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Limited Partnerships Are Free to Make Separate Consolidation Assessments

February 5, 2014
The FASB continued work on its consolidation project, focusing on the rights held by the parties in limited partnership arrangements. The board tentatively decided that limited partnerships would consider the rights held by other parties differently from other types of entities making decisions about whether to report holdings on their balance sheets.

The FASB made some progress with its consolidated reporting project on January 29, 2014, and clarified how rights held by other parties should be considered when asset managers assess whether their responsibilities in limited partnerships mean they must report the holdings on their balance sheets.

The discussions were part of the FASB’s effort to finalize the guidance in Proposed Accounting Standards Update (ASU) No. 2011-220, Consolidation (Topic 810): Principal versus Agent Analysis. The draft standard was released in November 2011 as part of a broader project on investment companies. The proposal calls for a “decision maker,” such as an asset manager, general partner in a trust, or board of directors, to determine whether it is acting as a principal with control of a fund or whether it has less exposure and should be considered an agent with no obligation to report the holding.

To make the assessment, the decision maker is supposed to analyze three factors: the rights held by other parties, the fees it receives, and the risk that returns will fluctuate.

FASB members focused on the concept of “rights held by other parties.” Under the proposal, the rights pertain to liquidation rights over the legal entity, participating rights over the activities that most significantly affect the entity’s economic performance, and kick-out rights—the limited partners’ ability to dissolve the partnership or remove the partner without cause.

The board wanted to clarify how the rights held by other parties and substantive voting rights should affect whether an off-balance-sheet vehicle should be considered a variable interest entity (VIE) or voting interest entity (VOE) and whether the decision maker should consolidate, or report on its balance sheet, the vehicles.

The FASB decided that limited partnerships and similar legal entities would be exercising substantive voting rights by the vote of a single limited partner or a vote of a simple majority of partners. The board decided not to change the evaluation of voting rights for other types of entities outside of limited partnerships.

“The reason we believe there should be a separate assessment is due to the unique purpose and design of limited partnerships,” a FASB research staff member said. “A general partner directs the activities that significantly impact the economic performance of a limited partnership. That is different from a corporation where majority shareholders ultimately direct management to operate the entity or corporation.”

The board also decided not to change existing U.S. GAAP requirements for evaluating kick-out rights or participating rights.

Under U.S. GAAP, if a business has a variable interest in an off-balance-sheet vehicle that is considered to be a variable interest entity, Topic 810, Consolidation, requires that the business assess whether it is considered the “primary beneficiary” of the holding.

To be the primary beneficiary, the business must have the power to direct the economic activities of the entity as well as the obligation to absorb losses—and reap benefits.

If another party has unilateral kick-out rights or unilateral participating rights, the business wouldn’t be considered the primary beneficiary and wouldn’t report the holding.

FASB members considered less stringent wording that would lead to fewer consolidations, but almost every member of the accounting board spoke out against that idea.

Anything less than “unilateral” would lead to structuring opportunities, FASB member Marc Siegel said.

“I don’t know how many times we have to learn a lesson about off-balance-sheet vehicles that cause problems just in the past 12 years,” Siegel said. “To broaden it… really scares me. I don’t want the unintended consequences.”

The FASB plans to continue discussing the project at its February 12 meeting, Chairman Russell Golden said.

The board’s principal-versus-agent project is part of a wider effort to shed more light on the activities of investment companies.

In November 2011, the board released two proposals alongside the principal-versus-agent analysis—Proposed ASU No. 2011-200, Financial Services—Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements, and Proposed ASU No. 2011-210, Real Estate—Investment Property Entities (Topic 973).

The FASB settled most of the issues in Proposed ASU No. 2011-200 when it published final amendments to U.S. GAAP in ASU No. 2013-08, Financial Services—Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements, and clarified how a business determines if it is an investment company and can account for its holdings at fair value.

The FASB decided to deal with disclosures about investments in other funds in a separate work stream, and in October, it said it would release a proposal on disclosures by the first half of 2014.

The investment property entities project in Proposed ASU No. 2011-210 has been taken off the board’s agenda.