FinREC seeks clarity in principal vs. agent proposal


The AICPA’s Financial Reporting Executive Committee (FinREC) sent a comment letter to FASB stating concerns about operational challenges that could be triggered by Proposed Accounting Standards Update (ASU), Consolidation (Topic 810)—Principal Versus Agent Analysis.

FASB issued the Proposed ASU on Nov. 3. The proposal would amend the evaluation of kick-out and participating rights held by noncontrolling shareholders in a consolidation analysis. The ASU also would change the requirements for determining whether a general partner controls a limited partnership. That could affect reporting entities that are involved with partnerships and similar entities. Although the amendments affect all companies that are required to evaluate whether they should consolidate another entity, businesses involved with variable-interest entities (VIEs) are expected to be most significantly affected.

FinREC agreed that the ASU would improve comparability of financial statements prepared in accordance with U.S. GAAP and IFRS. FinREC also supported the objective of alleviating inconsistency for evaluating kick-out and participating rights that resulted from the issuance of FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R) (now incorporated in FASB Accounting Standards Codification Topic 810, Consolidation).

In general, FinREC supported the ASU’s inclusion of an assessment of whether a decision-maker is using its authority in a principal or agent capacity based on the factors articulated in the Proposed ASU. FinREC agreed with the ASU’s conclusion that a qualitative analysis would be an improvement over the current list of criteria required in U.S. GAAP consolidation guidance for variable-interest entities (VIEs). But FinREC’s letter stated its concerns about operational challenges.

FinREC Chairman Richard Paul said in a telephone interview that the concept of the proposal generally is good, but said FinREC is seeking clarity for greater consistency of application.

“I think the board acknowledged by the deferral of the literature for certain types of entities that there were certain situations that may have had unintended consequences,” Paul said. “And I think some clarity around those situations is really what we’re looking for.”

Paul said that the most important recommendation in the letter asked FASB to reconsider its position on rights held by other parties in the principal versus agent analysis. FinREC wrote that, if redemption rights function in the same way as liquidation rights, they should be evaluated similarly to liquidation rights. In some cases, FinREC wrote, a redemption right can be in substance the same as a liquidation right.

In the background for the examples in the implementation guidance, FinREC wrote, there is specific mention of redemption rights but no mention of how they factor into the conclusion and the principal versus agent analysis. FinREC recommended that discussion of how redemption rights would affect the analysis be added to the examples.

Here are some of FinREC’s other views on the Proposed ASU:

  • The proposal states that the evaluation of a decision-maker’s capacity would consider the rights held by other parties; the compensation to which the decision-maker is entitled; and the decision-maker’s exposure to variability of returns from other interests it holds in an entity. FinREC wrote that the rights held by other parties should be considered first and independently of the other two factors.
  • FinREC wrote that substantive kick-out and participating rights held by multiple unrelated parties should be considered when evaluating whether a reporting entity should consolidate another entity, and that such rights should be determinative. FinREC suggested some language changes and asked FASB to provide guidance about how the dispersion of rights would factor into the determination of whether the rights are substantive. FinREC wrote that the rights should be held by a small number of parties in order to be substantive.
  • The proposed amendments would require money market funds to be evaluated for consolidation by their investment managers. FinREC is concerned that the proposed guidance will be interpreted to require money market funds and similar funds to be consolidated in certain situations even though FinREC doesn’t believe that is FASB’s intent. FinREC recommended that a reporting entity’s interest in an entity that complies with or operates in accordance with requirements similar to those included in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds be explicitly excluded from the scope of the proposal.
  • If FASB decides to require an entity to consider its direct and indirect economic interests when determining whether it is a principal or an agent, the board should provide more examples, FinREC recommended. FinREC requested that FASB’s examples illustrate how to apply the guidance when the related party is a debt- or guarantee-holder in the entity being evaluated.
  • FinREC has concerns about how the principal versus agent analysis evaluation of whether a general partner should consolidate a limited partnership would be applied for certain investment funds. FinREC asked for clarifying guidance to be issued so that the proposal won’t be misinterpreted to require that all general partners in certain entities be considered principals. FinREC also recommended that FASB consult with industries such as the real estate and energy-related industries to understand the impact of the proposal before finalizing the standard.
  • Reiterating a concern expressed in a previous letter on Proposed ASU, Financial Services—Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements, FinREC opposed the requirement that an investment company consolidate its interest in other investment companies. Regarding Topic 810, FinREC asked FASB to provide additional implementation guidance on how limited partners and similar structures should assess whether they should consolidate a limited partnership.

FinREC also offered suggestions on how a variable-interest entity should be defined; asked for examples on the application of the principal versus agent analysis where the general partner receives an equity-based performance fee; recommended that, if series funds are considered to be VIEs, FASB consider whether it’s relevant and useful for series funds to be subject to the disclosure requirements that are relevant for all other entities that have a variable interest in VIEs; and asked FASB to reach out to constituents with certain multiemployer plans that may be affected.

Ken Tysiac ( ) is a JofA senior editor.

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