ASU 2009-17: Consolidation Rules for VIEs

The accounting guidance for consolidating certain legal entities, found in Accounting Standards Codification (ASC) Topic 810, Consolidation, has evolved significantly. The framework was reshaped in response to lessons from the financial crisis, when it became clear that companies often had significant economic exposure to entities that were not on their balance sheets. The guidance is designed to improve financial reporting by assessing whether a company has a controlling financial interest that necessitates consolidation.

Identifying a Variable Interest Entity

The first step in the consolidation analysis is to determine if an entity is a Variable Interest Entity (VIE). A variable interest is a contractual, ownership, or other financial interest that changes with fluctuations in the entity’s net asset value. These interests absorb portions of an entity’s expected losses or receive portions of its expected residual returns.

An entity is classified as a VIE if it meets any of the following criteria:

• The entity lacks sufficient equity investment at risk, meaning it cannot finance its activities without additional subordinated financial support.
• Equity investors as a group lack the power to direct the activities that most significantly impact the entity’s economic performance.
• Equity investors are not obligated to absorb expected losses or do not have the right to receive expected residual returns.

Specific guidance applies to limited partnerships, which are presumed to be VIEs. This presumption can be overcome if the limited partners have substantive rights to remove the general partner or other rights that give them significant decision-making power.

Determining the Primary Beneficiary

Once an entity is identified as a VIE, the next step is to determine which enterprise, if any, is its primary beneficiary. The primary beneficiary is the enterprise that must consolidate the VIE, reporting its assets, liabilities, and results of operations in its own financial statements. This analysis requires continuous assessment to ensure the correct enterprise consolidates the VIE as circumstances change.

The determination of the primary beneficiary rests on a two-pronged test, and an enterprise must meet both conditions. The first is the “power” criterion, which is met if the enterprise has the power to direct the activities of the VIE that most significantly impact its economic performance. Power can be established through contractual arrangements, governance documents, or other agreements that grant decision-making authority.

The second condition is the “economics” criterion, where an enterprise has the obligation to absorb losses or the right to receive benefits from the VIE that could be significant. When making this assessment, a reporting entity must consider its indirect economic interests held through related parties, including interests held by parties under common control on a proportionate basis. If one party has power and another has the significant economic interest, no single enterprise is the primary beneficiary, and consolidation does not occur.

Scope Exceptions and Private Company Alternatives

The VIE consolidation model includes certain scope exceptions. For example, a reporting entity is not required to apply the VIE guidance to its interest in a legal entity, such as a money market fund, that is required to comply with rules similar to those for registered investment companies.

An accounting alternative is also available for private companies. A private company may elect not to apply VIE guidance to legal entities under common control if both the reporting entity and the legal entity being evaluated are not public business entities.

Required Financial Statement Disclosures

The accounting guidance mandates extensive disclosures to provide a clear understanding of an enterprise’s involvement with VIEs. These disclosures must detail the judgments made in the consolidation analysis, the nature of any restrictions on the VIE’s assets, and the risks associated with the involvement.

For an enterprise that consolidates a VIE, it must present the assets and liabilities of the VIE in its balance sheet, often separately from its own assets and liabilities. Alternatively, these amounts can be detailed in the footnotes, clearly identifying the assets that are restricted to settling the VIE’s obligations and the liabilities for which creditors of the VIE have no recourse to the primary beneficiary.

Enterprises that hold a significant variable interest in a VIE but are not the primary beneficiary also have specific disclosure obligations. These entities must disclose the nature of their involvement and why they are not the primary beneficiary. They are required to report the carrying amount and classification of the assets and liabilities in their own balance sheet that relate to the VIE, as well as their maximum exposure to loss from their involvement with the entity.