Should VIE Consolidation Guidance Apply to Private Companies?

The Financial Accounting Standards Board (FASB) recently issued a proposal that would exempt private companies from a provision in the guidance for the off-balance-sheet vehicles known as variable interest entities (VIEs). The FASB has long criticized VIEs, because some dishonest public companies have previously used them to mislead investors.

However, the use of VIEs among private companies is generally less controversial. Here’s the lowdown on a proposal that would allow them to skip the VIE consolidation guidance.

Public vs. private

The FASB’s proposal is a small part of a broader effort to simplify the accounting guidance in Topic 810, Consolidations. This topic addresses when a company should consolidate — or report on its balance sheet — holdings it has in other entities. After the 2002 Enron accounting scandal, the FASB revised its guidance to prevent other companies from hiding liabilities in off-balance-sheet vehicles. But accounting for VIEs is considered complicated, even for specialists in off-balance-sheet accounting.

Private companies have complained that the brother-sister entities they set up are for common tax and estate planning purposes — they’re generally not designed to mislead investors or mask debts. However, when in doubt about the guidance, many private companies err on the side of consolidation. This often frustrates their lenders, who would rather see individual balance sheets, rather than consolidated ones.

Assessment of power

The guidance in Topic 810 is based on an assessment of power: Whoever is in power is the parent entity and must report on its balance sheet its holdings. In certain private company transactions, such as those between friends or relatives, there are no formalized arrangements, the parent can change and there is little or no paperwork to back up decisions. These characteristics can make it difficult for private companies to assess who’s in power.

The FASB’s proposal would allow private companies to skip the consolidation guidance. But companies that opt out of consolidation would still have to provide detailed disclosures, conveying their involvement with and exposure to the affiliates.

Beyond consolidation

In addition to exempting private companies from the VIE model, the proposal calls for changes to other areas of the guidance. For example, indirect interests held through related parties in common control arrangements would be considered on a proportional basis for determining whether fees paid are variable interests. Under the existing guidance, such indirect interests under common control are considered direct interests in their entirety.

Also, the proposal would call for changes to the so-called “related-parties tiebreaker test.” This test helps financial professionals decide when to consolidate the reporting of complicated business relationships. The test may be relevant for situations in which power is shared among related parties or when related parties, as a group, have a controlling financial interest in a VIE. Under the revised guidance, the party for which “substantially all” of the activities either involve it or are conducted on its behalf would have a controlling financial interest in the entity.

A split board

Three FASB members oppose the proposal, but for different reasons.

• Lawrence Smith is concerned about carving out exemptions for private companies from accounting standards because doing so creates two different sets of rules and results in apples-to-oranges comparisons when benchmarking the performance of private and public companies.
• Christine Botosan believes the existing private company VIE accounting is too complex and wants the FASB to look at the VIE model more broadly. With the FASB’s proposal, “we are chipping away at the VIE model in a manner that could lead to unintended consequences,” she told the board in a written statement.
• Marc Siegel disagrees with the changes to the related-parties tiebreaker test. In his opinion, if deciding to consolidate is such a difficult call that it comes down to a special test, the business likely structured its transactions to complicate decision-making. “I don’t mind if [any company] is forced into consolidation,” Siegel said.

On the other hand, FASB Vice Chairman James Kroeker said he “strongly” supports the proposed changes to the tiebreaker test. However, he recommends that the FASB ask the public if the test is an antiabuse measure and, if so, what specific abuses the test prevents.

Although Kroeker supports the proposal, he has raised concerns about the private company exemption. “I see increasing concerns about impediments to accessing public capital, and I think the more we create public-private differences, the more we drive that difference,” he said.

Next steps

Many private companies welcome simplified guidance on VIEs. The FASB’s proposal was issued on June 22. The deadline for submitting comments is September 5, 2017.

© 2017