Consolidation of Variable Interest Entities
A Roadmap to Applying the Variable
This publication is provided as an information service by the Accounting Standards and Communications Group of Deloitte & Touche LLP. It does not address all possible fact patterns and the guidance is subject to change. Deloitte & Touche LLP is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte & Touche LLP shall not be responsible for any loss sustained by any person who relies on this publication.
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March 2010
Cont
en
ts
Acknowledgments 1
Introduction 2
Section 1 — Overview, Background, and Scope 5
1.01 Determining Which Consolidation Model to Apply 6
Substantive Terms and Arrangements 8
1.02 Consideration of Substantive Terms, Transactions, and Arrangements 8
Scope and Scope Exceptions 9
Overall Scope Considerations 10
1.03 Application of the VIE Model in ASC 810-10 to Non-SPEs 10
1.04 Qualification of a SPE as a Voting Interest Entity 10
1.05 Application of the VIE Model in ASC 810-10 to Multitiered Legal Entity Structures 11
1.06 Application of the VIE Model in ASC 810-10 to a Single Entity Held by a Holding Company 12
1.07 Elimination of the QSPE Scope Exception 13
Scope Exception for Employee Benefit Plans 14
1.08 Determining Whether Employee Benefit Plans Should Apply the VIE Model in ASC 810-10 to Their Investments 14
Scope Exception Related to Investments Accounted for at Fair Value 14
1.09 Scope Exception for Certain Investment Companies 15
Scope Exception for Governmental Organizations 15
1.10 Definition of Governmental Organization 15
1.11 Determining Whether a Governmental Organization Was Used to Circumvent the Provisions of the VIE Model
in ASC 810-10 16
Scope Exception for Not-for-Profit Organizations 17
1.12 Scope Exception for Not-for-Profit Organizations 17
1.13 Scope Exception for Not-for-Profit Organizations: Circumvention of the VIE Model in ASC 810-10 17
1.14 Accounting Guidance for NFPs as a Result of the VIE Model in ASC 810-10 18
1.15 Determining Whether Entities That Present Their Financial Statements Similarly to a NFP Can Qualify for the
Not-for-Profit Scope Exception 18
1.16 Retention of a For-Profit Reporting Entity’s Accounting Policies in the Consolidated Financial Statements of a
Not-for-Profit Reporting Entity 18
Scope Exception Related to Separate Accounts of Life Insurance Entities 19
1.17 Scope Exception for Separate Accounts of Life Insurance Entities 19
Exhaustive-Efforts Scope Exception 19
1.18 Meaning of the Term “Exhaustive Effort” 20
1.19 Application of Exhaustive-Efforts Scope Exception to an Inactive Entity Created Before December 31, 2003 20
Business Scope Exception 21
1.20 Definition of a Business Under ASC 810-10-15-17(d) 21
1.22 Applying the Business Scope Exception on a Reporting-Entity-by-Reporting-Entity Basis 22 1.23 Determining When a Reporting Entity Should Assess Whether It Meets the Business Scope Exception Under the
VIE Model in ASC 810-10 22
1.24 Definition of a Joint Venture and Joint Control as Used in the VIE Model in ASC 810-10-15-17(d)(1) 24 1.25 Determining Whether the Reporting Entity Participated Significantly in the Design or Redesign of the Legal Entity 25 1.26 Scope Exception for Legal Entities Deemed to Be a Business — Determining Whether Substantially All of the
Activities Either Involve or Are Conducted on Behalf of the Reporting Entity 25
1.27 Scope Exception for an Entity Deemed to Be a Business — Determining Whether Financing Is Subordinated 27
1.28 Additional Financial Support — Put and Call Options 28
1.29 Business Scope Exception — Determining Whether More Than Half the Total of Equity, Debt, and Other
Subordinated Financial Support Has Been Provided 29
1.30 Lessee’s Determination of Whether a Capital Lease With an Entity Should Be Assessed Under the VIE Model
in ASC 810-10 30
1.31 Consideration of Leasing Activities in Which the Legal Entity Is the Lessor 30
Section 2 — Determination of Whether the Reporting Entity Holds a Variable Interest 32
Identifying a Variable Interest 32
2.01 Determining Whether a Holding Is a Variable Interest 32
2.02 Identifying Whether a Reporting Entity Holds a Variable Interest Requiring Analysis Under the VIE Model in ASC 810-10 35
2.03 Determining When a Lease Represents a Variable Interest — Potential VIE Is a Lessor 36
2.04 Determining When a Lease Represents a Variable Interest — Potential VIE Is a Lessee 37
2.05 Determining Variable Interests Under the VIE Model in ASC 810-10 in a Synthetic CDO Structure When
Decision-Maker Fees Are Not Treated as a Variable Interest 37
2.06 Determining Variable Interests Under the VIE Model in ASC 810-10 in a Synthetic CDO Structure When
Decision-Maker Fees Are Treated as a Variable Interest 39
2.07 Netting of Instruments Other Than Equity 39
2.08 Applying the VIE Model in ASC 810-10 to Trust Preferred Security Arrangements and Similar Structures 40
Implicit Variable Interests 43
2.09 Implicit Variable Interests and “Activities Around the Entity” — Illustration 43
2.10 Implicit Variable Interests — Call and Put Options 46
2.11 Implicit Variable Interests — Total Return Swap 46
2.12 Implicit Variable Interests — Back-to-Back Asset Guarantee 47
2.13 Determining When an Implicit Guarantee (Variable Interest) Exists in a Related-Party Transaction 47
2.14 Implicit Variable Interests — Waiving of a Management Fee 51
The By-Design Approach to Determining Variability 51
2.15 Overview of the Guidance in ASC 810-10-25-21 Through 25-36 53
2.16 Applying the Guidance in ASC 810-10-25-21 Through 25-36 to Purchase and Supply Arrangements 55
2.17 Applying ASC 810-10-25-21 Through 25-36 to PPAs, Tolling Agreements, and Similar Arrangements 56
2.18 Off-Market Supply Agreements 58
2.19 Determining Whether a Variable Interest Is Subordinated Financial Support 59
2.20 Analyzing a MMF for Consolidation 60
2.21 How to Determine Whether an Embedded Derivative Is Clearly and Closely Related Economically to Its Asset
or Liability Host 62
2.22 Applying the Guidance in ASC 810-10-25-35 and 25-36 63
2.23 Meaning of the Term “Derivative Instrument” in ASC 810-10-25-35 and 25-36 65
2.24 Meaning of the Term “Market-Observable Variable” in ASC 810-10-25-35 66
Section 3 — Determination of Whether an Entity Is a VIE 68
Determination of Whether Equity Investment at Risk Is Sufficient Under ASC 810-10-15-14(a) 69
3.01 Determination of Equity Investment at Risk When the Investor’s Initial Accounting Basis of Its Equity Differs
From Fair Value 70
3.02 Including Mezzanine Equity Instruments in Total Equity Investment at Risk 70
3.03 Determination of Whether a Personal Guarantee Provided by an Equity Holder Represents Equity Investment at Risk 70 3.04 Determining Whether an Instrument With a Risks-and-Rewards Profile Similar to That of an Equity Investment
Qualifies as Equity 71
3.05 Impact of ASC 810-10-15-14(a) on the Determination of Total Equity Investment at Risk When the Investee
Is a Foreign Entity 71
3.06 Non-At-Risk Equity Investment as a Variable Interest 71
Equity Investments That Participate in Profits and Losses 72
3.07 Definition of “Profits and Losses,” as Used in ASC 810-10-15-14(a)(1) 72
3.08 Including Fixed-Rate, Nonparticipating Preferred Stock in the Total Equity Investment at Risk 73
3.09 Determining Whether an Equity Interest Participates Significantly in the Profits and Losses of an Entity 73
3.10 Impact of Put Options, Call Options, and Total Return Swaps on Equity Investment at Risk 74
3.11 Impact of Contracts and Instruments That Protect an Equity Investor on Equity Investment at Risk 76
Equity Investments Provided Directly or Indirectly by the Entity 77
3.12 Qualification of Equity Investments Issued in Exchange for Promises to Perform Services as Equity Investment at Risk 77 3.13 Determining Whether Fees Received by an Equity Investor for Services Performed at Inception or in the Future
Reduce Equity Investment at Risk 78
Equity Investments Financed by the Entity 78
3.14 Determining Whether Funds Borrowed by a Reporting Entity Qualify as Equity Investment at Risk 78
Sufficiency of Equity Investment at Risk 79
3.15 Determining Whether a Quantitative Assessment of Equity Investment at Risk Is Necessary 80
3.16 Qualitative Versus Quantitative Analysis of Whether an Entity Is a VIE 81
3.17 Quantitative Expected-Loss Calculation — After Adoption of ASU 2009-17 81
3.18 Consideration of Subordinated Debt in a Qualitative Assessment of Sufficiency of Equity at Risk 82
Determining Whether, as a Group, the Holders of the Equity Investment at Risk Lack Any of the Characteristics in
ASC 810-10-15-14(b) 83
3.19 Characteristics in ASC 810-10-15-14(b) Held Within the Group of At-Risk Equity Investors 84
3.20 Meaning of the Phrase “As a Group” in ASC 810-10-15-14(b) 84
3.21 Impact of ASC 810-10-15-14(b) on Determining Characteristics of Control or Lack of Control by the Group of
Holders of Equity Investment at Risk 85
3.22 Minimum Amount of Equity Held By an Investment Manager or GP 86
3.23 Ability of Holders of Equity Investment at Risk to Remove a Decision Maker 87
3.24 Decision-Making Rights Granted to an Equity Holder Separately From Its Equity Investment at Risk 87
3.25 Nonsubstantive Equity Investment of a GP 88
3.26 Determining Whether a GP Interest Should Be Aggregated With an LP (or Other) Interest in the Evaluation of a
Legal Entity Under ASC 810-10-15-14 88
Analysis of Fees Paid to a Decision Maker or Service Provider 90
3.27 Meaning of “Insignificant” in the Analysis of Fees Paid to a Decision Maker or Service Provider 90
3.28 Meaning of the Term “Same Level of Seniority” 91
3.29 Whether a Fee Paid to a Decision Maker or Service Provider That Represents a Variable Interest Could Potentially
Not Be Significant to a VIE 92
3.30 Determining Whether a Decision Maker or Service Provider Must Evaluate ASC 810-10-25-38A If the Fees Paid
to the Decision Maker or Service Provider Do Not Represent a Variable Interest 92
3.31 Reassessment of Fees Paid to a Decision Maker or Service Provider 93
Obligation to Absorb the Expected Losses of the Legal Entity 94
3.34 Determining Whether a Put Option on an Equity Interest Causes the Holders of the Equity Investment at Risk
to Lack the Obligation to Absorb the Expected Losses of the Entity 96
3.35 Determining Whether a Put Option on a Potential VIE’s Assets Causes the Holders of the Equity Investment
at Risk to Lack the Obligation to Absorb the Expected Losses of the Potential VIE 96
3.36 Determining the Effect of Other Arrangements on the Ability of the Equity Group to Absorb Expected Losses
or Receive Residual Returns 96
Right to Receive the Expected Residual Returns of the Legal Entity 98
3.37 Determining Whether an Investor Has the Right to Receive the Expected Residual Returns of a Legal Entity and
Whether the Investor’s Return Is Capped 98
3.38 Impact of an Outstanding Equity Call Option on Whether a Return Is Capped 99
3.39 Impact of a Call Option on an Entity’s Assets on Whether a Return Is Capped 99
Determining When the Equity Investors as a Group Are Considered to Lack the Characteristics in ASC 810-10-15-14(b)(1) 99
3.40 Application of the VIE Test Under ASC 810-10-15-14(c) 100
3.41 Considering a Reporting Entity’s Obligations to Absorb Expected Losses and Rights to Receive Expected Residual
Returns Other Than Those Provided Through Equity Interests When Applying ASC 810-10-15-14(c) 101
Initial Determination of Whether an Entity Is a VIE 102
3.42 Anticipated Changes in the Assessment of Whether an Entity Is a VIE 102
3.43 Future Sources of Financing to Include in a Potential VIE’s Expected Cash Flows 103
Reconsideration of Whether the Entity Is a VIE 104
3.44 Guidance on Reconsideration of Whether an Entity Is a VIE 104
3.45 Valuation of Equity Investment at Risk When a Reconsideration Event Occurs 107
3.46 Isolating the Impact of a Change in the Entity’s Governing Documents or Contractual Arrangements and the Impact
of Undertaking Additional Activities or Acquiring Additional Assets 107
3.47 Entering Into Bankruptcy 108
3.48 Emerging From Bankruptcy 108
Development-Stage Entities 109
3.49 Determining Whether a Development-Stage Entity Is a Business 109
3.50 Development Stage Entities — Assessing the Sufficiency of Equity Investment at Risk 109
Section 4 — Expected Variability and the Calculation of Expected Losses and Expected
Residual Returns 111
4.01 Definitions of Expected Losses and Expected Residual Returns 111
4.02 The Meaning of “Net Assets” Under the VIE Model in ASC 810-10 112
4.03 Purpose of Calculating the Expected Losses and Expected Residual Returns of the Entity 113
4.04 How to Determine the Expected Losses and Expected Residual Returns of the Entity 113
4.05 How to Determine the Expected Losses and Expected Residual Returns of the Entity — Example 116
4.06 Use of the Indirect Method to Calculate Estimated Cash Flows 121
4.07 Noncash Receipts or Distributions in the Determination of an Entity’s Estimated Cash Flow Scenarios 123 4.08 Inclusion of Low-Income Housing or Similar Tax Credits in a Calculation of Expected Losses and Expected
Residual Returns 124
4.09 Effect of Options on Specific Assets in the Determination of the Entity’s Estimated Cash Flows 124
4.10 Developing Estimated Cash Flow Scenarios and Assigning Probabilities for Expected Loss and Expected Residual
Return Calculations 125
4.11 Discount Rate to Use in the Calculation of Expected Losses and Expected Residual Returns 127
4.12 Cash Flow and Fair Value Approaches to Calculating Expected Losses and Expected Residual Returns 128
4.13 Appropriateness of Using Either the Cash Flow Approach or Fair Value Approach to Calculate Expected Losses and
Expected Residual Returns 128
4.14 Determining Whether Decision-Maker and Service-Provider Fees Are Included in Expected Losses and Expected
Residual Returns 129
4.15 Whether ASC 820-10 Affects an Expected Losses/Residual Returns Calculation 129
4.16 Allocation Methods That May Be Used to Determine Whether Fees Paid to Decision Makers or Service Providers
Section 5 — Interests in Specified Assets of the VIE and Silo Provisions 133
5.01 Accounting for Interests in Specified Assets and Silos 133
5.02 Consideration of Interests in Specified Assets 135
5.03 Guarantees That Represent a Variable Interest in the Entity Versus a Variable Interest in Specified Assets of the Entity 136 5.04 Considering a Party’s Other Interests in the Analysis of a Variable Interest in Specified Assets of an Entity 136 5.05 Considering a Related Party’s Interest in the Analysis of a Variable Interest in Specified Assets of an Entity 137
5.06 Determining Whether a Silo Exists 138
5.07 Determining Whether a Host Entity Is a VIE When a Silo Exists 139
5.08 Determining Whether the Silo Is a VIE If the Host Entity Is a VIE 140
5.09 Determining the Primary Beneficiary of the Host Entity and Silo 141
Section 6 — Determination of the Primary Beneficiary 142
6.01 How a Reporting Entity Applies the VIE Model in ASC 810-10 When It Appears Not to Be the Primary Beneficiary 143
6.02 Determining Whether More Than One Reporting Entity Can Consolidate a VIE 143
6.03 Risks to Which an Entity Is Designed to Be Exposed 144
6.04 Risks and Related Activities 144
6.05 Assessing Power to Direct When Decisions Are Made by a Board of Directors and a Manager 145
6.06 Consideration of All Risks in the Determination of the Power to Direct Activities of the VIE 147
6.07 Evaluating Power to Direct the Most Significant Activities of the VIE in Scenarios Involving a PPA 148
6.08 Determination of a Primary Beneficiary for Every VIE 149
6.09 Evaluating the Characteristic in ASC 810-10-25-38A(b) 149
6.10 Reconsideration of the Primary Beneficiary of a VIE 151
6.11 The Effect of Contingencies on Determining the Primary Beneficiary 153
6.12 Consideration of Forward Starting Rights in the Primary Beneficiary Analysis 155
6.13 Determination of Whether Kickout Rights are Substantive 156
6.14 Consideration of a Board of Directors as a Single Party in the Assessment of Kickout Rights 156
6.15 Withdrawal and Liquidation Rights 157
6.16 Evaluation of Shared Power Versus Multiple Unrelated Parties Performing Different Significant Activities 157
6.17 Shared Power Within a Related-Party Group 158
6.18 VIEs With No Ongoing Activities That Significantly Affect Their Economic Performance 159
Related-Party Considerations 160
6.19 Factors to Consider in the Determination of Whether a Relationship Represents a De Facto Agency 160
6.20 Aggregation of Variable Interests When the Reporting Entity Does Not Hold a Variable Interest Directly in the Entity 162 6.21 De Facto Agency Relationship When Only Part of an Interest Is Received as a Loan or Contribution From
Another Reporting Entity 162
6.22 Related-Party Determination — Interests Received as a Loan 163
6.23 Considering Whether Restrictions on a Reporting Entity’s Ability to Sell, Transfer, or Encumber Its Interests in a
VIE Constitute Constraint 164
6.24 The Effect of a Put Option on a De Facto Agency Relationship 165
6.25 Consideration of De Facto Agent Requirements in the Determination of the Primary Beneficiary in a Joint
Venture Arrangement 166
6.26 Determining Which Party in a Related-Party Group Is Most Closely Associated With a VIE 166
6.27 Determining the Primary Beneficiary in a Related-Party Group When Members of the Related-Party Group
Are Under Common Control 169
6.28 Consideration of the Factors in ASC 810-20 in the Determination of Which Related Party Is Most Closely Associated 169 6.29 Application of ASC 810-10-25-38A and ASC 810-10-25-44 When a Fee Paid to an Asset Manager Represents
Section 7 — Initial Measurement and Subsequent Accounting 173
Initial Measurement 173
7.01 Balance Sheet Classification of Parent’s Interest — Primary Beneficiary and VIE Under Common Control 173
7.02 Qualification of an Entity as a Business for Recording Goodwill Upon Consolidation of a VIE 174
Accounting After Initial Measurement 175
7.03 Accounting After Initial Measurement — Intercompany Eliminations 175
Section 8 — Presentation and Disclosures 177
Presentation 177
8.01 Application of the Presentation Requirements of ASC 810-10-45-25 to a Consolidated VIE 177
8.02 Separate Presentation of Certain Assets and Liabilities of Consolidated VIEs 178
8.03 Optional Separate Presentation of Certain Assets and Liabilities of Consolidated VIEs 179
Disclosures 179
8.04 Disclosures About Securitizations Under ASC 860 Versus Disclosures About Securitizations Under the VIE Model
in ASC 810-10 181
8.05 Definition of Maximum Exposure to Loss for Disclosure Purposes 182
Section 9 — Transition 183
9.01 Whether a Reporting Entity Can Elect the FVO for a VIE Upon Adopting ASU 2009-17 186
9.02 Determining VIE and Primary-Beneficiary Status Upon Transition to ASU 2009-17 186
Appendix A — Implementation Guidance 189
Appendix B — Glossary of Terms and Abbreviations Used in the VIE Model in ASC 810-10 205
Glossary of Terms 205
Abbreviations 206
Appendix C — Key Differences Between U.S. GAAP and IFRSs — Consolidated
Financial Statements 208
Appendix D — Reference Guide 212
Acknowledgments
Ashley Carpenter, Rob Comerford, Jon Howard, Jeff Nickell, Randall Sogoloff, Joe Ucuzoglu, and Bob Uhl provided the thought leadership necessary to formulate our views on the application of the key principles of Statement 167. James Barker worked with our Energy & Resources practice to develop our views on the application of Statement 167 to power purchase arrangements. Jim Schnurr continues to work with our Investment Management practice to provide input on Statement 167 and the ongoing joint consolidations project.
Xihao Hu and Sherif Sakr provided invaluable insight and perspective from our Financial Accounting and Reporting Services group.
Joe Renouf, Michael Lorenzo, Lynne Campbell, Yvonne Donnachie, and Joan Meyers delivered the first class production effort that we have come to rely on for all of Deloitte’s publications.
Courtney Sachtleben worked tirelessly to ensure this Roadmap was of the highest quality. Her dedication and commitment got this publication to the finish line.
Introduction
March 2010
To the clients, friends, and people of Deloitte:
Welcome back to the land of variable interest entities (VIEs). It’s been two-and-a-half years since we last updated our Roadmap on consolidation of VIEs, and the consolidations terrain has changed significantly in that time. The most noteworthy changes are (1) the issuance of Statement 167, (2) the release of the FASB Accounting Standards Codification (the “Codification”), and (3) the continued work of the FASB and IASB on a joint consolidations project.
Statement 167 — What’s All the Fuss About?
In June 2009, the FASB issued Statement 167, which amends the consolidation guidance applicable to VIEs. The Statement 167 amendments are effective as of the first annual reporting period that begins after November 15, 2009, and for interim periods within that first annual reporting period. Statement 167 replaces Interpretation 46(R)’s risks-and-rewards-based quantitative approach to consolidation with a more qualitative approach that requires a reporting entity to have some economic exposure to a VIE along with “the power to direct the activities that most significantly impact the economic performance of the entity.” The FASB also reminded its constituents that only substantive terms, transactions, and arrangements should affect the accounting conclusions under Statement 167; the SEC has reiterated this principle in numerous public speeches.
It’s not surprising that many initially concentrated on understanding how Statement 167 would affect qualifying special-purpose entities (QSPEs) and other structured finance entities because that seemed to be the FASB’s focus, particularly given that six of the nine implementation examples in Statement 167 address structured finance entities. However, the initial adoption of Statement 167 has proved time-consuming because it does not just apply to structured finance entities or entities historically considered VIEs under Interpretation 46(R). In addition, even if a reporting entity determines that it does not need to consolidate a VIE under Statement 167, it must provide extensive disclosures for any VIEs in which it holds a variable interest. In addition to the overall change in the Interpretation 46(R) consolidation model, Statement 167 contains the following significant provisions and amendments:
• The scope exemption for QSPEs is removed from Interpretation 46(R). As a result, transferors, sponsors, and investors in QSPEs need to consider the consolidation and disclosure provisions in Statement 167. • Kickout rights and participating rights are ignored in (1) the determination of whether an entity is a VIE
and (2) the identification of the VIE’s primary beneficiary, unless the rights are held by a single reporting entity.
• A reporting entity must continually reconsider which variable interest holder is the VIE’s primary beneficiary.
• A reporting entity must reconsider an entity’s VIE status if the equity interest holders lose the power from the voting rights of those investments to direct the entity’s most significant activities.
• An exemption to the de facto agent requirements exists when mutual transfer restrictions are based on terms mutually agreed to by willing, independent parties.
• A primary beneficiary must present separately, on the face of the balance sheet, (1) assets of consolidated VIEs that can only be used to settle obligations of those VIEs and (2) liabilities of consolidated VIEs for which creditors do not have recourse to the general credit of the primary beneficiary.
• Power is only considered shared (and no party consolidates) if (1) two or more unrelated parties together have the power to direct the VIE’s most significant activities and (2) decisions about those activities require the consent of each of the parties sharing power.
To address the new consolidations guidance under Statement 167, this edition of the Roadmap (1) includes over 30 new Q&As and (2) updates our existing Interpretation 46(R) Q&As.
The Codification — Do You Have All the New Topics, Subtopics, Sections,
Subsections, and Paragraphs Memorized?
In July 2009, the Codification became the single source of authoritative nongovernmental U.S. GAAP. The
Codification’s hierarchy is topic, subtopic, section, and paragraph, in that order, each with a numerical designation (e.g., ASC 810-10-25-37, which was formerly paragraph 6 of Interpretation 46(R)). ASU 2009-17 incorporated Statement 167’s amendments to the VIE model into the Codification. The beginning of each section of this Roadmap contains quotes from the appropriate Codification paragraphs. In addition, for those of you still trying to find your way through the Codification, we thought it would be helpful for each Codification paragraph to be followed by a reference to the corresponding pre-Codification paragraph from Interpretation 46(R), as amended by Statement 167.
Although ASC 810-10-55-37 (paragraph B22 of Interpretation 46(R)1) might not roll off your tongue like “B22
of FIN 46(R)” used to, the Codification is here to stay. However, we suspect that just as there are probably a few accountants who are clinging to their last version of the FASB’s Original Pronouncements (we know you are out there!), there are some that might need a little help finding the new VIE guidance in the Codification. Accordingly,
Appendix D of this Roadmap includes a guide that cross-references the paragraphs from ASC 810-10 to the guidance in Interpretation 46(R), as amended by Statement 167. The reference guide also lists the accounting topic and section from the Roadmap that these paragraph references apply to. (We thought a few hints and a little “cheat sheet” among friends might be helpful while we all adjust to the new layout of the Codification.)
No More Big Changes Expected Anytime Soon — Right?
Well — not really. Did we mention the joint consolidations project that the FASB and the IASB are working on? The IASB and FASB are jointly developing guidance for consolidation of all entities, including entities currently considered VIEs. Although Statement 167 was not developed as part of the joint project, the IASB staff closely followed the FASB’s work on Statement 167. The boards’ goal is to have one consolidation model whose principles are similar to those in Statement 167 and that would apply to all entities. In December 2008, the IASB issued Exposure Draft 10 (ED 10), Consolidated Financial Statements. Although the boards believe that the objectives for assessing control of structures under Statement 167 and ED 10 are fundamentally consistent, they also acknowledged that the guidance in ED 10 can potentially result in different consolidation conclusions — particularly for certain investment funds.
The boards are continuing to jointly deliberate several critical issues, including the evaluation of principal and agent relationships, the concept of effective control (e.g., the ability to control a voting interest entity when a reporting entity holds fewer than half of the voting rights), related parties, disclosures, and presentation requirements. The boards have stated their goal to issue an exposure draft during the second quarter of 2010 and a final standard before the end of 2010. We will continue to keep you updated on these developments through our Heads Up newsletters as well as through our Dbriefs webcast series.2
For a discussion of the current differences between the consolidation models under IFRSs and U.S. GAAP, see
Appendix C of this Roadmap.
1 You see – that’s helpful – isn’t it?
What’s This I Hear About a Deferral of Statement 167? Can I Get One Too?
In February 2010, the FASB issued ASU 2010-10, which amends certain provisions of the VIE model in ASC 810-10. The ASU defers the effective date of Statement 167 for a reporting entity’s interest in certain entities and certain money market mutual funds. It also addresses concerns that the joint consolidation model under development by the FASB and IASB may result in a different consolidation conclusion for asset managers and that an asset manager consolidating certain funds would not necessarily provide useful information to investors. In addition, the ASU amends certain provisions of ASC 810-10-55-37 (paragraph B22 of Interpretation 46(R), as amended by Statement 167) to change how a decision maker or service provider determines whether its fee is a variable interest. This Roadmap reflects the changes to ASC 810-10-55-37.
The ASU will defer the application of Statement 167 for a reporting entity’s interest in an entity (1) that has all the attributes of an investment company or (2) for which it is industry practice to apply measurement principles for financial reporting purposes that are consistent with those followed by investment companies. The deferral does not apply in situations in which a reporting entity has the explicit or implicit obligation to fund losses of an entity that could potentially be significant to the entity. The deferral also does not apply to interests in securitization entities, asset-backed financing entities, or entities formerly considered QSPEs. In addition, the deferral applies to a reporting entity’s interest in an entity that is required to comply with or operate in accordance with requirements similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. These entities will be subject to the deferral even if the money market fund manager has an explicit or implicit obligation to fund losses of the entity.
For reporting entities that meet the deferral conditions, the guidance on VIEs in ASC 810-10 (before the
amendments in ASU 2009-17 and the amendments to 810-10-55-37 in ASU 2010-10) would be used to determine whether (1) the legal entity is a VIE, (2) the reporting entity has a variable interest in a VIE, and (3) the reporting entity is the primary beneficiary of a VIE. However, all reporting entities must provide the disclosures in ASC 810-10, as amended by ASU 2009-17, for all VIEs in which they hold a variable interest or for which they are the primary beneficiary — regardless of whether the entity qualifies for the deferral. Q&A 1.01 of this Roadmap includes a decision tree to help you understand how the deferral may affect which consolidation model you will need to apply. In addition, see our January 27, 2010, Heads Up for information about the ASU’s other significant provisions.
The Road Forward
We understand that Statement 167 (like Interpretation 46(R) before it) can be a difficult standard to apply — particularly when you are new to its provisions. We believe this Roadmap can help you find your way and can help make the complex sound a little simpler. To those new to VIE land, and to our grizzled VIE veterans, we look forward to working with you.
Section 1 — Overview, Background, and
Scope
ASC 810-10
05-8 The Variable Interest Entities Subsections clarify the application of the General Subsections to certain legal entities
in which equity investors do not have sufficient equity at risk for the legal entity to finance its activities without additional subordinated financial support or, as a group, the holders of the equity investment at risk lack any one of the following three characteristics:
a. The power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impact the entity’s economic performance
b. The obligation to absorb the expected losses of the legal entity c. The right to receive the expected residual returns of the legal entity.
Paragraph 810-10-10-1 states that consolidated financial statements are usually necessary for a fair presentation if one of the entities in the consolidated group directly or indirectly has a controlling financial interest in the other entities. Paragraph 810-10-15-8 states that the usual condition for a controlling financial interest is ownership of a majority voting interest. However, application of the majority voting interest requirement in the General Subsections of this Subtopic to certain types of entities may not identify the party with a controlling financial interest because the controlling financial interest may be achieved through arrangements that do not involve voting interests. [Paragraph 1]
05-8A The reporting entity with a variable interest or interests that provide the reporting entity with a controlling financial
interest in a variable interest entity (VIE) will have both of the following characteristics:
a. The power to direct the activities of a VIE that most significantly impact the VIE’s economic performance b. The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive
benefits from the VIE that could potentially be significant to the VIE. [Paragraph 1A]
05-9 The Variable Interest Entities Subsections explain how to identify VIEs and how to determine when a reporting entity
should include the assets, liabilities, noncontrolling interests, and results of activities of a VIE in its consolidated financial statements. Transactions involving VIEs are common. Some reporting entities have entered into arrangements using VIEs that appear to be designed to avoid reporting assets and liabilities for which they are responsible, to delay reporting losses that have already been incurred, or to report gains that are illusory. At the same time, many reporting entities have used VIEs for valid business purposes and have properly accounted for those VIEs based on guidance and accepted practice. [Paragraph E5]
05-10 Some relationships between reporting entities and VIEs are similar to relationships established by majority voting
ASC 810-10 (continued)
05-11 VIEs often are created for a single specified purpose, for example, to facilitate securitization, leasing, hedging, research
and development, reinsurance, or other transactions or arrangements. The activities may be predetermined by the documents that establish the VIEs or by contracts or other arrangements between the parties involved. However, those characteristics do not define the scope of the Variable Interest Entities Subsections because other entities may have those same characteristics. The distinction between VIEs and other entities is based on the nature and amount of the equity investment and the rights and obligations of the equity investors. [Paragraph E18]
05-12 Because the equity investors in an entity other than a VIE generally absorb losses first, they can be expected to resist
arrangements that give other parties the ability to significantly increase their risk or reduce their benefits. Other parties can be expected to align their interests with those of the equity investors, protect their interests contractually, or avoid any involvement with the entity. [Paragraph E19]
05-13 In contrast, either a VIE does not issue voting interests (or other interests with similar rights) or the total equity
investment at risk is not sufficient to permit the legal entity to finance its activities without additional subordinated financial support. If a legal entity does not issue voting or similar interests or if the equity investment is insufficient, that legal entity’s activities may be predetermined or decision-making ability is determined contractually. If the total equity investment at risk is not sufficient to permit the legal entity to finance its activities, the parties providing the necessary additional subordinated financial support most likely will not permit an equity investor to make decisions that may be counter to their interests. That means that the usual condition for establishing a controlling financial interest as a majority voting interest does not apply to VIEs. Consequently, a standard that requires ownership of voting stock is not appropriate for such entities. [Paragraph E20]
1.01 Determining Which Consolidation Model to Apply
Under ASC 810-10, there are two primary1 models for determining whether consolidation is appropriate: the VIE
model and the voting interest model.
ASU 2009-17 amends the VIE model and is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, and for interim periods within those reporting periods. ASU 2010-10 indefinitely defers the amendments in ASU 2009-17 for a reporting entity’s interest in certain entities and amends the guidance in paragraph 810-10-55-37 (as amended by ASU 2009-17) on determining whether a decision-maker or service-provider fee represents a variable interest. The deferral will be most applicable to interests in certain investment funds. For reporting entities that meet the deferral conditions, the guidance on VIEs in ASC 810-10 (before the amendments in ASU 2009-17 and the amendments to 810-10-55-37 in ASU 2010-10) would be used to determine whether the legal entity is a VIE, whether the reporting entity has a variable interest in a VIE, and whether the reporting entity is the primary beneficiary of a VIE. However, all reporting entities must provide the disclosures in ASC 810-10, as amended by ASU 2009-17, for all VIEs in which they hold a variable interest or for which they are the primary beneficiary — regardless of whether the entity qualifies for the deferral.
Question
How should a reporting entity determine which consolidation model is appropriate under ASC 810-10?
1 While ASC 810-10 primarily focuses on the voting interest model and the VIE model, it also discusses consolidation of entities controlled by
Answer
When determining which consolidation model to apply, a reporting entity should consider the following flowchart:
Does one of the scope exceptions in ASC 810-10-15-12 or 15-17 apply?
Yes Apply the voting interest model in ASC 810-10. No
Does the potential VIE and the reporting entity’s interest in the potential VIE meet the deferral conditions in ASC 810-10-65-2(aa)?
Yes No
Does the reporting entity have a variable interest in the potential VIE under ASC 810-10 (before
the amendments by ASU 2009-17)?
No No Does the reporting entity have a
variable interest in the potential VIE under ASC 810-10 (as amended by ASU 2009-17)?
Yes Yes
Is the entity a VIE under ASC 810-10 (before the amendments by
ASU 2009-17)?
No No Is the entity a VIE under ASC
810-10 (as amended by ASU 2009-17)?
Yes Yes
Determine whether the reporting entity is the primary beneficiary
of the VIE under ASC 810-10 (before the amendments by
ASU 2009-17).
Apply the voting interest model in
ASC 810-10 to the entity. Determine whether the reporting entity is the primary beneficiary of the VIE under ASC 810-10 (as
amended by ASU 2009-17)?
Apply the disclosure requirements in ASC 810-10-5 (as amended by ASU 2009-17) for all VIEs in which the reporting entity holds a variable interest, regardless of whether the deferral conditions in ASC 810-10-65-2(aa) are met.
If one of the scope exceptions in ASC 810-10-15-12 or 15-17 does not apply to the potential accounting parent or potential accounting subsidiary, determining whether the potential VIE and the reporting entity’s interest in the potential VIE meet the deferral conditions in ASC 810-10-65-2(aa) is the first step in the assessment of whether an entity should be consolidated. Note that this determination is performed first because the analysis of whether the reporting entity has a variable interest in the entity, the entity is a VIE, or the reporting entity is the primary beneficiary may differ depending on whether the potential VIE and the reporting entity’s interest in the potential VIE meet the deferral conditions in ASC 810-10-65-2(aa).
After a reporting entity determines whether the deferral criteria are met, determining whether an entity is a VIE is the next step in assessing whether an entity should be consolidated. Even a company with wholly owned consolidated subsidiaries must determine whether any of its subsidiaries (as well as any interests it may have in other entities) are VIEs.
Example
Enterprise A has 60 percent of the voting interest in Entity B. Enterprise A also receives fees for providing asset management services to B. Unless one of the scope exceptions in ASC 810-10-15-12 and 15-17 applies to A (the potential accounting parent) or B (the potential accounting subsidiary), A must determine (1) whether B, and A’s interest in B, meets the conditions in ASC 810-10-65-2(aa), (2) whether A holds a variable interest or variable interests in B, and (3) whether B is a VIE.
Scenario 1: If B, and A’s interest in B, meets the conditions in ASC 810-10-65-2(aa), A must determine whether B is a VIE, as defined in ASC 810-10-15-14 (before the amendments in ASU 2009-17). If A holds a variable interest, as defined in ASC 810-10-20 and illustrated in ASC 810-10-55-16 through 55-41 (before the amendments in ASU 2009-17), in B and B is a VIE, A should assess whether it is the primary beneficiary in accordance with ASC 810-10-25-38 (before the amendments in ASU 2009-17). Enterprise A should also provide the disclosures in ASC 810-10 (as amended by ASU 2009-17).
Scenario 2: If B does not meet the conditions in ASC 810-10-65-2(aa), A must determine whether B is a VIE, as defined in ASC 10-15-14 (as amended by ASU 2009-17). If A holds a variable interest, as defined in ASC 810-10-20 and illustrated in ASC 810-10-55-16 through 55-41 (as amended by ASU 2009-17), in B and B is a VIE, A should assess whether it is the primary beneficiary in accordance with ASC 810-10-25-38A (as amended by ASU 2009-17). Enterprise A should also provide the disclosures in ASC 810-10 (as amended by ASU 2009-17). Scenario 3: If B meets the conditions in ASC 810-10-65-2(aa) but is not a VIE, as defined in ASC 810-10-15-14 (before the amendments by ASU 2009-17), A should apply the voting interest model in ASC 810-10 to B.
Scenario 4: If B does not meet the conditions in ASC 65-2(aa) and is not a VIE, as defined in ASC 810-10-15-14 (as amended by ASU 2009-17), A should apply the voting interest model in ASC 810-10 to B.
Substantive Terms and Arrangements
ASC 810-10
15-13A For purposes of applying the Variable Interest Entities Subsections, only substantive terms, transactions, and
arrangements, whether contractual or noncontractual, shall be considered. Any term, transaction, or arrangement shall be disregarded when applying the provisions of the Variable Interest Entities Subsections if the term, transaction, or arrangement does not have a substantive effect on any of the following:
a. A legal entity’s status as a VIE b. A reporting entity’s power over a VIE
c. A reporting entity’s obligation to absorb losses or its right to receive benefits of the legal entity. [Paragraph 2A]
15-13B Judgment, based on consideration of all the facts and circumstances, is needed to distinguish substantive terms,
transactions, and arrangements from nonsubstantive terms, transactions, and arrangements. [Paragraph 2A]
1.02 Consideration of Substantive Terms, Transactions, and Arrangements
Question
What is meant by “substantive terms, transactions, and arrangements” in ASC 810-10-15-13A?
Answer
In ASU 2009-17, the FASB added guidance to emphasize that when applying the provisions of the VIE subsections of ASC 810-10, a reporting entity should only consider substantive terms, transactions, and arrangements, whether contractual or noncontractual. The Board thought that it needed to add this language to avoid situations in which the form of an entity may indicate that an entity is not a VIE or that a reporting entity is not a primary beneficiary when the substance of the arrangement may indicate otherwise.
Paragraph A35 in the Basis for Conclusions of Statement 167 states, in part:
When the provisions of ASC 810-10 (as amended by ASU 2009-17) are applied, the consolidation conclusion should not be affected by any term, transaction, or arrangement that does not truly affect the reporting entity’s power or rights to receive benefits or obligations to absorb losses. A reporting entity should use judgment, based on consideration of all the facts and circumstances, to distinguish substantive terms, transactions, and arrangements from nonsubstantive terms, transactions, and arrangements.
To further emphasize this point, the SEC has reminded registrants of the staff’s skepticism about accounting conclusions that do not conform to the economic substance of the arrangement. For example, in remarks regarding the implementation of ASU 2009-17 before the 2009 AICPA National Conference on Current SEC and PCAOB Developments, Arie Wilgenburg, a professional accounting fellow in the SEC’s Office of the Chief Accountant, discussed the following examples:
[A]ssume a company has transferred assets to a structure to be managed by a third party, but the
manager’s equity interest in the structure is minimal and appears to be guaranteed given the management fee structure. In addition, assume the manager can be removed by the reporting enterprise if the
manager’s performance is unsatisfactory. The combination of the above factors indicates that the company may not have relinquished control; rather the manager may simply be acting as an agent on behalf of the reporting enterprise.
We have also seen other, similar structures that include a buy-sell clause rather than a removal right, as a mechanism for dissolving the structure. However, if the manager does not have the financial ability to exercise its rights under the buy-sell provision, the substance of this provision may be a call option by the transferor. Again, this may be an indication that the manager is simply acting as an agent on behalf of the reporting enterprise.
At the same conference, James Kroeker, chief accountant in the SEC’s Office of the Chief Accountant, indicated that the staff would consider involving the Division of Enforcement if it becomes aware of arrangements such as those discussed by Mr. Wilgenburg.
Scope and Scope Exceptions
ASC 810-10
15-12 The guidance in this Topic does not apply in any of the following circumstances:
a. An employer shall not consolidate an employee benefit plan subject to the provisions of Topic 712 or 715. b. [Subparagraph superseded by Accounting Standards Update No. 2009-16]
c. [Subparagraph superseded by Accounting Standards Update No. 2009-16]
d. Investments accounted for at fair value in accordance with the specialized accounting guidance in Topic 946 are not subject to consolidation according to the requirements of this Topic.
e. 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. [Paragraph 4]
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:
a. 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.
b. 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.
c. 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
ASC 810-10 (continued)
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.
d. 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). [Paragraph 4]
Overall Scope Considerations
1.03 Application of the VIE Model in ASC 810-10 to Non-SPEs
Question
Does the VIE model in ASC 810-10 apply only to SPEs?
Answer
No. ASC 810-10-15-12 and 15-17 provide scope exceptions for certain reporting entities and potential VIEs. Variable interest holders should evaluate all entities that do not fall under these scope exceptions (such entities may include limited partnerships, joint ventures, cooperatives, and trusts) to determine whether they represent VIEs. (For more information about the determination of which consolidation model to apply, see Q&A 1.01.)
Note that ASU 2009-16 eliminated the scope exception for QSPEs. Therefore, transferors, sponsors, and investors in QSPEs should consider the consolidation and disclosure provisions in ASC 810-10. (For more information about the elimination of the QSPE scope exception, see Q&A 1.07.)
1.04 Qualification of a SPE as a Voting Interest Entity
If an SPE is a VIE, it is subject to consolidation under the VIE model in ASC 810-10.
Question
Are all SPEs automatically considered VIEs and within the scope of the VIE model in ASC 810-10?
Answer
If an entity is outside the scope of the VIE model in ASC 810-10, it should be considered for consolidation under the voting interest model in ASC 810-10.
1.05 Application of the VIE Model in ASC 810-10 to Multitiered Legal Entity Structures
Question
In an ownership structure in which multiple layers of legal entities exist, should a reporting entity apply the VIE model in ASC 810-10 to each of its subsidiaries on a consolidated or nonconsolidated basis?
Answer
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 become those of the parent company upon consolidation. When a reporting entity applies the VIE model in ASC 810-10 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 (see ASC 810-10-25-21 through 25-36).
Note that there are situations in which a reporting entity may “look through” a holding company and in which it therefore would not be required to examine the structure on a consolidated basis. For more information, see
Q&A 1.06.
Example 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. On a nonconsolidated basis, H 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. Before applying the business scope exception, the investors must first determine whether any of the four conditions in ASC 810-10-15-17(d) exist for H’s consolidated activities and cash flows. If so, the business scope exception cannot be applied. A holding company that has ownership interests in a single entity in multitiered structures should also consider the guidance in Q&A 1.06.
Example 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 Example 1, the attributes of the consolidated entity become those of the parent company. In this example, the attributes of E and N become those of the holding company.
Example 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 only asset is a building that is leased to the investor.
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 the previous two examples, the attributes of the consolidated entity 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 a single-lessee leasing arrangement with one of the investors, which is a condition in which the business scope exception cannot be applied (see ASC 810-10-15-17(d)(4)).
1.06 Application of the VIE Model in ASC 810-10 to a Single Entity Held by a Holding
Company
Holding companies are frequently established (often for legal or tax purposes) to hold some or all of the ownership interests in an entity. In many cases, reporting entities have ownership interests in these holding companies for the sole purpose of investing in an underlying 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 in ASC 810-10 directly to the underlying entity as if the holding company does not exist. This is particularly relevant to the business scope exception in ASC 810-10-15-17(d).
For example, assume that an investor has a 40 percent ownership interest in a holding company that is not a joint venture. The holding company was designed for the sole purpose of acquiring 100 percent of the ownership interests in an existing business (as defined in ASC 805). The investor was involved in the design of the holding company, but was not involved in either the design or redesign of the business. Assume that the investor and the holding company do not meet any of the other conditions in ASC 810-10-15-17(d). If the investor can look through the holding company to the underlying entity, it can apply the business scope exception. If the investor cannot look through the holding company, it cannot apply the business scope exception because the investor was involved in the design of the holding company (see ASC 810-10-15-17(d)(1)).
Question
Is it appropriate for a reporting entity to look through a holding company and apply the provisions of the VIE model in ASC 810-10 directly to a single underlying entity as if the holding company does not exist?
Answer
A reporting entity is never required to look through a holding company, and doing so often would be inappropriate under the VIE model in ASC 810-10. (For more information, see Q&A 1.05.) In limited circumstances, however, an investor may be able to look through a holding company and apply the VIE model in ASC 810-10 directly to a single underlying entity. The investor can only do this when (1) the holding company is truly a nonsubstantive entity because it does not have any substantive identity separate from that of the underlying entity and (2) the economics of the arrangement do not change as a result of inserting a holding company in between the investors and the underlying entity.
performed separately for the holding company and the underlying entity. All facts and circumstances should be considered, including the (1) design of both the holding company and the underlying entity and (2) nature of the relationships with the variable interest holders and their related parties.
The existence of all the following conditions may indicate that a reporting entity can look through a holding company to a single underlying entity when applying the VIE model in ASC 810-10:
• Other than its ownership interests in the single underlying 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 entity are substantively the same. • The governing documents associated with the holding company and the underlying 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.
• 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 entity instead of in the holding company.
• The reporting entity holds no variable interests in the single underlying entity.
Example 1
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 entity and consolidates that entity. The entity is a business as defined in ASC 805. Other than its ownership interests in the 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 entity. Assume that the five conditions described above exist in this arrangement.
Although not required to do so, in this example, the investor can look through the holding company and apply the VIE model in ASC 810-10 directly to the entity. To apply the business scope exception, the investor must first determine whether any of the four conditions in ASC 810-10-15-17(d) exist for either the investor or the single underlying entity. If so, the business scope exception cannot be applied.
Example 2
Assume the same facts as in Example 1, except that the holding company takes out a loan from a third-party bank. In this example, the investor would not be able to look through the holding company because the holding company’s loan precludes the investor from looking through the holding company to the underlying entity.
Example 3
An investor has 40 percent of the ownership interests in a holding company, which holds 100 percent of the ownership interests in an entity. The entity takes out a loan from a third-party bank. The investor has guaranteed repayment of the loan in the event of default.
In this example, the investor would not be able to look through the holding company because the guarantee represents a direct variable interest in the entity.
1.07 Elimination of the QSPE Scope Exception
Before the adoption of ASU 2009-17, variable interests held in certain QSPEs were outside the scope of the VIE consolidation model.
Question
Can a reporting entity involved with a QSPE continue to apply the scope exception upon adopting ASU 2009-17?
Answer
qualify for the exemption in ASC 810-10-15-17(c) if (1) the reporting entity is unable to obtain the information required to complete its consolidation analysis after making an exhaustive effort and (2) the entity was created before December 31, 2003.
In addition, an entity that did not previously qualify for the scope exception may not reassess whether it now qualifies simply as a result of adopting ASU 2009-17.
Scope Exception for Employee Benefit Plans
ASC 810-10
15-12 The guidance in this Topic does not apply in any of the following circumstances:
a. An employer shall not consolidate an employee benefit plan subject to the provisions of Topic 712 or 715. [Paragraph 4(b)]
1.08 Determining Whether Employee Benefit Plans Should Apply the VIE Model in ASC
810-10 to Their Investments
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.
Question
Are employee benefit plans within the scope of the VIE model in ASC 810-10?
Answer
No. Employee benefit plans are not within the scope of the VIE model in ASC 810-10.
Defined Benefit Plans
For defined benefit plans, a reporting entity should apply the guidance in ASC 960 (i.e., fair value for all plan investments). ASC 960-325-35-1 states, in part, “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 VIE model in ASC 810-10.
Other Employee Benefit Plans
For other employee benefit plans (defined contribution plans, employee health and welfare benefit plans), a reporting entity should apply the guidance in ASC 962 and ASC 965, respectively. Because that guidance generally requires that investments be carried at fair value (see ASC 962-325-35-1), the VIE model in ASC 810-10 would not apply to other employee benefit plans.
Other Parties
Other parties involved with employee benefit plans, such as service providers, should apply the VIE model in ASC 810-10, as warranted by the facts and circumstances. For employee benefit plans that are subject to the provisions of ASC 715 and ASC 712 (see ASC 810-10-15-12(a)), employer-sponsors are allowed a scope exception from applying the VIE model in ASC 810-10.
Scope Exception Related to Investments Accounted for at Fair Value
ASC 810-10
15-12 The guidance in this Topic does not apply in any of the following circumstances:
1.09 Scope Exception for Certain Investment Companies
Question
What entities qualify for the scope exception in ASC 810-10-15-12(d)?
Answer
SEC Regulation S-X, Rule 6-03(c)(1), states, in part, that consolidated statements of a registered investment company “may be consolidated only with the statements of subsidiaries which are investment companies.” ASC 810-10-15-12(d) states that investments accounted for at fair value in accordance with the specialized accounting guidance in ASC 946 are exempt from the provisions of ASC 810-10. However, a reporting entity that adopts the implementation guidance in ASC 946-10-55 is subject to the provisions of the VIE model in ASC 810-10 at the time of adoption. Upon the adoption of ASC 946-10-55, the guidance in this Q&A is no longer applicable. The original effective date for the implementation guidance in ASC 946-10-55 was fiscal years beginning on or after December 15, 2007. However, the implementation guidance in ASC 946-10-55 has been indefinitely deferred. See ASC 946-10-65-1 for more details.
Scope Exception for Governmental Organizations
ASC 810-10
15-12 The guidance in this Topic does not apply in any of the following circumstances:
e. 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. [Paragraph 4(i)]
1.10 Definition of Governmental Organization
Question
What is the definition of “governmental organization,” as used in ASC 810-10-15-12(e)?
Answer
Paragraph 1.01 of the AICPA Audit and Accounting Guide State and Local Governmental Units defines governmental organization as follows:
Public corporations and bodies corporate and politic are governmental entities. Other entities are governmental entities 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, entities 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, entities 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.
Paragraph 3 of the GASB staff paper Applicability of GASB Standards lists additional characteristics that may indicate 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.
