Chapter 8 — Related-Party Considerations
Chapter 8 — Related-Party Considerations
8.1 Introduction
The effect of interests held by related
parties requires careful consideration
when applying the VIE consolidation requirements since
such interests may be used to achieve a desired
consolidation conclusion for VIEs. The VIE model
includes specific considerations regarding related
parties, including identification of de facto agents
(additional entities that are considered related
parties in a VIE consolidation analysis) and how
interests held by the reporting entity’s related parties
affect the consolidation analysis. The VIE model
further distinguishes between the treatment of
interests held by related parties under common control,
related parties that are not under common control,
and de facto agents.
Related-party considerations are pervasive in the consolidation analysis, and
they are applied differently in each of its steps. Accordingly, related-party
implications are discussed throughout this Roadmap. In this chapter, the
identification of related parties and de facto agents is addressed in Section 8.2, and a high-level
summary of how related parties should be considered in each step of the
consolidation analysis is presented in Section 8.3.
8.2 Identifying Related Parties and De Facto Agents
ASC 810-10
25-43 For purposes of applying the guidance in the Variable Interest Entities Subsections, unless otherwise specified, the term related parties includes those parties identified in Topic 850 and certain other parties that are acting as de facto agents or de facto principals of the variable interest holder. All of the following are considered to be de facto agents of a reporting entity:
- A party that cannot finance its operations without subordinated financial support from the reporting entity, for example, another VIE of which the reporting entity is the primary beneficiary
- A party that received its interests as a contribution or a loan from the reporting entity
- An officer, employee, or member of the governing board of the reporting entity
- A party that has an agreement that it cannot sell, transfer, or encumber its interests in the VIE without the prior approval of the reporting entity. The right of prior approval creates a de facto agency relationship only if that right could constrain the other party’s ability to manage the economic risks or realize the economic rewards from its interests in a VIE through the sale, transfer, or encumbrance of those interests. However, a de facto agency relationship does not exist if both the reporting entity and the party have right of prior approval and the rights are based on mutually agreed terms by willing, independent parties.
- Subparagraph superseded by Accounting Standards Update No. 2009-17
- Subparagraph superseded by Accounting Standards Update No. 2009-17
- A party that has a close business relationship like the relationship between a professional service provider and one of its significant clients.
ASC 850-10-20 defines the term “related parties” as follows:
Related parties include:
- Affiliates of the entity
- Entities for which investments in their equity securities would be required, absent the election of the fair value option under the Fair Value Option Subsection of Section 825-10-15, to be accounted for by the equity method by the investing entity
- Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management
- Principal owners of the entity and members of their immediate families
- Management of the entity and members of their immediate families
- Other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests
- Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.
8.2.1 Identifying Related Parties
The VIE subsections of ASC 810-10 define related parties as those identified in
ASC 850 and certain other parties that are acting
in a de facto agency capacity with the variable interest
holder. However, identifying which parties meet
the definition of a related party of the reporting
entity under ASC 850 will often require judgment,
especially in complex structures.
Example 8-1
Subsidiary A and Equity Method Investee (EMI) 1 form a joint venture that is a
VIE. When identifying its related parties as part
of its consolidation analysis, A would consider
EMI 1 a related party. Specifically, in accordance
with ASC 810-10-25-1, Investor has a controlling
financial interest in A; therefore, A is part of
the consolidated group. Correspondingly, in
accordance with ASC 323-10-15-6, this same
consolidated group (through the interests held by
Investor) has significant influence over the
operating and financial policies of EMI 1.
Accordingly, the consolidated group can exert
significant influence over EMI 1 to the extent
that in a transaction between A and EMI 1,
Investor (or the consolidated group) might prevent
EMI 1 from fully pursuing its own separate
interests and meets the definition of a related
party in ASC 850. Therefore, A and EMI 1 are
considered related parties in the assessment of
which party should consolidate the joint
venture.
Example 8-2
Equity Method Investees (EMIs) 1 and 2 form a joint venture that is a VIE. The joint venture was created with at-market terms, and there are no other transactions between EMI 1 and EMI 2. Investor has significant influence over the operating and financial policies of both EMIs 1 and 2. However, assume that both EMI 1 and EMI 2 have a typical corporate governance structure in which Investor is not able to unilaterally make decisions for the investees or influence the decision to form the VIE in a manner that prevents each party from fully pursuing its own interests. Therefore, unless there are other arrangements between EMIs 1 and 2, the related-party relationship is between Investor and the two EMIs, and not between EMI 1 and EMI 2. Accordingly, on the basis of these facts and circumstances, EMI 1 and EMI 2 would not be related parties.
8.2.2 Related Parties Under Common Control
In certain parts of the VIE consolidation analysis, the effects of interests
held by the reporting entity’s related parties will depend on whether the
related party is “under common control.” Therefore, the determination of whether
a related party is under common control could significantly affect the
consolidation conclusion.
The Codification does not specifically define common control. However, in paragraph BC69 of ASU 2015-02, the FASB explains that under the VIE model, and specifically in the application of ASC 810-10-25-42, ASC 810-10-25-44A, and ASC 810-10-55-37D, entities under common control would include “subsidiaries controlled (directly or indirectly) by a common parent, or a subsidiary and its parent.”
Example 8-3
Company R has a wholly owned, consolidated asset management subsidiary, Subsidiary A. Subsidiary A is the 1 percent general partner of the Fund. Subsidiary A’s general partner interest gives A decision-making rights over the Fund, and in exchange for performing its services, A is entitled to receive a base management fee and a performance-based fee (or carried interest) equal to 20 percent of all returns in excess of a specified threshold. These fees are considered “commensurate” and “at market” (see Section 4.4.1). Company R also has a 1 percent general partner interest in Co-Investment Fund E. Company R has the power through its general partner interest to direct all the significant activities of E and cannot be removed without cause. However, R does not have an obligation to absorb losses of E or a right to receive benefits from E that could potentially be significant to E. Therefore, R does not consolidate E. Because R does not consolidate E, a parent-subsidiary relationship does not exist between R and E, and thus E and A are not considered related parties under common control.
The parent in a parent-subsidiary relationship does not need to be a separate
legal entity. That is, an individual
that possesses a controlling financial
interest may be identified as a parent.
The ASC master glossary defines “parent,” in part,
as “[a]n entity that has a
controlling financial interest in one or more
subsidiaries” (emphasis added).
On the basis of the above description of common control, common ownership does not represent common control. That is, in some instances, two or more reporting entities may have a high degree of common ownership, which would typically result in a conclusion that the reporting entities are not under common control.
Example 8-4
Two unrelated individuals (that have not agreed to vote in concert) each own 50 percent of both Entity A and Entity B, but neither has a controlling financial interest in either A or B. In this case, A and B would be considered related parties with common ownership, but not under common control.
8.2.3 Identifying De Facto Agents
The VIE model expands the population of other entities whose interests are
considered by the reporting entity in its VIE
analysis to include interests of parties that are
acting in a de facto agency relationship with the
reporting entity. The FASB identified certain
relationships that may indicate that one party
(the “de facto agent”) may be acting on behalf of
another (the “de facto principal”). However,
regardless of whether a reporting entity is
identified as a de facto agent or a de facto
principal, the reporting entity must consider the
impact of the related-party relationship
throughout the VIE model.
The following sections discuss the de facto agents identified by the FASB in ASC
810-10-25-43:
-
“A party that cannot finance its operations without subordinated financial support from the reporting entity, for example, another VIE of which the reporting entity is the primary beneficiary” — Section 8.2.3.1.
-
“A party that received its interests as a contribution or a loan from the reporting entity” — Section 8.2.3.2.
-
“An officer, employee, or member of the governing board of the reporting entity” — Section 8.2.3.3.
-
“A party that has an agreement that it cannot sell, transfer, or encumber its interests in the VIE without the prior approval of the reporting entity [that prevents the other party from managing the economics of its interest]. However, a de facto agency relationship does not exist if both the reporting entity and the party have [rights] of prior approval and the rights are based on mutually agreed terms by willing, independent parties” — Section 8.2.3.4.
-
“A party that has a close business relationship like the relationship between a professional service provider and one of its significant clients” — Section 8.2.3.5.
8.2.3.1 Subordinated Financial Support Received From the Reporting Entity
A de facto agency relationship exists if the other party is financially dependent on the reporting entity or a legal entity consolidated by the reporting entity. Identifying such a de facto agency relationship is typically straightforward.
8.2.3.2 Interests Received as a Loan or Contribution
A de facto agency relationship is generally created when another party receives its interest in the VIE as a contribution or a loan from the reporting entity, even if the loan or contribution only covers a portion of the interest. While this de facto agency is intended to prevent a reporting entity from avoiding consolidation of a VIE by structuring transactions so that another party holds a variable interest in the VIE that the reporting entity is exposed to through the loan, it is not simply an anti-abuse provision. That is, it is on the FASB’s list of de facto agencies; thus, if the de facto agency criteria are met, the parties are generally considered related.
We have historically viewed fixed-price put options to be the economic
equivalent of a loan (see Table
5-1 in Section 5.2.2.4.1). That view was
premised on the fact that a nonrecourse loan and a
purchased put option give an investor similar
down-side protections. While we appreciate that
some may continue to hold that view, our
perspective on the issue has evolved. Although
purchased put options and nonrecourse loans
provide similar down-side protections, substantive
differences between them exist related to form and
substance. Notably, a loan provides capital to the
investor to make an investment, whereas the
purchased put option does not provide any capital
to the option’s holder up front. That is, a lender
provides capital to the borrower when the lender
extends a loan; an option’s writer does not extend
financing to the buyer of the put option up front.
On the basis of that distinction, we have updated
our interpretation related to this matter and
believe a purchased put option should be
considered analogous to a loan guarantee. The
down-side protection provided by the put option is
economically equivalent to a guarantee of the
financing deployed to invest in the entity.
However, not all interests received as a loan will result in a de facto agency relationship. In very limited situations, two reporting entities need not consider themselves related parties when one of the reporting entities has received its interest as a loan from the other reporting entity. This exception would be limited to scenarios in which the party providing the loan to another party involved with the potential VIE is in the business of extending credit in the normal course of its business. In addition to this requirement, the following factors (not all-inclusive) may indicate that the existence of a loan between two variable interest holders does not create a related-party relationship under ASC 810-10-25-43:
- The creditor does not control and is not able to significantly influence the debtor.
- The debtor receives the full benefits and obligations associated with its financed interest. The debtor’s rights associated with its interest are not affected by the fact that the financing was provided by another variable interest holder.
- The debtor was not required to obtain its financing from the creditor. That is, the debtor has the right to obtain its interest in whatever way it chooses (i.e., paying cash or financing the interest with any party it chooses).
- The loan is originated in the normal course of business as an arm’s-length commercial transaction. A reporting entity must consider whether the loan was provided at market rates in a manner similar to its consideration of rates provided for comparable transactions.
- The lender has full recourse to the debtor’s assets, the debtor’s ability to repay the loan does not depend on the performance of the interest lent, and the creditor is able to pursue any remedy available by law.
- The creditor has the right to sell, pledge, or hold the loan.
- The debtor has the right to sell or hold the financed interest. Restrictions placed on the financed interest should be considered in a manner similar to the analysis required by ASC 810-10-25-43(d).
Example 8-5
Company A and Company B establish VIE X, each contributing 50 percent of the equity. Company B has a commercial lending subsidiary that provides credit for various business transactions in the normal course of business. Company A, to finance its equity contribution to VIE X, was approved to borrow an equal amount of funds from B’s lending subsidiary. The loan was originated in a manner similar to all other commercial loans of B, A was not required to obtain the funds from B, B has full recourse to all of A’s assets, and there are no restrictions in the lending arrangement on A’s ability to sell or hold its interest in VIE X. On the basis of these facts and circumstances, although A happened to obtain the funds necessary for its investment in VIE X from B’s lending subsidiary, the parties may conclude that a de facto agency relationship does not exist.
Example 8-6
Assume the same facts as in the example above, except that Company B does not
make commercial loans in the normal course of its
business. Instead, in the formation of VIE X, A
and B agreed that A would borrow funds necessary
to make its equity investment from B. On the basis
of these facts and circumstances (primarily, that
B is not in the business of making similar loans),
a de facto agency relationship exists. Said
differently, the lending arrangement was a primary
part of the design and purpose of the formation of
X.
8.2.3.3 Officer, Employee, or Member of the Governing Board of the Reporting Entity
A de facto agency relationship will also exist if the other party is an officer, employee, or member of the governing board of the reporting entity. Identifying this de facto agency relationship is typically straightforward.
8.2.3.4 Transfer Restrictions
A de facto agency relationship can be created contractually on the basis of the
terms of an arrangement. For example, ASC
810-10-25-43(d) states that a de facto agency
relationship is present when a party has entered
into an agreement under which it “cannot sell,
transfer, or encumber its interests in the VIE
without the prior approval of the reporting
entity.” However, a de facto agency relationship
exists only if having to obtain such approval
constrains the other party’s ability to manage
substantially all of its economic interest in the
VIE. Whether restricting sales or transfers
constrains another party depends on the facts and
circumstances. Factors to consider in determining
whether a restriction constitutes a constraint may
include, but are not limited to, the following:
-
Generally, in the determination of whether a restriction on sales or transfers constrains another party, a phrase in a contractual agreement such as “without prior approval, which cannot be unreasonably withheld” indicates that a variable interest holder is not constrained from managing the economic risks or realizing the economic rewards of its interest. In other circumstances, a phrase such as this may not be an indicator that the variable interest holder is not constrained. Conversely, a de facto agency relationship is presumed if such language is absent from a contractual agreement or if the agreement only cites narrow specific circumstances that would not typically be encountered under which approval cannot be unreasonably withheld. We believe that this interpretation specifically addresses sales and transfers and should generally not be applied to the evaluation of whether the rights held by a noncontrolling shareholder are substantive participating rights. For a discussion of the effect of such contractual language on the evaluation of whether a noncontrolling interest holder has substantive participating rights, see Section D.2.3.1.
-
If a party has the ability to realize the economic benefits of its interest by selling that interest without the reporting entity’s prior approval, the party would not be constrained even if the reporting entity’s approval is required for all other transfers or encumbrances of that interest.
-
If the right of prior approval is designed solely to prevent transfer of the interest to a competitor or to a less creditworthy, or otherwise less qualified, holder, and such parties are not the only potential purchasers of that interest, the party would not be constrained.
-
A party is constrained if it cannot sell, transfer, or encumber its interest but can manage the risk of owning the interest by hedging that risk.
-
A right of first refusal (a requirement that gives the holder of the right the ability to match an offer) or a right of first offer (a requirement that the interest holder must first offer to sell its interest to the holder of the right prior to selling it to a third party) generally does not create a de facto agency relationship. This is because these rights would not constrain the variable interest holder from managing its economic interest in the entity.
-
A restriction that precludes a variable interest holder from selling, transferring, or pledging its interest for a period of time would create a de facto agent relationship during that period. However, once the restriction expires, the party would no longer be considered a de facto agent, and the reporting entity would need to reevaluate its consolidation conclusion.
In addition, as indicated in ASC 810-10-25-43(d), “a de facto agency relationship does not exist if both the reporting entity and the party have right of prior approval and the rights are based on mutually agreed terms by willing, independent parties.” For example, in a typical joint venture structure, transfer restrictions are often imposed on all the venturers to maintain the structure of the joint venture. Since these transfer restrictions “are based on mutually agreed terms by willing, independent parties,” the venturers may not be de facto agents.
Example 8-7
Company X has a $1 million interest in VIE 1. Company Y, another interest holder in VIE 1, must approve all sales and transfers of X’s interest. Company X does not have a similar right of prior approval for sales and transfers of Y’s interest in VIE 1. Company X otherwise may encumber its interest in VIE 1 without the approval of Y; however, financial institutions will only lend X up to $300,000 if X uses its $1 million interest as collateral. Thus, X is able to manage only a portion of its risk by encumbering its interest. Because X cannot realize, by encumbrance, all or most of the cash inflows that are the primary economic benefits of its interest, X is constrained and is deemed to have a de facto agency relationship with Y.
Example 8-8
Assume the same facts as in the example above. In addition, Company X enters
into a total return swap with an unrelated third
party, Banker 1, to economically hedge its
variable interest. Under the total return swap, X
will receive cash equal to substantially all of
the benefits encompassed in its variable interest
during the term of the swap. Under the terms of
the swap, X is not acting as an agent for Banker
1. Although X has managed its risk of ownership in
VIE 1, X is constrained (because a total return
swap is not a sale, transfer, or encumbrance) and
is deemed to have a de facto agency relationship
with Y.
Example 8-9
Assume the same facts as in Example 8-7,
except that VIE 1 is a franchise (that does not
meet the business scope exception in ASC
810-10-15-17(d)), and the franchise agreement
stipulates that the franchisor must approve any
prospective purchases of the franchisee’s interest
that are to competitors, less creditworthy
purchasers, or purchasers that do not intend to
maintain the franchise at the existing level of
quality. There are several other potential
purchasers that would qualify. The franchisee is
not considered constrained under ASC
810-10-25-43(d) because it can still manage its
economic interest in VIE 1 through sale and
transfer (i.e., the restriction is only on the
sale to a nonqualified investor and there are
other qualified investors who could purchase the
interest).
Example 8-10
Two parties enter into a joint venture for 20 years. The entity does not meet the business scope exception in ASC 810-10-15-17(d) and is determined to be a VIE. The joint venture partners have entered into a five-year lock-up agreement whereby neither party is permitted to sell, transfer, or encumber its interest in the joint venture without the written consent of the other party. Since the two parties both have the right of prior approval, have mutually agreed on the prior approval terms, and are willing, independent parties, the two parties are not considered related parties (i.e., de facto agents) for the term of the lock-up period.
8.2.3.4.1 Effect of a Put Option on Analyzing Transfer Restrictions
In certain situations in which transfer restrictions are contractually in place, a de facto agency relationship may not be present if the restricted party has a separate put option that effectively allows that party to manage its economics through exercise of the put option. The existence of a fair value put option that is currently exercisable for 100 percent of the interest held and with no restrictions may be sufficient to allow the reporting entity holding the put option to manage the economic risks or realize the economic rewards from its interests in a VIE. However, the reporting entity should evaluate all facts and circumstances to determine whether a put option would affect whether a de facto agency relationship exists. For example, fair value should be based on an independent valuation as of the exercise date rather than on a predetermined formula that is not updated to reflect current market conditions. Conversely, if the exercise price of the put option is fixed or at other than fair value, the de facto agency relationship cannot be overcome.
8.2.3.5 Close Business Relationship
A de facto agency relationship can also exist if the reporting entity has a close business relationship with another party. We understand that the intent of this guidance is to prevent potential structuring opportunities in which a reporting entity attempts to avoid consolidation by transferring its variable interests in a legal entity to its professional service providers. In certain situations, a reporting entity may contract with service providers and delegate power to those providers over certain activities to achieve off-balance-sheet accounting. In these cases, inclusion of these service providers as de facto agents would require the reporting entity to consider whether it should consolidate because of the combination of its direct power and economics as well as the power or economics granted to the service provider.
At the 2008 AICPA Conference on Current SEC and PCAOB Developments, an SEC staff member, Professional Accounting Fellow Robert Malhotra, discussed the close business relationship provision. Although his remarks refer specifically to FIN 46(R), the guidance on close business relationships has not changed as a result of Statement 167 and ASU 2015-02. His speech stated, in part:
In the context of paragraph 5(c) of FIN 46R, the staff has been asked whether certain close business associates may be considered related parties under Statement 57 or paragraph 16 of FIN 46R. In this context, the staff believes that close business associates may only be considered related parties if one party can control or can significantly influence the other party to an extent that one of the parties might be prevented from fully pursuing their own separate interest should that party choose to do so. That being the case, the mere past practice or future intent of close business associates to collaborate would be insufficient to conclude the parties are related. The staff believes that this is consistent with the definition of a related party included in Paragraph 24 of Statement 57. [Footnote omitted]
Therefore, reporting entities should carefully evaluate professional service
providers as potential close business
relationships to determine whether one party
controls or significantly influences the other
party such that one of the parties might be
prevented from fully pursuing its own interest.
Reporting entities should examine professional
service providers, such as attorneys, investment
bankers, and accountants, who help structure a
transaction or entity to determine whether the
purpose of the structuring was to avoid
consolidation (i.e., the service provider is
acting solely as an intermediary). Considerations
in this analysis should include but not be limited
to whether:
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The reporting entity does not appear to have a variable interest in the structured entity because the variable interest is held by the service provider.
-
The service provider lacks other significant sources of income.
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The service provider is incentivized to make decisions that align with the reporting entity.
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The service provider was significantly involved in the formation and structuring of the legal entity.
-
The cash flow streams result in “round tripping.”
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.