Introduction | DART – Deloitte Accounting Research Tool

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The Evolution Story

After more than four decades of little change, the accounting guidance on consolidation began to evolve rapidly in the early 2000s. Changes have included the creation and almost immediate amendment of the VIE model, major overhauls of the initial VIE model, and several updates to the consolidation framework for limited partnerships (or similar entities). The timeline below provides an overview of these and other key events.

The significant events are explained in the sections below, along with discussions of whether the related guidance and concepts continued to evolve, changed into new concepts, or became extinct as a result of subsequent amendments.

ARB 51 (Survived and Evolved Into the Voting Interest Entity Model)

ARB 51 (issued in 1959) established a presumption that consolidated financial statements are more meaningful than separate statements when a reporting entity directly or indirectly has a controlling financial interest in another legal entity. The ARB 51 model, later codified in ASC 810 and referred to in this Roadmap as the voting interest entity model, has survived with some modifications over the years. Under the evolved model, control is presumed by the holder of a majority voting interest unless noncontrolling shareholders have substantive participating rights. For companies with simple capital structures or in which voting interests are held through a legal entity’s equity, the model results in a meaningful consolidation conclusion. However, the model’s survival has been threatened by external factors and the development of more complicated capital structures over the last half century. Although the model has thus far survived, the standard setters have continued to amend it over the years, and in January 2003, they developed the VIE model to address these concerns.

SOP 78-9 (Extinct)

SOP 78-9 required general partners of limited partnerships to consolidate the limited partnership unless the limited partners had “important rights” such as the right to replace the general partner or partners, approve the sale or refinancing of principal assets, or approve the acquisition of principal partnership assets. Since there was very little authoritative guidance on assessing whether a limited partner’s rights were “important rights,” views varied about what constituted such rights. The guidance was eventually clarified but later rescinded in EITF 04-5, as discussed below.

Statement 94 (Survived)

Among other changes, Statement 94 eliminated the “non-homogeneity” exception in ARB 51 that was used by companies as a reason to not consolidate majority owned (or wholly owned) subsidiaries on the basis that the subsidiary’s character was different from that of the parent. Subsidiaries most commonly not consolidated on this basis included finance, insurance, real estate, and leasing subsidiaries of manufacturing and merchandising enterprises. Since the issuance of Statement 94, a subsidiary must be consolidated, regardless of whether the subsidiary’s and parent’s operations are homogenous.

Special-Purpose Entities — Various EITF Issues (Extinct)

From 1989 to 1996, in reaction to various structures designed to achieve off-balance-sheet treatment as well as the proliferation of special-purpose entities (SPEs) and securitizations, the EITF addressed several issues related to SPEs. For example, it reached consensuses on EITF 90-15 (certain leasing transactions), EITF 95-6 (accounting by a REIT for an investment in a service corporation), EITF 96-21 (leasing transactions involving SPEs), and the SEC observer comments in Topic D-14 that addressed SPEs. Despite these targeted improvements to the consolidation guidance, transactions were frequently structured in a manner that would achieve continued off-balance-sheet treatment. As a result, and in reaction to these concerns, the FASB issued FIN 46 in 2003 (see discussion below), which superseded the consolidation provisions in these EITF issues.

EITF 96-16 (Survived and Incorporated Into the Voting Interest Entity Model)

Before the issuance of EITF 96-16, there were no criteria under the consolidation requirements for determining whether control rested with a majority voting interest if certain rights were granted to the minority shareholder. The consensus in EITF 96-16 was that the rights of a minority shareholder should overcome the presumption of consolidation by the majority owner if those rights, individually or in the aggregate, give the minority shareholder the ability to effectively participate in significant decisions that would be expected to be made in the “ordinary course of business” (referred to as substantive participating rights). The concepts in EITF 96-16 have survived the subsequent amendments to the consolidation requirements and have been codified in ASC 810’s voting interest entity model.

FIN 46 and FIN 46(R) (New Species — Evolved Several Times Since Issuance and Many Concepts Remain)

In the late 1990s and early 2000s, companies began structuring entities to separate economics from voting rights and thereby avoid consolidation under the voting interest entity model. The Enron scandal began to unfold in October 2001, and the subsequent congressional hearings in 2002 accelerated the creation of a new consolidation species — the VIE. The FASB issued FIN 46 in early 2003 after an extremely short time deliberating such a fundamental change to the consolidation landscape. One may argue that many of the complex concepts in today’s VIE model were born of the desire to quickly “fix” the gap in the consolidation framework that permitted SPEs to remain off balance sheet. For example, the VIE concept ended up applying to many more entities than the abusive SPEs it was intended to address, including many operating entities. Given these complexities, the FASB (by the end of 2003) had issued eight staff interpretations and a revised version of the new guidance (FIN 46(R)).

The VIE concept as created by FIN 46 (and subsequently amended by FIN 46(R)) requires reporting entities to identify a “controlling financial interest” on the basis of which party, if any, is exposed to a majority of the risks or rewards of the legal entity. Given the design of a VIE, an analysis of voting rights was not viewed as an effective way to determine whether a reporting entity has a controlling financial interest in that legal entity, and exposure to a majority of the risks and rewards became the proxy for identifying control for a VIE. That is, at the time, the FASB questioned whether an investor would accept a majority of the exposure to a VIE without being able to control the decisions. Frequently, a subjective and complex calculation needed to be performed of the expected losses and expected residual returns of the VIE. As a result, during the FIN 46(R) era, a reporting entity with neither stated nor implied power often ended up consolidating a VIE. In addition, in an effort to curtail perceived structuring through related parties, the FASB expanded the list of related parties that are considered in the evaluation to include “de facto agents,” which continues to be a difficult concept to apply.

EITF 04-5 (Evolution of SOP 78-9 — Extinct, but Many of Its Concepts Survived as Part of Identifying Whether a Limited Partnership Is a VIE)

Before EITF 04-5, general partners of limited partnerships (and similar entities) analogized to the guidance in SOP 78-9 to determine whether the limited partner’s rights prevented the general partner from consolidating the partnership. Although EITF 04-5 resulted in amendments to the guidance on evaluating whether a general partner should consolidate a limited partnership, the evaluation still focused on the rights held by the limited partners. Specifically, under EITF 04-5, a general partner was presumed to control a limited partnership that was not a VIE. However, if the limited partners held substantive kick-out or participating rights, this presumption could have been overcome. Although EITF 04-5 (codified in ASC 810-20) was rescinded by ASU 2015-02, the concept survived, and a general partner is now required to evaluate the rights of the limited partners in the determination of whether the limited partnership (or similar entity) is a VIE. See the discussion of ASU 2015-02 below.

Statement 167 (Evolution of FIN 46(R))

The financial crisis in the late 2000s had a significant effect on the economy and, in turn, on the structures and financial statements of many companies. This, along with concerns related to the consolidation conclusions reached under the VIE model, resulted in the FASB’s reconsideration of the VIE model introduced by FIN 46(R). As mentioned above, FIN 46(R) completely separated the analysis of whether a reporting entity had power over a VIE from the analysis of whether the reporting entity should consolidate the VIE. Rather, the evaluation focused on the reporting entity’s economic exposure to the VIE. Statement 167 represented a significant reversal from the view that a VIE should be consolidated by a reporting entity solely as a result of the reporting entity’s economic exposure to the VIE. Instead, although Statement 167 retained the concept of a VIE, it amended the guidance to require a reporting entity to consolidate a VIE if it has both (1) the power to direct the activities of the VIE that most significantly affect the VIE’s economic performance and (2) a variable interest in the VIE that is potentially significant.

Although Statement 167’s power requirement for consolidation of a VIE was a significant improvement over the FIN 46(R) guidance, many complexities remained in identifying VIEs and determining which party should consolidate them. In addition, because of a concern that the Statement 167 VIE model would result in unnecessary consolidation by investment managers of the funds they manage, the FASB provided a deferral specific to interests in investment companies (and certain other similar entities). Under the deferral, reporting entities with interests in a qualifying investment company continued to apply the FIN 46(R) model when evaluating whether the legal entity was a VIE and should be consolidated. Accordingly, when Statement 167 was adopted, reporting entities had to determine whether their interest was in a legal entity that was within the scope of the voting interest entity model, the FIN 46(R) VIE model, the Statement 167 VIE model, or the EITF 04-5 model.

ASU 2015-02 (Further Evolution of the VIE Model and Extinction of EITF 04-5)

ASU 2015-02 continued the consolidation evolution story. While the ASU did not introduce any new models, it revised the VIE model and eliminated EITF 04-5, requiring all legal entities to be evaluated as either a voting interest entity or VIE. Further, under the ASU, the evaluation of whether a VIE should be consolidated is still based on whether the reporting entity has both (1) power and (2) potentially significant economics.

Some key highlights of the ASU’s changes are as follows:

The Statement 167 deferral for interests in investment companies (and certain similar entities) was eliminated, thereby removing from U.S. GAAP the risks-and-rewards-based consolidation model under FIN 46(R).
The limited partnership model in ASC 810-20 was eliminated. As a result, limited partnerships are VIEs unless the limited partners have substantive kick-out or participating rights. Consequently, while more limited partnerships are VIEs, it is less likely that a general partner will consolidate a limited partnership.
The guidance on fees paid to a decision maker or service provider was amended. Accordingly, the fees themselves are less likely to be considered a variable interest, a legal entity is less likely to be a VIE, and a decision maker is less likely to consolidate the legal entity.
The ASU significantly amended how variable interests held by a reporting entity’s related parties or de facto agents affect its consolidation conclusion. In addition, the related-party tiebreaker test (and mandatory consolidation by one of the related parties) will be performed less frequently than under the previous VIE models.

ASU 2016-17 (Continued Evolution of the VIE Model)

Related-party considerations in the primary-beneficiary analysis (see Section 7.4) evolved under ASU 2016-17. The FASB issued ASU 2016-17 to amend its guidance on a decision maker’s consideration of indirect interests held through related parties under common control in the evaluation of whether the decision maker has both the power and potentially significant economics in the primary-beneficiary assessment. Under the ASU, a decision maker considers these interests proportionately in a manner similar to its consideration of indirect interests held through related parties that are not under common control. Before ASU 2016-17, a decision maker considered the related party’s interest in the VIE in its entirety (as if held by the decision maker) when evaluating whether the decision maker had a potentially significant variability interest.

Although the change as a result of ASU 2016-17 was minor, its effect on decision makers is significant. The related-party tiebreaker test is performed more frequently under the ASU because it is less likely that decision makers will meet the economics criterion1 on their own when their economic exposure to a VIE through a related party under common control is considered proportionately.

However, since it did not change how related-party interests are considered in the evaluation of whether a fee arrangement is a variable interest, ASU 2016-17 introduced asymmetry into the VIE model. Thus, indirect interests held through related parties under common control are considered as direct interests in the variable interest analysis but as indirect interests on a proportionate basis in the primary-beneficiary assessment. However, the FASB ultimately issued ASU 2018-17 in October 2018, as discussed further below, which aligns the evaluation of indirect interests held by related parties.

ASU 2018-17 (Continued Evolution of Related-Party Provisions)

ASU 2018-17 eliminates the asymmetry resulting from ASU 2016-17 regarding consideration of a decision maker’s related-party interests in the VIE model described above. The ASU requires a decision maker to evaluate indirect interests held by related parties under common control in a similar manner when assessing whether the fee arrangement is a variable interest and whether the decision maker is the primary beneficiary; that is, those interests will be considered on a proportionate basis rather than in their entirety (see Section 4.4.2.3.1).

In addition, ASU 2018-17 broadens ASU 2014-07’s private-company scope exception to the VIE guidance for certain entities that are under common control and have leasing arrangements. Under ASU 2018-17, the exception applies to all 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 certain criteria (see Section 3.5).

The guidance in ASU 2018-17 is effective for public business entities in periods beginning after December 15, 2019, and for private entities for fiscal years beginning after December 15, 2020, and for interim periods beginning after December 15, 2021.

Continued Evolution?

The voting interest entity model and VIE model have survived evolution thus far. Are we entering another period in which only minor changes will be made to the consolidation requirements, such as the one enjoyed from 1959 to 2002? Or will economic conditions, transaction structures that continue to evolve in response to changing regulatory and tax environments, FASB priorities, or some combination thereof prompt further changes to address the future environment?

Over the years, many of the amendments to the models were designed to identify the appropriate consolidation framework for different types of legal entities. In the 1990s, the EITF made several attempts to define an SPE. And for the past 16 years, practitioners have been applying the complex guidance on identifying a VIE. A single model under which a controlling financial interest can be determined regardless of whether a legal entity is a VIE has yet to be achieved, but it would simplify the analysis (and this Roadmap).

In September 2017, the FASB issued a proposed ASU that would reorganize all the consolidation guidance and move it to a new topic (ASC 812), which would contain two separate subtopics: one for VIEs and one for voting interest entities. The Board issued the proposal in connection with its project to reorganize the consolidation guidance, which it undertook in response to feedback that ASC 810 is often “difficult to navigate.” The Board’s goal was to organize the guidance to reflect the order in which the consolidation analysis should occur. However, on the basis of feedback received on its 2021 Invitation to Comment Agenda Consultation, the Board removed this reorganization project from its technical agenda in April 2022 and instead added a research project that will address whether a single consolidation model can be established for business entities.

Consolidation Decision Trees

ASC 810-10-05-6 contains a flowchart2 that consists of a series of decision trees to help reporting entities identify (1) which consolidation model to apply, if any; (2) whether a reporting entity should consolidate a VIE; and (3) whether a reporting entity should consolidate a voting interest entity. The flowchart below incorporates the concepts in the FASB’s flowchart and serves as a guide to the consolidation accounting literature and this Roadmap.

Footnotes

Throughout this Roadmap, we refer to the characteristics described in ASC 810-10-25-38A(b) as the “economics criterion.” See Section 7.1 for further discussion.

ASC 810-10-05-6 states that the flowchart “provides an overview of the guidance in this Subtopic for evaluating whether a reporting entity should consolidate another legal entity. The flowchart does not include all of the guidance in this Subtopic and is not intended as a substitute for the guidance in this Subtopic.”

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