On October 31, 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2018-17, Targeted Improvements to Related Party Guidance for Variable Interest Entities, which provides private companies an alternative to not apply variable interest entity (VIE) guidance to certain common control arrangements. Essentially, the amendments in ASU 2018-17 expand and supersede the private company alternative provided by ASU 2014-07, Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements (A Consensus of the Private Company Council), permitting private companies to apply the new alternative to all qualifying common control arrangements (not just leasing arrangements).
Private Company Accounting Alternative
Currently, U.S. GAAP requires an entity to consolidate another entity in which it has a controlling financial interest. There are two primary models for assessing whether there is a controlling financial interest—the voting interest model and the VIE model. Under the voting interest model, the principle for a controlling financial interest is contractual or other legal arrangements that provide ownership of a majority voting interest. Under the VIE model, an entity is deemed to have a controlling financial interest when it has both the power to direct the activities of the entity and the obligation to absorb losses or the right to receive benefits of the entity.
Under this new alternative (ASU 2014-17), a private company, at its option, would be exempt from applying the VIE model to such arrangements when certain criteria are met (see below). As a result, a private company electing to adopt this alternative would no longer consolidate the legal entity in its financial statements. If a private company elects this alternative, it would be required to disclose additional information about how it is involved with, and exposed to risks of, the entity under common control. In addition, companies within the scope of this option would continue to apply other applicable guidance, such as that related to leases, guarantees, and related party transactions.
Under the amendments in ASU 2018-17, a legal entity need not be evaluated by a private company (reporting entity) under the VIE model if all the following criteria are met:
- The reporting entity and the legal entity are under common control.
- The reporting entity and the legal entity are not under common control of a public business entity (PBE).
- The legal entity under common control is not a PBE.
- The reporting entity does not directly or indirectly have a controlling financial interest in the legal entity when considering the voting interest model (the VIE model should not be applied when making this determination).
Applying this accounting alternative is an accounting policy election. If a private company elects to apply this accounting alternative, it should apply it to all legal entities if criteria (a) through (d) are met. In addition, a private company is required to apply other consolidation guidance, specifically the voting interest entity model.
The term “common control” is not defined in U.S. GAAP. For purposes of applying the private company alternative, the FASB indicated that the term common control should be broader than what the SEC observed in EITF Issue No. 02-5, Definition of “Common Control” in Relation to FASB Statement No. 141. (Some private companies currently look to the SEC’s observations in EITF Issue No. 02-5 to determine common control, but the EITF never reached a final consensus on that Issue). The FASB expects that arrangements that are currently considered to be under common control will continue to be under common control in other areas of U.S. GAAP.
Elliott Davis Observation: A private company still has the option to present combined financial statements for entities under common control.
A private company (reporting entity) that elects the accounting alternative must provide the following disclosures:
- The nature and risks associated with a reporting entity’s involvement with the legal entity under common control.
- How a reporting entity’s involvement with the legal entity under common control 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 statement of financial position resulting from its involvement with the legal entity under common control.
- The reporting entity’s maximum exposure to loss resulting from its involvement with the legal entity under common control. If the reporting entity’s maximum exposure to loss resulting from its involvement with the legal entity under common control cannot be quantified, that fact should be disclosed.
- If the reporting entity’s maximum exposure to loss (as required by (d)) exceeds the carrying amount of the assets and liabilities as described in (c), qualitative and quantitative information to allow users of financial statements to understand the excess exposure. That information should include, but is not limited to, the terms of the arrangements, considering both explicit and implicit arrangements, that could require the reporting entity to provide financial support (for example, implicit guarantee to fund losses) to the legal entity under common control, including events or circumstances that could expose the reporting entity to a loss.
In making these disclosures, the private company (reporting entity) should consider exposures through implicit guarantees, based on the facts and circumstances. Those facts and circumstances may include whether:
- There is an economic incentive for the private company to act as a guarantor or to make funds available.
- Such actions have happened in similar situations in the past.
Further, the disclosures under this alternative are required to be disclosed in combination with the disclosures required by other topics (for example, FASB ASC 460, Guarantees, FASB ASC 840, Leases, and FASB ASC 850, Related Party Disclosures) about the lessor. The disclosures could be made by aggregating all disclosures in a single note or by including cross-references within the notes to financial statements.
Other Disclosure Considerations
Disclosure of New Guidance before Effective Date
When new accounting guidance has been issued but is not yet effective as of the balance sheet date, companies often disclose the issuance of the new accounting guidance, as follows:
- Existence of the new accounting guidance
- Date the entity must adopt the new guidance or, if early adoption is permitted, the date that it plans to adopt it
- Method of adoption (e.g., retrospective application)
- Impact of new guidance on reported financial position and results of operations
The following is an example of this disclosure for the new accounting alternative if the private company is not adopting the guidance early:
ASU 2018-17, Applying Variable Interest Entities Guidance to Common Control Arrangements
In October 2018, the FASB amended the Consolidation topic of the Accounting Standards Codification. Under the amended guidance, a nonpublic entity has the option to exempt itself from applying the variable interest entity consolidation model to qualifying common control arrangements. The amendments will be effective for the Company for annual periods beginning after December 15, 2020, and interim periods within annual periods beginning after December 15, 2021, with early adoption permitted. The Company will apply a full retrospective approach in which financial statements for each individual prior period presented and the opening balances of the earliest period presented are adjusted to reflect the period-specific effects of applying the amendments.
Disclosure of Change in Accounting Principle
According to FASB ASC 250, Accounting Changes and Error Corrections, certain information should be disclosed in the fiscal period in which a change in accounting principle is made.
Elliott Davis Observation: An entity that issues interim financial statements should provide the required disclosures in the financial statements of both the interim period of the change and the annual period of the change.
Generally, reporting entities are allowed to change accounting principles only if the change is required through amendments to the ASC or when reporting entities can justify the use of an allowable alternative accounting principle on the basis that it is preferable. However, private companies initially adopting the accounting alternative do not need to establish preferability under ASC 250, sincethe FASB intends for the use of the alternatives to be entirely elective.
Elliott Davis Observation: If a private company makes the initial election in the year of adoption and then decides in a later reporting period to change that election, the preferability criterion in ASC 250 would need to be satisfied. In addition, the change would have to be accounted for retrospectively.
The following is an example of the disclosure of a change in accounting principle for the new accounting alternative in the period of adoption:
ASU 2018-17, Applying Variable Interest Entities Guidance to Common Control Arrangements
In October 2018, the FASB amended the Consolidationtopic of the Accounting Standards Codification. Under the amended guidance, a nonpublic entity has the option to exempt itself from applying the variable interest entity (VIE) consolidation model to qualifying common control arrangements. The amendments are effective for annual periods beginning after December 15, 2020, and interim periods within annual periods beginning after December 15, 2021, with early adoption permitted. The Company adopted the amended guidance and elected to exempt itself from applying the VIE consolidation model to qualifying common control arrangements in . The financial statements for the year ended [December 31, 2018] have been adjusted to reflect the period-specific effects of applying the amendments.
Accounting Policy Disclosures
Use of the new accounting alternative should be considered an accounting policy election in much the same manner as other policy choices within U.S. GAAP. ASC 235, Notes to Financial Statements, provides guidance about policy note disclosures. Using the accounting alternative would typically result in significant differences in the financial statements compared to financial statements that do not include the alternative. As a result, policy note disclosures need to be clear as to the accounting approach used when alternative accounting treatments are available.
Elects PCC Alternative
The Company does not apply the variable interest entity consolidation model to its qualifying common-control arrangements.
Does Not Elect PCC Alternative
The Company accounts for the investments it makes in certain legal entities in which equity investors do not have (1) sufficient equity at risk for the legal entity to finance its activities without additional subordinated financial support, or (2) as a group, the holders of the equity investment at risk do not have either the power, through voting or similar rights, to direct the activities of the legal entity that most significantly impact the entity’s economic performance, or (3) the obligation to absorb the expected losses of the legal entity or the right to receive expected residual returns of the legal entity. These certain legal entities are referred to as “variable interest entities” or “VIEs.”
The Company would consolidate the results of any such entity in which it determined that it had a controlling financial interest. The Company would have a “controlling financial interest” in such an entity if the Company had both the power to direct the activities that most significantly affect the VIE’s economic performance and the obligation to absorb the losses of, or right to receive benefits from, the VIE that could be potentially significant to the VIE. On a quarterly basis, the Company reassesses whether it has a controlling financial interest in any investments it has in these certain legal entities.
Effective Date and Transition
The amendments in ASU 2018-17 are effective for a private company for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. Entities are required to apply the amendments in ASU 2018-17 retrospectively with a cumulative-effect adjustment to retained earnings at the beginning of the earliest period presented. Early adoption is permitted.
ASU 2018-17 provides practicability provisions to consolidate and deconsolidate a legal entity upon initial adoption of the amendments. If a reporting entity is required to deconsolidate a legal entity due to the initial application of the amendments in ASU 2018-17, the initial measurement of any retained interest in the deconsolidated former subsidiary depends on whether the determination of its carrying amount is practicable.
- If determining the carrying amount is practicable, the reporting entity initially measures any retained interest in the deconsolidated former subsidiary at its carrying amount at the date the amendments in ASU 2018-17 first apply.
- If determining the carrying amount is not practicable, any retained interest in the deconsolidated former subsidiary should be measured at fair value at the date the amendments in ASU 2018-17 first apply.
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