The Securities and Exchange Commission is taking a closer look at who consolidates a variable interest entity, noticing some differences in how companies apply existing guidance and offering views to help make reporting more consistent.
Christopher Rogers, professional accounting fellow at the SEC, told a national conference of the American Institute of Certified Public Accountants recently that the staff has noticed several practice issues with respect to the consolidation guidance in Accounting Standards Codification Topic 810, especially around the application of shared power, determining when a decision maker is acting in an agency capacity, and how to consider power and economics when related parties are under common control.
With respect to shared power, Rogers said existing guidance provides that no one party would consolidate a VIE when the power to direct significant activities is truly shared by multiple unrelated parties, but he made it clear that meeting that test is tricky. “For shared power to exist, the guidance seems to suggest that all decisions related to the significant activities of the VIE require the consent of each party sharing power,” he said. “When decisions related to a significant activity do not require joint consent, the staff has struggled to find a basis in the accounting literature to support that shared power can in fact exist.”
The critical first step, said Rogers, is to determine what activities most significantly impact the economic performance of a VIE, and that should take into account the purpose and design of the VIE and the risks and rewards that the VIE was designed to create and pass along to variable interest holders. “This analysis often requires a significant amount of judgment,” he said. “Keep in mind, decisions relating to activities that are not considered significant should not be considered in the primary beneficiary assessment.”
Rogers also challenged companies to reconsider how they evaluate power when a decision maker is acting in an agency capacity. “Said differently, does the VIE consolidation analysis stop if a reporting entity determines that a fee paid to a decision maker by a VIE is not a variable interest?” he asked. “The staff believes that in certain cases it may be necessary to continue the consolidation analysis when it is determined that a fee paid to a decision maker is not a variable interest and further consider whether the substance of the arrangement identifies a party other than the decision maker as the party with power,” he said. “While this can require a great deal of judgment, additional scrutiny may be necessary if a decision maker is acting as an agent and one variable interest holder is absorbing all or essentially all of the variability that the VIE is designed to create and pass along.”
Roger said the staff also has received several questions lately regarding whether the related party tie-breaker guidance must always be considered when determining which party in a common control group is the primary beneficiary of a VIE. “While common control arrangements do require careful consideration to determine if stated power is in fact substantive, the staff does not believe there is a requirement to consider the related party tie-breaker guidance or that the guidance is necessarily determinative unless no party in the common control group individually meets both characteristics of a primary beneficiary,” he said.
The Financial Accounting Standards Board is trying to wrap up an update to accounting standards on consolidation, focused on the principal vs. agent analysis. The board had hoped to have the standard issued in 2014 and ready to apply to year-end financial statements, but recently determined the best-case scenario is to issue the final guidance in February 2015. It will allow for early adoption, so could still be applied if issued early enough in February, said FASB Chairman Russ Golden.