Many private companies frequently engage in common control arrangements that may be subject to complex variable-interest entity (VIE) guidance.
Last year, FASB issued a financial accounting and reporting standard that provides private companies an accounting policy election not to apply VIE guidance to legal entities under common control (including common control leasing arrangements) when certain criteria are met as long as the common control parent and the legal entity being evaluated for consolidation are not public. (See FASB Accounting Standards Update No. 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities.)
This standard is effective for private companies in fiscal years beginning after Dec. 15, 2020, and early adoption is permitted. And although companies still have a while to implement the standard (unless they want to adopt early), we have been receiving some private company stakeholder questions as to how FASB developed the standard in the first place and how it actually works.
PRIVATE COMPANY CONSIDERATIONS
In working with the Private Company Council (PCC) and reviewing feedback from additional outreach performed by the FASB staff, FASB learned that most private company stakeholders find the VIE guidance (see the sidebar, "Controlling Financial Interests Under Current GAAP") unduly complex and costly to apply. This is most evident in applying VIE guidance to legal entities under common control.
When a private company and a legal entity (that the private company reporting entity has an interest in) are under the common control of a parent, it is difficult to determine whether the legal entity is a VIE. If it is determined that the legal entity is a VIE, it is also difficult to determine whether the reporting entity is the primary beneficiary of that legal entity.
It's important to note that the Private Company Decision-Making Framework helps FASB and the PCC identify:
- Differences in the informational needs of users of public company financial statements and users of private company financial statements, and
- Opportunities to reduce the relatively greater cost and complexity of preparing financial statements for private companies in accordance with GAAP.
Additionally, the framework observes that many private companies have multiple entities under common control, which often results in transactions with affiliates and other related parties.
The board learned that for private companies, significant diversity exists in the application of consolidation guidance to common control arrangements. Said differently, practice is reaching different conclusions for the same common control fact patterns. Adding to the difficulty in applying the guidance is the fact that private companies under common control often have no explicit or arm's-length contractual arrangements in place unless required by a third party.
With the assistance of the PCC, the board performed outreach to learn whether consolidation of another legal entity under the same common control as the private company reporting entity provides users of private company financial statements with decision-useful information.
Generally, the board learned that these users do not consider consolidation in these situations helpful for purposes of analyzing the stand-alone financial statements of a private company. Often, if the private company provides financial statements in which another legal entity under common control is consolidated, users request consolidating schedules to enable them to reverse the effects of consolidation.
HOW THE STANDARD WORKS
After considering the feedback received from the PCC and additional outreach, the board decided to develop a private company accounting alternative for common control arrangements that meet certain criteria. The alternative was provided generally because of:
- The lack of explicit or arm's-length contractual arrangements in private company common control scenarios, and
- Feedback indicating that private company users typically don't find consolidation in these scenarios to be useful.
Under the alternative, a private company can elect not to apply VIE guidance to legal entities under common control if both the parent and the legal entity being evaluated for consolidation are not public companies.
Because the board expects arrangements involving subsidiaries of public companies to be more formalized, the board decided against allowing the accounting alternative when a common control parent is a public business entity. Likewise, the board decided against allowing a legal entity being evaluated for consolidation to be a public business entity to apply the accounting alternative.
This accounting alternative effectively expands a similar alternative finalized in 2014 solely for common control leasing arrangements. Private companies electing the accounting alternative will have to provide detailed disclosures about their involvement with and exposure to the legal entity under common control.
In finalizing the accounting alternative, the board concluded that an inconsistent consolidation policy within the same company diminishes user relevance. Therefore, if the accounting alternative is elected, it must be applied by a private company to all current and future legal entities under common control that meet the criteria for applying the alternative. In other words, the alternative cannot be applied selectively to different common control arrangements.
In providing the accounting alternative, the board did not intend to change how current practice determines whether an arrangement is under common control for other areas of GAAP. The board expects that arrangements that are currently considered to be under common control will continue to be considered under common control.
We at FASB expect that the accounting alternative will improve useful information for the users of private company financial statements while reducing the cost and complexity associated with applying VIE guidance to private companies under common control. Collectively, the board and the PCC believe that the exception is a good example of how the Private Company Decision-Making Framework can be applied to address the needs of private company stakeholders.
Controlling financial interests under current GAAP
Two primary models can be used for assessment.
Current U.S. GAAP requires an organization (including a private company) to consolidate an entity in which it has a controlling financial interest.
There are two primary models for assessing whether an entity has a controlling financial interest in another entity:
- The voting interest model, and
- The variable-interest entity (VIE) model.
To determine which model applies, an organization must determine whether the entity being evaluated is a VIE or a voting interest entity. Under the voting interest model, a controlling financial interest generally is obtained through ownership of a majority of an entity's voting interests.
Under the VIE model, a reporting entity has a controlling financial interest (the reporting entity is deemed to be the primary beneficiary) when it has both:
- The power to direct the activities that most significantly affect the economic performance of the VIE, and
- The obligation to absorb losses or the right to receive benefits of the entity that could potentially be significant to the VIE.
About the author
Susan Cosper, CPA, was appointed to FASB on May 1, 2019. She also serves as the FASB liaison to the PCC and chairs the Emerging Issues Task Force. She previously served as FASB's technical director and is a CPA in New York, New Jersey, and Pennsylvania.
To comment on this article or to suggest an idea for another article, contact Ken Tysiac, the JofA's editorial director, at Kenneth.Tysiac@aicpa-cima.com or 919-402-2112.
- "Private Company GAAP Alternatives: It's Not Too Late," JofA, March 2019
- "FASB Expands Private Company Consolidation Relief," JofA, Oct. 31, 2018
- "FASB Endorses Private Company VIE Alternative for Lease Arrangements," JofA, Feb. 19, 2014