The FASB published an update to U.S. GAAP that will let private companies skip the complex variable interest entity guidance in the consolidated reporting standard. The complexities of accounting for businesses under common control is often cited as the most problematic financial reporting issue for private companies.
Private companies on October 31, 2018, got long-awaited relief from the FASB from what they have described as one of the most complicated areas of U.S. GAAP.
Accounting Standards Update (ASU) No. 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities, gives private companies the option to skip what is known as the variable interest entity (VIE) guidance in FASB ASC 810, Consolidation. Instead, private companies can consider the less complex method in the guidance to assess whether common brother-sister business transactions need to be consolidated, or reported on their balance sheets.
“Quite a few private companies are looking forward to it,” said BDO USA LLP national assurance partner Gautam Goswami. “It’s not only nuanced guidance for preparers, it’s nuanced guidance for everyone, including auditors and users.”
FASB ASC 810 requires businesses to consolidate holdings they have in other entities when they have a controlling financial interest in them. The standard is designed to prevent companies from hiding liabilities in off-balance sheet vehicles. For years, the decision to consolidate was based largely on whether a business had majority voting rights in a related legal entity. The FASB amended the standard in 2003, in the wake of the Enron scandal, to beef up the guidelines on when to consolidate, introducing the guidance on variable interest entities.
“Enron figured out a way within the standard to create off-balance-sheet structures with financing that was completely guaranteed by the host company but yet was off the balance sheet — and the VIE guidance was written to fix that,” said Billy Atkinson, chair of the FASB’s Private Company Council (PCC) from 2012 to 2015.
Under the VIE guidance, a business has the controlling financial interest when it has both the power to direct the activities that most significantly affect an entity’s economic performance, and it also holds the right to receive significant benefits from the entity as well as the obligation to absorb its losses. Financial reporting professionals tend to regard the guidance complicated to follow. Private companies in particular complained that some of their most common business relationships are not set up to trick investors or pump up stock prices but for tax or estate planning purposes.
They said the consolidated reporting guidance was unnecessarily complex, and the variable interest entity model, in particular, forced them to consolidate multiple affiliated and subsidiary businesses onto a parent’s balance sheet, frustrating lenders and creditors, who wanted cleaner balance sheets. In addition, in companies where ownership is shared among close relatives, determining who holds the power is not always clear, they said.
“When the VIE guidance came out, it didn’t make a distinction between the reasons why a company had to apply VIE guidance — it just had to be applied to everything,” Goswami said. “This is obviously very nuanced guidance. Private companies, even smaller public companies, were finding it very difficult.”
The PCC, which keeps the FASB abreast of private company accounting issues, considered the VIE issue for its number one problem, Atkinson said.
“We said, ‘Look guys, we’ve had about 10 years-plus of application of this guidance. Let’s see if we can untangle it a bit for the impact on private companies that fall prey to the complicated structural guidance,” Atkinson said.
In March 2014, the FASB issued ASU No. 2014-07, Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements, a Consensus of the Private Company Counci, which let private companies ignore the VIE guidance for certain leasing transactions, such as a private company with a separate entity to house its real estate assets. Private companies applauded this update to U.S. GAAP, but problems still persisted with the consolidation guidance for transactions that did not involve leases.
ASU No. 2018-17 applies to all private company common control transactions that meet certain criteria, and it supersedes the amendments in ASU No. 2014-07, the FASB said.
A private company that makes use of the latest amendments to FASB ASC 810 must disclose in its financial statements its involvement with, and exposure to, the legal entity under common control.
“It provides private companies the choice to not apply VIE guidance to their common control arrangements—thereby reducing costs without compromising the relevance of the financial reporting information to financial statement users,” FASB Chairman Russell Golden said in a statement.
In addition to providing relief to private companies applying the consolidation guidance, the FASB also in ASU No. 2018-17 amended the standard’s guidance for asessing how fees paid to “decision makers” determine a consolidation decision. The update requires businesses to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety.
“People should not miss out that at least one part of the guidance applies to all companies,” Goswami said.
For private companies, the amendments in ASU No. 2018-17 are effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. Other organizations must apply the standard for fiscal years beginning after December 15, 2019, and for interim periods within those fiscal years. The FASB said it is permitting adoption of the amendments ahead of the effective date.