate the potential consolidation of a lessor entity that holds a single asset that it leases to the lessee reporting entity and accounts for as a finance lease. While the accounting treatment of a finance lease under ASC 842 may be similar to the consolidation of the asset and related debt obligation, the accounting result may be different (see Section 4.3.9.2) and therefore a lessee must evaluate its interest in the lessor for consolidation unless it qualifies for a scope exception.

Whether a legal entity is considered a single-lessee leasing arrangement depends on whether the primary activity of the legal entity is leasing (as lessor) to a single lessee. This evaluation is based on various qualitative and quantitative factors, including why the legal entity was created, the terms of the lease contracts the legal entity has entered into, the significance of the legal entity’s cash flows derived from leasing activities compared with its other activities, and the significance of the assets being leased compared with the legal entity’s other assets.

For legal entities whose primary activity is leasing, the next step is to determine whether the assets or group of assets is being leased by a single lessee. In making this determination, a reporting entity should look to the substance of the arrangement. For example, although governing documents may permit the leasing of assets of the legal entity to more than one party, the reporting entity should consider the intent of the legal entity and the actual leasing arrangements. The leasing of assets to multiple parties that are all part of a related-party group would generally be equivalent to leasing assets to a single lessee.

Example 3-30

Entity A is designed to own and lease retail buildings as well as an office park with multiple office buildings to various commercial and noncommercial tenants, and it meets the definition of a business in ASC 805. About 60 percent of A’s leasing activities are conducted with Enterprise B, an equity investor that leases office buildings; the remaining 40 percent of the leasing activities are conducted with unrelated third-party customers. There are no other arrangements between B and A. In this example, although A’s primary activity is leasing, A was designed to lease its properties (and is actually leasing its properties) to B as well as to unrelated third-party customers. Therefore, A would not meet the condition in ASC 810-10-15-17(d)(4) and should apply the business scope exception if none of the other conditions in ASC 810-10-15-17(d) are met.

Example 3-31

Assume the same facts as in the example above except that Entity A does not have any leasing activity with unrelated third-party customers and Enterprise B leases 100 percent of A’s properties (the retail buildings and all office park buildings). In this example, A meets the condition in ASC 810-10-15-17(d)(4), and B cannot apply the business scope exception because this transaction is considered a single-lessee leasing arrangement.

Example 3-32

Entity A (a business) leases construction equipment to unrelated third parties, which represents 30 percent of A’s cash flows. Entity A’s remaining business activities do not involve leasing, securitizations, or asset-backed financings. Enterprise B enters into a contract in which it will lease several pieces of construction equipment from A. Once executed, the lease contract will represent all the cash flows from A’s leasing business. There are no other arrangements between A and B.

Although the cash flows from the lease contract represent all of A’s leasing business, A was not specifically designed to enter into single-lessee leasing arrangements. In addition, A’s activities are not primarily related to either leasing or asset-backed financings, as demonstrated by its significant business activities with parties other than B. Therefore, A does not meet the condition in ASC 810-10-15-17(d)(4), and B should apply the business scope exception if none of the other conditions in ASC 810-10-15-17(d) are met.

Example 3-33

Entity A owns 10 office buildings and 10 parking garages. It leases each of these buildings and parking garages to a different enterprise that is either partially or wholly owned by the same parent, Enterprise X. Entity A meets the definition of a business in ASC 805. Further, A’s governing documents do not restrict it from entering into lease contracts with parties other than X and its related-party group, nor was A designed solely to lease its properties to X. However, even though A’s governing documents allow it to enter into lease contracts with parties other than X and its related-party group, the actual activities of A involve leasing the office buildings and parking garages to a single related-party group. The individual lease contracts should therefore be viewed as a single-lessee leasing arrangement. Consequently, X cannot apply the business scope exception to A because the condition in ASC 810-10-15-17(d)(4) is met.

Footnotes

The requirement that all the conditions must be met is consistent with the views expressed by SEC Professional Accounting Fellow Chris Rogers at the 2014 AICPA Conference on Current SEC and PCAOB Developments. Deloitte’s Roadmap Equity Method Investments and Joint Ventures provides more information.

3.5 Private-Company Alternative

ASC 810-10

15-17AD A legal entity need not be evaluated by a private company (reporting entity) under the guidance in the Variable Interest Entities Subsections if all of the following criteria are met:

The reporting entity and the legal entity are under common control.
The reporting entity and the legal entity are not under common control of a public business entity.
The legal entity under common control is not a public business entity.
The reporting entity does not directly or indirectly have a controlling financial interest in the legal entity when considering the General Subsections of this Topic. The Variable Interest Entities Subsections shall not be applied when making this determination.

Applying this accounting alternative is an accounting policy election. If a private company elects to apply this accounting alternative, it shall apply this alternative to all legal entities if criteria (a) through (d) are met. A reporting entity that elects the accounting alternative and, thus, does not apply the guidance in the Variable Interest Entities Subsections shall continue to apply other accounting guidance (including guidance in the General Subsections of this Subtopic) unless another scope exception from this Topic applies. A reporting entity applying this alternative shall disclose the required information specified in paragraphs 810-10-50-2AG through 50-2AI unless the legal entity is consolidated by the reporting entity through accounting guidance other than VIE guidance.

15-17AE To determine whether the private company (reporting entity) and the legal entity are under common control of a parent solely for the purpose of applying paragraph 810-10-15-17AD(a), the private company shall consider only the parent’s direct and indirect voting interest in the private company and the legal entity. In other words, only the guidance in the General Subsections of this Topic shall be considered for determining whether a parent has a direct or indirect controlling financial interest in the private company and the legal entity as required in paragraph 810-10-15-17AD(a). The guidance in the Variable Interest Entities Subsections of this Topic shall not be applied for making this determination. See paragraphs 810-10-55-205AU through 55-205AZ for illustrative guidance.

15-17AF If any of the criteria in paragraph 810-10-15-17AD for applying the accounting alternative cease to be met, a private company shall apply the guidance in the Variable Interest Entities Subsections at the date of change on a prospective basis, except for situations in which a reporting entity becomes a public business entity. When a reporting entity becomes a public business entity, it shall apply the guidance in the Variable Interest Entities Subsections in accordance with Topic 250 on accounting changes and error corrections.

A reporting entity that is a private company can elect, as an accounting alternative, to not apply the VIE guidance to legal entities under common control as long as the reporting entity, the common-control parent, and the legal entity being evaluated for consolidation are not public business entities and meet the criteria in ASC 810-10-15-17AD. ASC 810-10-15-17AD allows a private company (reporting entity) not to apply the VIE model if:

“The reporting entity and the legal entity are under common control.”
“The reporting entity and the legal entity are not under common control of a public business entity.”
“The legal entity under common control is not a public business entity.”
“The reporting entity does not directly or indirectly have a controlling financial interest in the legal entity when considering the General Subsections of this Topic [ASC 810]. The Variable Interest Entities Subsections shall not be applied when making this determination.”

ASC 810-10-15-17AE provides guidance on applying the first criterion above, which requires a determination that the reporting entity and the legal entity are under common control. Specifically, ASC 810-10-15-17AE states that solely in the application of the first criterion, a private-company reporting entity should consider only the voting interest entity model when making this determination. That is, a private-company reporting entity should not consider the VIE guidance when determining whether the first criterion of ASC 810-10-15-17AD is met.

The example below illustrates the application of ASC 810-10-15-17AD.

Example 3-34

Parent has a 100 percent direct voting interest in Entity A (the reporting entity) and a 70 percent direct voting interest in Entity B. Entity A has a 30 percent direct voting interest in B and a 60 percent direct voting interest in C. Third-Party Investor has a 40 percent direct voting interest in C.

The respective voting interest of Parent, A, and Third-Party Investor are summarized in the diagram below.

Further assume the following:

None of the entities are public business entities; therefore, criteria (b) and (c) in ASC 810-10-15-17AD are met.
There are no contractual arrangements through which a third party controls B or C.
Third-Party Investor does not have substantive participating rights in C.

Parent has a controlling financial interest in A, B, and C through its direct and indirect voting interests. Therefore, A, B, and C are under common control with respect to criterion (a) in ASC 810-10-15-17AD.

Entity A can apply the private-company scope exception of ASC 810-10-15-17AD to B because A does not directly or indirectly have a controlling financial interest in B and therefore also meets criterion (d). However, A cannot apply the scope exception to C because A has a controlling financial interest in C and therefore does not meet criterion (d).

The private-company scope exception is considered an accounting policy that, if elected, should be applied consistently to all legal entities that qualify for it. Because the scope exception is limited to the VIE guidance, private-company reporting entities will continue to be required to evaluate the consolidation guidance under the voting interest entity model to determine whether they have a controlling financial interest. Such entities that apply the scope exception but do not have a controlling financial interest under the voting interest entity model will be required to provide enhanced disclosures (see ASC 810-10-50-2AG through 50-2AI) that are similar to those required of entities that apply the VIE guidance. See Section 11.2.4.3 for a discussion of the required disclosures.

Connecting the Dots

Common-Control Considerations

As noted above, a reporting entity is permitted to apply the private-company scope exception only if the reporting entity and legal entity are under common control on the basis of a common-control parent’s voting interest. In the illustration below, we would not expect Subsidiary A (the reporting entity) to be eligible to apply the private-company scope exception because Parent is the primary beneficiary of Subsidiary A through a contractual arrangement and does not hold any voting interest in Subsidiary A. Therefore, Subsidiary A (the reporting entity) and Subsidiary B (the legal entity) are not under common control of Parent solely on the basis of voting interest.

Applicability of the Private-Company Scope Exception to Parent-Subsidiary Relationships

In paragraph BC69 of ASU 2015-02, the FASB explains that in accordance with the VIE model, entities under common control include “subsidiaries controlled (directly or indirectly) by a common parent, or a subsidiary and its parent.”

Although paragraph BC69 of ASU 2015-02 highlights that a parent and its subsidiary are entities under common control, we do not believe that the private-company scope exception can be applied to parent-subsidiary common-control relationships when the parent is the reporting entity. To be under common control for the application of criterion (a) in ASC 810-10-15-17AD, a parent must have a controlling financial interest through its voting interest in both the reporting entity and the legal entity. If the parent is also the reporting entity, criterion (d) in ASC 810-10-15-17AD is not met because the reporting entity (in this case, the parent) has a controlling financial interest in the legal entity through its voting interest.

Effective Date and Transition

In March 2016, the FASB issued ASU 2016-03, which gives private companies a one-time unconditional option to forgo a preferability assessment the first time they elect a private-company accounting alternative within the ASU’s scope. ASU 2016-03 contains no effective date or transition guidance, eliminates the effective dates of private-company accounting alternatives that are within the ASU’s scope, and extends the transition guidance for such alternatives indefinitely.

In October 2018, the FASB issued ASU 2018-17, which, in part, expands the private-company accounting alternative to the VIE guidance for entities under common control. ASU 2018-17 includes an effective date and transition guidance for applying the new private-company scope exception and other guidance in the ASU. During deliberations of the ASU, the FASB discussed whether the effective date and transition guidance in ASU 2018-17 should be aligned with ASU 2016-03; however, the Board decided that such alignment would be burdensome for reporting entities that currently apply the existing accounting alternative under ASC 810 because they would have to apply the new private-company scope exception immediately to maintain their existing accounting presentation and, consequently, apply the exception to all other legal entities that are eligible for it at that time. Accordingly, the December 15, 2020, effective date of ASU 2018-17 for private companies is intended to give those companies sufficient time to decide whether they want to elect the new private-company scope exception. However, a reporting entity will be required to perform a preferability assessment in accordance with ASC 250 if it elects the exception after the effective date of ASU 2018-17 and the election represents a change in accounting policy.