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Consolidation Guidance Tweaked to Scope Out Agents

November 8, 2011

The Financial Accounting Standards Board is brushing up its fairly new rules on consolidations to address concerns that investment managers or others acting as agents for their clients might get caught up in the guidance and treated as if they are owners.

FASB has proposed an accounting standards update that would establish criteria for a reporting entity to follow to determine whether it is using its decision making power as a principal with an ownership interest or as an agent for someone else. Accounting rules adopted in 2009 require companies to consider their power to direct the activities of an entity and the benefit they derive from such an entity as the key criteria for determining whether that entity must be consolidated, or added to the parent company's financial statements. FASB developed the rule to bring onto corporate balance sheets special-purpose or variable-interest entities that carried risk but remained hidden to investors.

Under the proposed new guidance, FASB establishes criteria to sort out the difference between principals and agents based on rights held by other parties, compensation for the decision maker, and exposure to the variability of returns from other interests that it holds in the entity. If a party is determined by the criteria to be an agent rather than a principal, that party would not consolidate the variable interest entity to its own balance sheet.

Currently, the requirements for evaluating kick-out rights and participating rights are not consistent throughout U.S. accounting rule, says Dee Mirando-Gould, a director in the financial management practice at consulting firm MorganFranklin. “FASB's proposal would change how participating rights affect the consolidation analysis for voting interest entities and partnerships to align the consolidation requirements for these entities with those for variable interest entities,” she says.

Lisa Filomia-Aktas, a partner with Ernst & Young, says the guidance doesn't change the 2009 consolidation guidance for companies, but adds to the analysis of who should consolidate a special-purpose entity. Companies with interests in general partnerships, limited partnerships or joint ventures might be more affected by the proposed guidance than companies with no such interests, she says.

FASB is accepting comments on the proposal through Jan. 17.