Spotlight on Consolidation

The consolidation rules under U.S. Generally Accepted Accounting Principles (GAAP) can be complicated to follow, especially for private companies. In September, the Financial Accounting Standards Board (FASB) made a significant step toward simplifying the consolidated reporting guidance.

Consolidation rules

Accounting Standards Codification (ASC) Topic 810, Consolidation, currently requires businesses to consolidate, or report on their balance sheets, holdings they have in other entities when they have a controlling financial interest in them. The guidance has two primary models to make the assessment: 1) the voting interest model, and 2) the variable interest entity (VIE) model.

Under the voting interest model, a business has a controlling financial interest when it holds a majority of an entity’s voting interests. Under the VIE model, the assessment is more complicated: A business has a controlling financial interest when it has the power to direct the activities that most significantly affect the economic performance of the entity and it also holds the right to receive significant benefits from the entity, as well as the obligation to absorb its losses.

Revised classification of topics

Proposed Accounting Standards Update (ASU) No. 2017-280, Consolidation (Topic 812): Reorganization, aims to improve navigation and understanding of the guidance. The proposal will affect any business or organization that has to determine if it should consolidate an interest in a legal entity on its balance sheet. But it doesn’t change how management and auditors analyze consolidated reporting or decide whether to consolidate an interest in an off-balance sheet vehicle on the parent company’s balance sheet.

Instead, the proposal would move Topic 810, Consolidation, to a new accounting standard, Topic 812. The new standard would include two subtopics:

1. Subtopic 812-20, Consolidation — Variable Interest Entities, and
2. Subtopic 812-30, Consolidation — Voting Interest Entities.

The proposal includes some other changes that address some secondary aspects of consolidated reporting. For example, the guidance for consolidation of entities controlled by contract in Topic 810 would move to Topic 958, Not-for-Profit Entities. The FASB said it is making the change because only not-for-profit organizations use this area of U.S. GAAP.

The proposal also calls for superseding Subtopic 810-30, Research and Development Arrangements. The FASB said some areas of the research-and-development guidance will be clarified to make it easier to understand, but the accounting itself won’t change.

Private company consolidation proposal

The FASB’s latest proposal also includes the draft guidance from Proposed ASU No. 2017-240, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities. That proposal was released in June to let private companies avoid using the guidance for VIEs for some common control lease arrangements and similar legal structures.

If Proposed ASU 2017-240 becomes a final standard, private companies will be allowed to elect an accounting policy alternative that, once elected, would have to be followed for other entities under common control meeting the same criteria. However, the FASB said the alternative wouldn’t be applicable to all common control arrangements.

Work in progress

Comments on the private company consolidation proposal (Proposed ASU No. 2017-240) were due on September 5. So far, the feedback has been mixed. While the board received largely positive responses, some accounting firms told the FASB that the proposal could lead to abuse. Specifically, they raised concerns that it might undo post-Enron accounting reforms and help businesses hide liabilities from their balance sheets.

Comments on the proposal to reorganize the consolidation guidance (Proposed ASU No. 2017-280) are due by December 4. The FASB is likely to address the feedback on both proposals at the same time and finalize them in tandem.

Effective date

The effective date for the proposed changes will be set once the FASB decides to issue them as a final standard. But the FASB would prefer to have companies implement the changes in Proposed ASU No. 2017-280 at the same time as the amendments in ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, with the same transition method.

ASU No. 2015-02 was issued in February 2015 with a 2016 effective date for public companies and a 2017 effective date for private ones. Businesses that have already adopted the changes in ASU No. 2015-02 will have to apply the changes in Proposed ASU No. 2017-280 by adjusting results from prior periods starting with the fiscal year in which they adopted the changes in the 2015 amendments, through what the accounting board calls retrospective application.

Sidebar: Consolidation: A double-edged sword

After the 2002 Enron accounting scandal, the Financial Accounting Standards Board (FASB) revised its guidance to prevent other companies from hiding liabilities in off-balance-sheet vehicles. But the revised consolidation guidance is considered complicated even for experts in the field.

Private companies also have complained that the guidance is burdensome to them and doesn’t help  their stakeholders. The brother-sister entities private companies set up aren’t designed to mislead investors or mask debts. Rather, they’re for common tax and estate planning purposes. Yet the nuances of the VIE guidance often result in private companies erring on the side of consolidation. And the consolidated financials frustrate lenders, who would rather see individual balance sheets.

The FASB is trying to toe a fine line: It wants to provide investors and lenders with transparent financial information. But it doesn’t want its guidance to result in unnecessarily complicated or costly financial reporting.

© 2017