To Consolidate or Not? FASB Issues Simplified Consolidation Guidance
The Financial Accounting Standards Board (FASB) recently adopted Accounting Standards Update (ASU) No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. The revised standard clarifies the consolidated reporting guidance in U.S. Generally Accepted Accounting Principles (GAAP) for limited partnerships, limited liability companies (LLCs) and other types of off-balance-sheet vehicles used for mortgage-backed securities, collateralized loan obligations and collateralized debt obligations.
Riddled with confusion
Consolidated financial statements provide an aggregated look at the financial position of a parent and its subsidiaries to gauge the combined health of an entire group of companies, rather than each company’s standalone financial position. But companies sometimes have trouble determining when to consolidate with limited partnerships, LLCs and other off-balance-sheet entities.
Some companies go through the hassle and expense of consolidation only to discover that stakeholders want deconsolidated statements to better analyze each entity’s economic and operational results. For example, this may happen in situations where the company doesn’t hold a majority of the off-balance-sheet entity’s voting rights or the company isn’t exposed to a majority of the legal entity’s economic benefits or obligations.
To address these issues, FASB simplified the consolidation guidance and refined the criteria for judging when entities should consolidate their financial results. The issuance of ASU No. 2015-02 in February concludes a project that has dragged on for several years and included the 2011 publication of Proposed ASU No. 2011-220, Consolidation (Topic 810): Principal versus Agent Analysis. In late 2014, FASB appeared close to issuing the final amendments, but the board pulled back after an external review led to a large number of questions about the proposed changes.
Under the final version of the guidance, companies will apply two consolidation models, rather than the four models provided under existing guidance. The new guidance emphasizes the “risk of loss” when determining a controlling financial interest. In addition, the amendments:
- Modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs) or voting interest entities,
- Eliminate the presumption that a general partner should consolidate a limited partnership,
- Affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships, and
- Provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to follow requirements that are similar to those for registered money market funds.
The amendments also clarify how to treat the fees paid to an asset manager or other entity that makes the decisions for the investment vehicle and whether the fees should be considered in determining when a VIE should be reported on the asset manager’s balance sheet.
In a news release, FASB Chairman Russell Golden announced, “This new standard simplifies consolidation accounting by reducing the number of consolidation models, providing incremental benefits to stakeholders. For example, specialized guidance for legal entities will be eliminated by removing the indefinite deferral for certain investment funds and certain money market funds will no longer have to apply the guidance.”
FASB expects some businesses and organizations to incur one-time costs if the deferral’s elimination means they have to apply the revised guidance in Accounting Standards Codification Topic 810-10, Consolidation, to determine if they’re the primary beneficiary of a VIE. Examples of industries that could be significantly impacted by the revised guidance are investment management, banking, insurance and life sciences. Some money market funds will no longer be subject to consolidation after the changes go into effect.
For public companies the standard takes effect for periods beginning after Dec. 15, 2015. For private companies, the standard takes effect for annual periods beginning after Dec. 15, 2016, and for interim periods beginning after Dec. 15, 2017. Early adoption is permitted, including adoption in interim periods.