A private company with a variable interest in another entity needs to understand the accounting requirements for consolidating that entity’s financial results within its own reporting.
What is a Variable Interest Entity?
A variable interest entity (VIE) is a legal structure in which a company, known as a “reporting entity” in accounting guidance, has a controlling interest in another business, and that interest exposes or entitles the reporting entity to the economic risks or rewards of the other organization.
Typical arrangements using a VIE structure include:
- The owner of a reporting entity setting up another entity to conduct business in another geographic region without having a legal ownership relationship to the reporting entity.
- The owner of the reporting entity owning a building under a separate entity with which the reporting entity has a leasing relationship.
- Other off-balance-sheet activities.
VIE Consolidation Rules and Private Company Election Impacts
Under U.S. GAAP, ASC 810 defines requirements for reporting entities to determine how to consolidate the financial results of both organizations under the voting interest and variable interest models.
In some circumstances, private companies may elect not to consolidate VIE results, but companies considering this election need to understand the requirements, and the potential implications of not consolidating, to make the best choice for their situation.
For example, a private company whose strategic plans include a public offering in the future may choose to consolidate its VIE results to avoid having to later unwind the election not to. Because public companies are required to consolidate VIE results, a private company that plans to become public should follow the same VIE accounting guidance as a public business entity.
VIE Reporting Considerations
Reporting entities shall evaluate entities for which the company has a variable interest under ASC 810 to determine if consolidation is appropriate. After all variable interests are identified, a company shall first use the variable interest model, then the voting interest model, to determine if consolidation is required.
- Under the Variable Interest Model: A company evaluates whether an entity qualifies as a VIE and determines the “primary beneficiary” of the VIE. This model seeks to identify who has controlling financial interest in an entity, rather than focusing on legal ownership only. Any entities identified to be the primary beneficiary of a VIE under the variable interest model shall be consolidated for financial reporting.
- Under the Voting Interest Model: A company evaluates whether the reporting entity has a controlling financial interest in an entity. This is typically based on the concept that a reporting entity should have the right to make significant financial and operating decisions, and often defined as more than 50% legal ownership.
Any entities identified as having majority ownership under the voting interest model shall be consolidated for financial reporting. Entities scoped out of the variable interest model shall be evaluated under the voting interest model.
The Private Company Exception
In October 2018, the FASB issued guidance allowing private companies to make an accounting policy election to forego applying VIE guidance when certain criteria are met:
- The reporting entity and the VIE are under common control.
- The reporting entity and the VIE are not under common control of a public business entity.
- The VIE under common control is not a public business entity.
- The reporting entity does not directly or indirectly have a controlling financial interest in the VIE under the guidance.
This policy election must be applied to all current and future legal entities under common control that meet the specified criteria. The alternative cannot be applied to some common control arrangements and not to others.
To determine if the private company (the reporting entity) and the VIE are under common control of a parent for the purpose of applying this guidance, reporting entities would only consider a parent’s voting interests in the private company and the legal entity.
Disclosure Requirements
A private company is required to provide detailed disclosures about its involvement with, and exposure to, a VIE under common control. If the reporting entity elects not to evaluate its variable interests, it must provide an explanation that, based on the ownership structure and guidance under the Voting Interest Model, management has determined its VIEs are not are not appropriate for consolidation. As such, the nature of the relationship, details of transactions with the entity, and other relevant information will be disclosed in the financial statements.
If the election is not taken, common disclosures include:
- The nature and risks associated with a reporting entity’s involvement with the VIE.
- How a reporting entity’s involvement with the VIE affects the reporting entity’s financial position, financial performance, and cash flows.
- The carrying amounts and classification of the assets and liabilities in the reporting entity’s balance sheet resulting from its involvement with the VIE.
- The reporting entity’s maximum exposure to loss resulting from its involvement with the VIE (typically determined to be the debt balance for leased property).
- If the reporting entity’s maximum exposure to loss resulting from its involvement with the VIE cannot be quantified, that fact should be disclosed.
- If the reporting entity’s maximum exposure to loss exceeds the carrying amount of the assets and liabilities, information to allow users of financial statements to understand the excess exposure. That information should include terms that could require the reporting entity to provide financial support to the VIE.
In applying the disclosure guidance, a reporting entity under common control should consider potential exposures through implicit guarantees. For instance, if they have an economic incentive to act as a guarantor or to make funds available to the VIE. To learn more about VIE consolidation and the optional elections available to private companies, contact us.
