Way, way back in 2002, the FASB responded to the Enron debacle by issuing the infamous accounting standard referred to as FIN46. While the noble goal was to curtail the ability of companies to keep potential liabilities off their balance sheets (off-balance sheet risks), the pronouncement probably created more angst than any other standard for nonpublic companies. In addition, the requirement to consolidate commonly owned entities that met the definition of a “Variable Interest Entity” with the primary operating entity financial statements often convoluted the financial reporting for users, both internal and third-party.
The common scenario for private companies was a commonly owned real estate entity holding a rental asset with the only business activity being to lease that real estate asset to the commonly owned operating company for the conduct of its operations. Under this simple and very frequent arrangement, the financial statements of the operating entity and the real estate entity usually required consolidation.
The FASB provided some relief from this requirement to private companies in 2014 through an accounting policy election (available only to private companies) to not consolidate leasing entities under common control if certain common and generally present criteria are met. Many private companies took advantage of this relief as soon as it became available. Generally, the companies’ bankers and other users preferred to review financial statements on a separate company basis, because the operations of the entities are so dissimilar.
Targeted Improvements to Related Party Guidance for Variable Interest Entities
In October 2018, the FASB issued ASU No. 2018-17 “Consolidations (Topic 810) – Targeted Improvements to Related Party Guidance for Variable Interest Entities”, which allows the existing private company accounting policy alternative to not consolidate to be applied to ALL qualifying commonly controlled entities, not just common-control leasing entities.
What does it take to qualify?
- The reporting entity and other entity(ies) are under common control
- None of the entities are, or are under the common control of, a public business entity
- The reporting entity does not, directly or indirectly, have a controlling voting interests
As a reminder, this standard, as well as the related standards that preceded it, apply only to legal entities. Additionally, this accounting policy, if elected, must be applied to all legal entities if the criteria are met. In other words, it is not OK to consolidate some and not others meeting the same criteria. Regardless, a reporting entity that elects this accounting alternative can still present combined (versus consolidated) financial statements if users view that presentation as more meaningful for specific purposes.
This new VIE guidance is effective for calendar year end 2021 financial statements applied retrospectively through all periods presented with a cumulative-effect adjustment to retained earnings at the beginning of the earliest year presented. As with most new standards issued, early adoption is permitted. Expect most private companies to adopt as soon as possible, thus putting the VIE chapter in private company financial reporting to an end.