8.3 Related-Party Considerations Under the VIE Model
As discussed throughout this Roadmap, interests held by a reporting entity’s
related parties or de facto agents could have a significant effect on the reporting entity’s
consolidation conclusions. The table below summarizes, and provides references to expanded
discussions about, the effect of related parties and de facto agents on the VIE analysis.
Table 8-1 Effect of
Related Parties and De Facto Agents on VIE Analysis
Evaluation Under the Consolidation Analysis | Which Interests Held by Reporting Entity’s Related Parties Should Be
Considered? | Which Interests Held by Reporting Entity’s De Facto Agents Should Be
Considered? |
|---|---|---|
Applicability of “business scope exception”
(see Section 8.3.1) | All | All, except for interest held by de facto agents because of “transfer
restrictions” |
Determining whether the reporting entity holds a variable interest for
arrangements other than decision-maker or
service-provider arrangements (see Section 8.3.2) | All | All |
Determining whether a decision maker or service provider holds a variable interest (see Section 8.3.3) | Any indirect interest through the related party (except most employees and
employee benefit plans) | Any indirect interest through the de facto agent (other than employees) |
Determining whether an entity is a VIE — analyzing kick-out and participating rights for a legal entity other than a
limited partnership or similar entity (see Section 8.3.4) | All | All |
Determining whether an entity is a VIE — analyzing kick-out rights and participating rights for a limited partnership or similar entity (see Section 8.3.5) | Entities under common control with the general partner or other parties acting on behalf of the general partner | Parties acting on behalf of the general partner |
Determining whether an entity is a VIE — substantially all of the activities involve or are conducted on behalf of a reporting entity and its related parties
(see Section 8.3.6) | All | All, except for interest held by de facto agents because of “transfer
restrictions” |
Identifying a VIE’s primary beneficiary
(see Section
8.3.7) | All | All |
8.3.1 Business Scope Exception
The “business scope exception” exempts reporting entities from evaluating whether a legal entity that qualifies as a business under ASC 805 is a VIE unless one or more conditions apply (see Section 3.4.4). In evaluating whether an entity that is a business meets any of the conditions that would preclude it from qualifying for the business scope exception, the reporting entity must consider interests held by its related parties, including those held by de facto agents, other than de facto agency relationships created by transfer restrictions as described in Section 8.2.3.4. Under the business scope exception guidance in FIN 46(R), any transfer restriction resulted in the identification of a de facto agent. The FASB therefore decided to exclude transfer restriction de facto agents from the analysis of the business scope exception in FIN 46(R) because investors in joint ventures under joint control otherwise would have not been able to qualify for this exception. Although the definition of a de facto agent created by transfer restrictions has changed since issuance of FIN 46(R), this exclusion has not.
8.3.2 Determining Whether the Reporting Entity Holds a Variable Interest for Arrangements Other Than Decision-Maker or Service-Provider Arrangements
A reporting entity that does not hold a variable interest directly in a VIE
should generally not consider variable interests held by its related parties as its own
(other than decision-maker fees or service-provider fees as discussed in Section 8.3.3). However, it may not always be apparent
whether a reporting entity holds a variable interest in a legal entity, because the
reporting entity may not have a direct contractual interest in the VIE (i.e., the
reporting entity may be implicitly or indirectly exposed to the VIE through its related
party). A reporting entity should carefully scrutinize all arrangements (whether explicit
or implicit) between related parties to determine whether an implicit variable interest
exists when (1) the reporting entity’s related parties have entered into transactions on
behalf of the reporting entity and (2) the reporting entity otherwise would have
consolidated the VIE if it was determined that the reporting entity had a direct or
explicit variable interest in the VIE. (For more information about implicit variable
interests, see Section
4.3.10.)
Example 8-11
Companies A and B formed a VIE with the issuance of an equity instrument to A and a debt instrument to B. Company C, a related party of A, provided a loan to A to purchase its interest, but C does not have an interest directly in the VIE and does not limit A’s exposure to expected losses or expected residual returns. In preparing its financial statements, C generally does not have to consider whether it would need to consolidate the VIE because it does not hold a direct variable interest in that entity. However, C holds a variable interest in A as a result of its related-party loan, and it may need to consider whether A is a VIE. Further, regardless of whether A is considered a VIE, if the terms of the loan are such that A is acting as an agent for C (e.g., a nonrecourse participating loan for which C essentially is receiving all the risks and rewards of A’s interest in the VIE), C may be deemed to have an implicit variable interest in the VIE.
8.3.3 Determining Whether the Reporting Entity Holds a Variable Interest (Decision-Maker and Service-Provider Fees)
As discussed in Section
4.4.2.3, a reporting entity that is a decision maker or service provider
must, among other things, analyze other interests held by certain related parties and de
facto agents. Understanding the impact that related parties and de facto agents have on
this determination can be challenging because of the nature of items that are included in,
or excluded from, the assessment. The table below summarizes how interests held by related
parties should be considered in the assessment of a reporting entity’s exposure to
expected losses or expected residual returns through its other interests under ASC
810-10-55-37(c).
Table
8-2 Consideration of Interests Held by Related Parties
|
Decision Maker’s Interests
|
Related Parties’ Interests (Including Entities Under Common
Control)
|
|---|---|
|
Always include the direct interests
held by the decision maker in its evaluation.
|
Include the decision maker’s indirect interest through its related parties and de facto agents on a
proportionate basis. That is, the decision maker is required to have a variable interest in the related party.
However, if the interest is provided to the related party to circumvent the
consolidation guidance, it must be included with any indirect interests held
by the decision maker (see Section
4.4.2.3.2).
The FASB specifically excluded employees and employee
benefit plans of the decision maker unless the employee or employee benefit
plan is being used to circumvent the VIE model (see Sections 4.4.2.3.5 and 4.4.2.3.6 for more
information about the impact of employees and employee benefit plans).
|
8.3.4 Determining Whether a Legal Entity Is a VIE — Analyzing Kick-Out and Participating Rights for a Legal Entity Other Than a Limited Partnership or Similar Entity
In the evaluation of whether the equity group at risk has the power to direct the activities that most significantly affect the legal entity’s economic performance, ASC 810 distinguishes between entities that are limited partnerships (and similar entities) and all other entities. The FASB created this dual approach because the general partner of a limited partnership typically has the unilateral ability to direct a limited partnership’s most significant activities.
A legal entity other than a limited partnership is a VIE unless the equity group at risk (the equity investors) holds voting rights or similar rights that enable the group to direct the activities that most significantly affect the legal entity’s economic performance. In some situations, the right to direct these activities may be held by a party that is not considered part of the equity group; however, the equity group may have the ability to participate in these decisions or remove the decision maker.
In the evaluation of whether kick-out rights or participating rights held by the equity group at risk give the equity holders the power to direct the activities that most significantly affect the legal entity’s economic performance, these rights would only be considered if they can be exercised by a single equity holder, including the equity holder’s related parties and de facto agents. Rights held by multiple unrelated parties would be ignored. In addition, rights that give another party outside the equity investment at risk the ability to remove such power from the equity group would only be considered in the analysis if they can be exercised by a single interest holder, including the interest holder’s related parties and de facto agents. For example, if a single debt holder of a legal entity is able to participate in the most significant decisions of the entity, the legal entity would be considered a VIE. However, if two unrelated debt investors together held this right, the entity would not be a VIE.
See Section 5.3.1.1.3.4 for further discussion.
8.3.5 Determining Whether an Entity Is a VIE — Analyzing Kick-Out and Participating Rights for a Limited Partnership or Similar Entity
The evaluation of whether the equity group at risk has the power to direct the activities that most significantly affect the economic performance of a limited partnership (or similar entity) focuses on the rights of the limited partners. A limited partnership is a VIE unless (1) a simple majority or lower threshold of the limited partners with equity at risk can kick out the general partner or (2) the limited partners with equity at risk have substantive participating rights.
In the evaluation of kick-out rights held by the limited partners, any rights held by entities under common control of the general partner or other parties acting on behalf of the general partner are excluded from the evaluation. Accordingly, if a related party that is considered to be acting on behalf of the general partner is able to participate in the exercise of the kick-out rights, the limited partners may not meet the simple majority threshold, and the legal entity would therefore be a VIE. Note that this evaluation does not focus on related parties or de facto agents of the general partner but rather on those parties “acting on behalf of the general partner.” In the determination of whether participating rights are substantive, ASC 810-10-25-13(c) requires the consideration of related-party relationships as defined in ASC 850.
See Section 5.3.1.2.2 for further discussion.
8.3.6 Determining Whether an Entity Is a VIE — Substantially All of the Activities Involve or Are Conducted on Behalf of a Reporting Entity and Its Related Parties
A legal entity is a VIE if (1) it has an investor that has disproportionately few voting rights relative to that investor’s economic exposure to the legal entity and (2) substantially all of the activities of the legal entity either involve or are conducted on behalf of the investor (including that investor’s related parties and some de facto agents) with disproportionately few voting rights (see Section 5.4.2 for more information). All related entities under ASC 850, and all but one de facto agency relationship, must be included in the assessment of whether the “substantially all” criterion (criterion (2) above) is met. Only de facto agency relationships created by transfer restrictions as described in Section 8.2.3.4 should be excluded in the performance of this assessment.
8.3.7 Identifying a VIE’s Primary Beneficiary
As discussed in Section
7.3.5, interests of related parties must be considered in the evaluation of
whether a single decision maker possesses the economics criterion (i.e., the second
characteristic of a controlling financial interest) if the reporting entity has an
interest in the related party. The table below indicates when such interests should be
included in the evaluation.
Table 8-3 Inclusion
of Related-Party Interests in the Economics-Criterion Evaluation
Decision Maker’s Interests | Entities Under Common Control | Other Related Parties |
|---|---|---|
Always include the direct interests held by the decision maker in its evaluation. | Include the related party’s proportionate interest (see Section 7.3.5.1 for additional information) if the decision maker has a variable interest in the related party under common control (see Section 8.2.2 for definition of common control). In other words, any interests held by related parties under common control would be ignored in the individual assessment of the economics criterion if the decision maker does not have a variable interest in the related party. | Include the decision maker’s indirect exposure through its related parties and de facto agents (including employees and benefit plans) if the decision maker has a variable interest in the related party. In other words, any interests held by related parties and de facto agents would be ignored in the individual assessment of the economics criterion if the decision maker does not have a variable interest in the related party. |
If neither the reporting entity nor its related parties (including de facto agents) individually possess the characteristics of a primary beneficiary on their own, the reporting entity must consider all related parties and
de facto agents (even if the reporting entity does not have a variable interest in the related party or de facto agent) in analyzing whether one of the parties should consolidate under ASC 810-10-25-44 through 25-44B. See Section 7.4.2 for more information.