Financial reporting developments A comprehensive guide

Consolidation Determination of a controlling financial interest and accounting for changes in ownership interests (after the adoption of ASU 2015-02)

September 2017

To our clients and other friends

This Financial reporting developments (FRD) publication is designed to help you understand the financial

reporting issues associated with applying the consolidation models and consolidation procedure.

The guidance on applying the Variable Interest Model or the Voting Model is complex, and knowing when

and how to apply each model can be challenging. Consolidation evaluations always begin with the Variable

Interest Model, which applies to all entities, with certain limited exceptions. The Variable Interest Model

focuses on identifying the reporting entity with power to make the decisions that most significantly

impact the economic performance of an entity being evaluated for consolidation. That power may be

exercisable through equity interests or other means. It also requires determining whether a reporting

entity with power has benefits, which means the obligation to absorb losses or the right to receive

benefits from an entity that potentially could be significant to the entity.

This edition includes excerpts from and references to the FASBs Accounting Standards Codification

(ASC), issued by the Financial Accounting Standards Board (FASB or Board), interpretive guidance and

examples. We also have updated the content to reflect recent standard-setting activities related to the

evaluation of indirect interests as part of the primary beneficiary analysis (Accounting Standards Update

(ASU) 2016-17), the application of the Voting Model for not-for-profit entities (ASU 2017-02) and the

application of gains and losses from the derecognition of nonfinancial assets (ASC 610-20) and to

provide further clarifications and enhancements to our interpretative guidance. See Appendix C for a

summary of updates.

In June 2017, the FASB proposed allowing private companies to make an accounting policy election to

not apply the Variable Interest Model to certain common control arrangements. The proposal also would

reduce the circumstances in which a decision maker or service provider concludes that its fees constitute

a variable interest. The proposal would eliminate todays most closely associated test and require

entities to consider a new set of factors to determine which party in a related party group, if any, should

consolidate a variable interest entity (VIE). For additional information, see our To the Point publication,

The FASB proposes more changes to the consolidation guidance. Additionally, in September 2017, the

FASB proposed reorganizing its consolidation guidance in a new topic, ASC 812, which would separately

address variable interest entities and voting interest entities in response to stakeholders concerns that

todays guidance is difficult to navigate. The proposal also would move the guidance on the consolidation

of entities controlled by contract to ASC 958, Not-for-Profit Entities, and clarify certain aspects of the

consolidation guidance. We encourage readers to monitor developments in these areas.

We hope this publication will help you understand and apply the consolidation guidance in ASC 810.

We are also available to answer your questions and discuss any concerns you may have.

September 2017

Financial reporting developments Consolidation | i

Contents

1 Overview ................................................................................................................... 1

1.1 The models ............................................................................................................................ 1

1.1.1 Variable Interest Model ................................................................................................. 1

1.1.2 Voting Model ................................................................................................................ 2

1.2 Navigating the Variable Interest Model .................................................................................... 4

1.2.1 Step 1. Does a scope exception to consolidation guidance (ASC 810) apply? .................... 4

1.2.2 Step 2. Does a scope exception to the Variable Interest Model apply? (updated September 2017) ........................................................................................... 5

1.2.3 Step 3. Does the reporting entity have a variable interest in an entity? (updated September 2017) ........................................................................................... 6

1.2.4 Step 4. Is the entity a VIE? ............................................................................................. 8

1.2.5 Step 5. If the entity is a VIE, is the reporting entity the primary beneficiary? (updated September 2017) ...................................................................... 13

1.3 Summary ............................................................................................................................ 18

2 Definitions of terms ................................................................................................. 19

2.1 Legal entity ......................................................................................................................... 19

2.2 Controlling financial interest ................................................................................................. 19

2.3 Common control .................................................................................................................. 20

2.4 Decision maker and decision-making authority ...................................................................... 22

2.5 Power ................................................................................................................................. 22

2.6 Expected losses, expected residual returns and expected variability ....................................... 22

2.7 Indirect interest (updated September 2017) ......................................................................... 23

2.8 Kick-out rights and liquidation rights ..................................................................................... 24

2.9 Participating rights .............................................................................................................. 25

2.10 Protective rights .................................................................................................................. 25

2.11 Primary beneficiary.............................................................................................................. 26

2.12 Related parties and de facto agents ...................................................................................... 26

2.13 Subordinated financial support ............................................................................................. 28

2.14 Variable interest entity ......................................................................................................... 28

2.15 Variable interests ................................................................................................................. 29

2.16 Collateralized financing entity ............................................................................................... 29

2.17 Voting interest entity ........................................................................................................... 29

2.18 Private company (updated September 2017) ........................................................................ 30

2.19 Public business entity ........................................................................................................... 30

2.20 Reporting entity and entity ................................................................................................... 31

3 Consideration of substantive terms, transactions and arrangements .......................... 32

4 Scope ...................................................................................................................... 34

4.1 Introduction ........................................................................................................................ 34

4.2 Legal entities ....................................................................................................................... 34

4.2.1 Common arrangements/entities subject to the Variable Interest Model .......................... 35

4.2.2 Portions of entities ...................................................................................................... 37

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4.2.3 Collaborative arrangements not conducted through a separate entity ............................ 38

4.2.4 Majority-owned entities ............................................................................................... 38

4.2.5 Application of Variable Interest Model to tiered structures............................................. 39

4.2.6 Fiduciary accounts, assets held in trust ........................................................................ 40

4.2.7 Series funds ................................................................................................................ 40

4.3 Scope exceptions to consolidation guidance .......................................................................... 42

4.3.1 Employee benefit plans ............................................................................................... 43

4.3.1.1 Employee benefit plans not subject to ASC 712 or 715 ....................................... 43

4.3.1.2 Employee stock ownership plans......................................................................... 44

4.3.1.3 Deferred compensation trusts (e.g., a rabbi trust) ............................................... 44

4.3.1.4 Applicability of the Variable Interest Model to the financial statements of employee benefit plans ................................................................. 45

4.3.1.5 Service providers to employee benefit plans ....................................................... 45

4.3.2 Investment companies ................................................................................................ 45

4.3.3 Governmental entities ................................................................................................. 46

4.3.3.1 Governmental financing entities ......................................................................... 46

4.3.4 Money market funds ................................................................................................... 47

4.4 Scope exceptions to the Variable Interest Model .................................................................... 48

4.4.1 Not-for-profit organizations (updated September 2017) ............................................... 51

4.4.1.1 Not-for-profit organizations used to circumvent consolidation ............................. 52

4.4.1.2 Not-for-profit organizations as related parties ..................................................... 53

4.4.2 Separate accounts of life insurance reporting entities ................................................... 53

4.4.3 Information availability ................................................................................................ 53

4.4.4 Business scope exception ............................................................................................ 54

4.4.4.1 Definition of a business (updated September 2017) ............................................ 55

4.4.4.2 Significant participation in the design or redesign of an entity .............................. 56

4.4.4.2.1 Determining whether an entity is a joint venture .................................. 56

4.4.4.2.2 Determining whether an entity is a franchisee ..................................... 57

4.4.4.3 Substantially all of the activities of an entity either involve or are conducted on behalf of a reporting entity ............................................................ 58

4.4.4.4 A reporting entity and its related parties have provided more than half of an entitys subordinated financial support ................................................. 59

4.4.5 Private company accounting alternative (updated September 2017) ............................. 60

5 Evaluation of variability and identifying variable interests .......................................... 62

5.1 Introduction ........................................................................................................................ 62

5.2 Step-by-step approach to identifying variable interests .......................................................... 63

5.2.1 Step 1: Determine the variability an entity was designed to create and distribute .............. 64

5.2.1.1 Consideration 1: What is the purpose for which the entity was created? ............... 65

5.2.1.2 Consideration 2: What is the nature of the risks in the entity? .............................. 65

5.2.1.2.1 Certain interest rate risk.................................................................... 66

5.2.1.2.2 Terms of interests issued ................................................................... 68

5.2.1.2.3 Subordination ................................................................................... 68

5.2.2 Step 2: Identify variable interests ................................................................................. 69

5.2.2.1 Consideration 1: Which variable interests absorb the variability designated in Step 1? ......................................................................................... 70

5.2.2.2 Consideration 2: Is the variable interest in a specified asset of a VIE, a silo or a VIE as a whole? ............................................................................ 72

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5.3 Quantitative approach to identifying variable interests ........................................................... 72

5.4 Illustrative examples of variable interests .............................................................................. 73

5.4.1 Equity investments ...................................................................................................... 73

5.4.1.1 Interests held by employees ............................................................................... 73

5.4.2 Beneficial interests and debt instruments ..................................................................... 74

5.4.3 Trust preferred securities ............................................................................................ 75

5.4.4 Derivative instruments ................................................................................................ 78

5.4.4.1 Common derivative contracts ............................................................................. 80

5.4.4.2 Forward contracts .............................................................................................. 82

5.4.4.3 Total return swaps ............................................................................................. 82

5.4.4.4 Embedded derivatives ........................................................................................ 84

5.4.5 Financial guarantees, written puts and similar obligations ............................................. 87

5.4.6 Purchase contracts ..................................................................................................... 88

5.4.7 Operating leases ......................................................................................................... 89

5.4.7.1 Private company accounting alternative (updated September 2017) ................... 90

5.4.8 Lease prepayments ..................................................................................................... 90

5.4.9 Local marketing agreements and joint service agreements in the broadcasting industry .................................................................................................. 90

5.4.9.1 Local marketing agreements .............................................................................. 90

5.4.9.2 Joint service agreements ................................................................................... 91

5.4.10 Purchase contracts for real estate ............................................................................... 91

5.4.11 Netting or offsetting contracts ..................................................................................... 92

5.4.12 Implicit variable interests ............................................................................................. 94

5.4.13 Fees paid to decision makers or service providers ......................................................... 97

5.4.13.1 Conditions (a) and (d): Fees are commensurate with the level of effort required and include only customary terms and conditions ....................... 100

5.4.13.2 Condition (c): Other interests held by a decision maker or service provider ......... 102

5.4.13.2.1 Interests held by related parties when evaluating fees paid to a decision maker or service provider (updated September 2017) ........... 105

5.4.13.2.2 Interests held by employees when evaluating fees paid to a decision maker or service provider ...................................................... 108

5.4.13.3 Fees that expose a reporting entity to risk of loss .............................................. 109

5.4.13.4 Reconsideration of a decision makers or service providers fees as variable interests ............................................................................................. 109

5.5 Variable interests in specified assets ................................................................................... 111

6 Silos ...................................................................................................................... 115

6.1 Introduction ...................................................................................................................... 115

6.2 Determining whether the host entity is a VIE when silos exist ............................................... 118

6.3 Effect of silos on determining variable interests in specified assets ....................................... 121

6.3.1 Relationship between specified assets and silos .......................................................... 123

7 Determining whether an entity is a VIE .................................................................... 124

7.1 Introduction ...................................................................................................................... 124

7.2 The entity does not have enough equity to finance its activities without additional subordinated financial support ............................................................................ 124

7.2.1 Forms of investments that qualify as equity investments ............................................. 126

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7.2.2 Determining whether an equity investment is at risk ................................................... 128

7.2.2.1 Equity investment participates significantly in both profits and losses ................ 128

7.2.2.2 Equity interests that were issued by the entity in exchange for subordinated interests in other VIEs ................................................................. 130

7.2.2.3 Amounts provided to the equity investor directly or indirectly by the entity or by other parties involved with the entity ........................................ 130

7.2.2.4 Amounts financed for the equity holder directly by the entity or by other parties involved with the entity ................................................................ 134

7.2.2.5 Other examples of determining equity investments at risk ................................. 136

7.2.3 Methods for determining whether an equity investment at risk is sufficient .................. 139

7.2.3.1 10% test a misnomer ..................................................................................... 140

7.2.3.2 The entity can finance its activities without additional subordinated financial support .............................................................................................. 140

7.2.3.3 The entity has at least as much equity invested as other entities that hold only similar assets of similar quality in similar amounts

and operate with no additional subordinated financial support ........................... 141

7.2.3.4 The amount of equity invested in the entity exceeds the estimate of the entitys expected losses based on reasonable quantitative evidence ................... 142

7.2.3.5 Illustrative examples ........................................................................................ 143

7.2.4 Development stage entities (updated September 2017) .............................................. 145

7.3 The equity holders, as a group, lack the characteristics of a controlling financial interest ....... 145

7.3.1 The power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entitys economic performance ...................... 146

7.3.1.1 Step 1: Consider purpose and design ................................................................ 148

7.3.1.2 Step 2: Identify the activities that most significantly impact the entitys economic performance ......................................................................... 148

7.3.1.3 Step 3: Identify how decisions about significant activities are made and the party or parties that make them ........................................................... 148

7.3.1.3.1 Corporations and similar entities ...................................................... 149

7.3.1.3.2 Limited partnerships and similar entities (updated September 2017) .. 152

7.3.1.3.3 Kick-out rights ................................................................................ 154

7.3.1.3.4 Participating rights ......................................................................... 157

7.3.1.3.5 Protective rights ............................................................................. 158

7.3.1.4 Effect of decision makers or service providers when evaluating ASC 810-10-15-14(b)(1) .................................................................................. 160

7.3.1.5 Franchise arrangements when evaluating ASC 810-10-15-14(b)(1) ................... 161

7.3.1.6 Limited liability companies ............................................................................... 162

7.3.2 Obligation to absorb an entitys expected losses ......................................................... 164

7.3.2.1 Common arrangements that may protect equity investments at risk from absorbing losses ....................................................................................... 167

7.3.2.2 Disproportionate sharing of losses .................................................................... 169

7.3.2.3 Variable interests in specified assets or silos ..................................................... 169

7.3.2.4 Illustrative examples ........................................................................................ 170

7.3.3 Right to receive an entitys expected residual returns .................................................. 171

7.3.3.1 Disproportionate sharing of profits ................................................................... 174

7.3.3.2 Variable interests in specified assets or silos ..................................................... 174

7.3.3.3 Illustrative examples ........................................................................................ 175

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7.4 Entity established with non-substantive voting rights ........................................................... 176

7.4.1 Condition 1: Disproportionate votes to economics ...................................................... 178

7.4.2 Condition 2: Substantially all of an entitys activities either involve or are conducted on behalf of an investor that has disproportionately few voting rights ........... 179

7.4.3 Related party and de facto agent considerations ......................................................... 182

7.4.4 Illustrative examples ................................................................................................. 183

7.5 Initial determination of VIE status ....................................................................................... 185

8 Primary beneficiary determination .......................................................................... 187

8.1 Introduction ...................................................................................................................... 187

8.2 Power ............................................................................................................................... 188

8.2.1 Step 1: Consider purpose and design .......................................................................... 189

8.2.1.1 Involvement with the design of the VIE ............................................................. 189

8.2.2 Step 2: Identify the activities that most significantly impact the VIEs economic performance .............................................................................................. 189

8.2.3 Steps 3 and 4: Identify how decisions about significant activities are made and the party or parties that make them ..................................................................... 191

8.2.3.1 Related party considerations ............................................................................ 193

8.2.3.2 Situations in which no party has the power over a VIE ....................................... 193

8.2.3.3 Shared power .................................................................................................. 194

8.2.3.4 Power conveyed through a board of directors and no one party controls the board ............................................................................................ 195

8.2.3.5 Multiple unrelated parties direct the same activities that most significantly impact the VIEs economic performance ........................................ 196

8.2.3.6 Multiple unrelated parties direct different activities that most significantly impact the VIEs economic performance ........................................ 196

8.2.3.6.1 Different parties with power over the entitys life cycle ...................... 197

8.2.3.6.2 Evaluating rights held by the board of directors and an operations manager in an operating entity ........................................ 198

8.2.4 Kick-out rights, participating rights and protective rights ............................................. 200

8.2.4.1 Kick-out rights ................................................................................................. 200

8.2.4.2 Participating rights ........................................................................................... 201

8.2.4.3 Protective rights .............................................................................................. 202

8.2.4.4 Potential voting rights (e.g., call options, convertible instruments) ..................... 203

8.3 Benefits ............................................................................................................................. 203

8.3.1 Fees paid to decision makers or service providers ....................................................... 205

8.3.2 Evaluating disproportionate power and benefits ......................................................... 206

8.4 Other frequently asked questions ....................................................................................... 208

9 Determining the primary beneficiary in a related party group ................................... 210

9.1 Introduction (updated September 2017) ............................................................................. 210

9.2 Single decision maker (updated September 2017) ............................................................... 211

9.3 Shared power among multiple related parties ...................................................................... 216

9.4 Multiple decision makers within the related party group ....................................................... 216

9.5 Determining which party is most closely associated with a VIE .............................................. 218

9.5.1 Principal-agency relationship ..................................................................................... 218

9.5.2 Relationship and significance of a VIEs activities to members of a related party group .............................................................................................................. 218

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9.5.3 Exposure to variability associated with the anticipated economic performance of the VIE ............................................................................................. 220

9.5.4 Purpose and design ................................................................................................... 220

9.6 One member of a related party group not clearly identified .................................................. 220

10 Related parties and de facto agents ........................................................................ 222

10.1 Related parties .................................................................................................................. 222

10.2 De facto agents ................................................................................................................. 222

10.2.1 A party that has an agreement that it cannot sell, transfer or encumber its interests in the VIE without the prior approval of the reporting entity ...................... 223

10.2.1.1 One-sided versus two-sided restrictions ............................................................ 224

10.2.1.2 Common contractual terms .............................................................................. 224

10.2.1.2.1 Right of first refusal ........................................................................ 224

10.2.1.2.2 Right of first offer ........................................................................... 225

10.2.1.2.3 Approval cannot be unreasonably withheld ....................................... 225

10.2.2 A party that has a close business relationship ............................................................. 225

10.2.3 Separate accounts of insurance enterprises as potential related parties ....................... 225

11 Voting Model and consolidation of entities controlled by contract ............................. 226

11.1 Introduction ...................................................................................................................... 226

11.1.1 SEC regulations on consolidation ............................................................................... 227

11.1.2 Scope of the Voting Model ......................................................................................... 227

11.2 Voting Model: Controlling financial interests ........................................................................ 229

11.2.1 Voting Model: Consolidation of corporations ............................................................... 229

11.2.1.1 Consolidation of a not-for-profit organization other than a partnership .............. 229

11.2.2 Voting Model: Control of limited partnerships and similar entities ................................ 230

11.2.2.1 Not-for-profits that are the general partner of a for-profit limited partnership (added September 2017) ............................................................... 232

11.2.3 Circumstances when more than a simple majority is required for control ...................... 233

11.2.4 Evaluating indirect control ......................................................................................... 233

11.2.5 Evaluating call options, convertible instruments and other potential voting rights ............ 235

11.2.6 Control when owning less than a majority of voting shares .......................................... 235

11.2.6.1 Evaluating size of minority investment relative to other minority investors ......... 236

11.3 Exceptions to consolidation by a reporting entity holding a majority of voting stock or limited partnership interests .................................................................................. 236

11.3.1 Foreign currency exchange restrictions ...................................................................... 237

11.3.2 Evaluating the effect of noncontrolling rights .............................................................. 238

11.3.2.1 Participating rights ........................................................................................... 240

11.3.2.1.1 Evaluating the substance of noncontrolling rights .............................. 242

11.3.2.2 Protective rights .............................................................................................. 246

11.3.2.3 Assessment of noncontrolling rights ................................................................. 247

11.4 Control by contract (updated September 2017) .................................................................. 247

12 Reconsideration events .......................................................................................... 249

12.1 Reconsideration of whether an entity is a VIE ...................................................................... 249

12.1.1 Common VIE reconsideration events .......................................................................... 250

12.1.1.1 Conversions of accounts receivables into notes ................................................. 252

12.1.1.2 Transfer of an entitys debt between lenders ..................................................... 252

12.1.1.3 Asset acquisitions and dispositions ................................................................... 252

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12.1.1.4 Distributions to equity holders .......................................................................... 253

12.1.1.5 Replacement of temporary financing with permanent financing ......................... 253

12.1.1.6 Adoption of accounting standards .................................................................... 254

12.1.1.7 Incurrence of losses that reduce the equity investment at risk ........................... 254

12.1.1.8 Acquisition of a business that has a variable interest in an entity ........................ 254

12.1.1.9 Bankruptcy ...................................................................................................... 255

12.1.1.10 Loss of power or similar rights .......................................................................... 255

12.2 Reconsideration of whether a reporting entity is the primary beneficiary .............................. 255

13 Initial measurement and consolidation .................................................................... 257

13.1 Introduction ...................................................................................................................... 257

13.2 Primary beneficiary and VIE are under common control ....................................................... 257

13.3 Primary beneficiary of a VIE that is a business ..................................................................... 257

13.4 Primary beneficiary of a VIE that is not a business ............................................................... 258

13.4.1 Contingent consideration in an asset acquisition when the entity is a VIE that does not constitute a business ............................................................................ 259

13.5 Primary beneficiary of a VIE that is a collateralized financing entity ...................................... 260

13.5.1 Measurement alternative for consolidated collateralized financing entities ................... 260

13.6 Other considerations .......................................................................................................... 264

13.6.1 Pro forma and Form 8-K reporting requirements ........................................................ 264

13.6.2 SEC Regulation S-X Rules 3-05 and 3-14 and Form 8-K reporting requirements ........... 264

13.7 Pre-existing hedge relationships under ASC 815 ................................................................. 265

13.8 Continuation of leveraged lease accounting by an equity investor in a deconsolidated lessor trust ................................................................................................. 265

14 Consolidated financial statements .......................................................................... 266

14.1 Consolidation procedure .................................................................................................... 266

14.1.1 Acquisition through a single investment ..................................................................... 266

14.1.2 Acquisition through multiple investments ................................................................... 266

14.2 Proportionate consolidation ............................................................................................... 267

14.3 Differing fiscal year-ends between parent and subsidiary ..................................................... 269

14.4 Using subsidiary financial statements prepared as of an earlier period end for consolidation procedure in circumstances when the subsidiary has the same

fiscal year-end as the parent ............................................................................................... 270

14.5 Subsidiarys accounting basis is not US GAAP ...................................................................... 271

14.6 Differing accounting policies between parent and subsidiary ................................................ 271

15 Nature and classification of a noncontrolling interest ............................................... 272

15.1 Noncontrolling interests ..................................................................................................... 272

15.1.1 Noncontrolling interests in consolidated variable interest entities ................................ 273

15.2 Equity contracts issued on the stock of a subsidiary ............................................................. 273

16 Attribution of net income or loss and comprehensive income or loss ......................... 275

16.1 Attribution procedure ........................................................................................................ 275

16.1.1 Substantive profit sharing arrangements (updated September 2016) .......................... 275

16.1.2 Attribution of losses in excess of noncontrolling interests carrying amount ................. 280

16.1.2.1 Distributions in excess of the noncontrolling interests carrying amount ............. 280

16.1.3 Attribution to noncontrolling interests held by preferred shareholders ......................... 281

16.1.4 Attribution of goodwill impairment (updated September 2017) ................................... 282

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16.1.5 Attributions related to business combinations before the adoption of Statement 141(R) ..................................................................................................... 283

16.1.6 Effect of attribution on a parents effective income tax rate ......................................... 284

16.1.7 Attribution of dividends payable in nonmonetary assets .............................................. 285

16.1.8 Attributions of dividends of a consolidated trust issuing trust preferred securities ........ 285

17 Intercompany eliminations ..................................................................................... 286

17.1 Procedures for eliminating intercompany balances and transactions (updated September 2017) .............................................................................................................. 286

17.1.1 Effect of noncontrolling interest on elimination of intercompany amounts .................... 288

17.1.2 Variable interest entities ............................................................................................ 288

17.1.2.1 Accounting for liabilities of a variable interest entity after initial consolidation .... 291

17.1.3 Shares of a parent held by its subsidiary ..................................................................... 292

17.1.3.1 Presentation in the subsidiarys separate financial statements ........................... 293

17.1.4 Intercompany derivative transactions ........................................................................ 293

17.2 Examples ........................................................................................................................... 293

18 Changes in a parents ownership interest in a subsidiary while control is retained ...... 306

18.1 Scope (updated September 2017) ...................................................................................... 306

18.1.1 Increases in a parents ownership interest in a subsidiary ............................................ 309

18.1.1.1 Accounting for contingent consideration ........................................................... 309

18.1.2 Decreases in a parents ownership interest in a subsidiary that is in the scope of ASC 810 without loss of control ................................................................... 310

18.1.2.1 Accounting for a stock option of subsidiary stock .............................................. 311

18.1.2.2 Scope exception for in substance real estate transactions (updated September 2017) .............................................................................. 312

18.1.2.3 Scope exception for oil and gas conveyances .................................................... 312

18.1.2.4 Decreases in ownership of a subsidiary that is not a business or nonprofit activity (updated September 2017) ................................................... 313

18.1.2.5 Issuance of preferred stock by a subsidiary ....................................................... 314

18.1.2.6 Decreases in ownership through issuance of partnership units that have varying profit or liquidation preferences ................................................... 314

18.1.2.7 Issuance of subsidiary shares as consideration in a business combination........... 315

18.1.3 Accumulated other comprehensive income considerations .......................................... 316

18.1.3.1 Accounting for foreign currency translation adjustments ................................... 317

18.1.4 Allocating goodwill upon a change in a parents ownership interest .............................. 317

18.1.5 Accounting for transaction costs incurred upon a change in a parents ownership interest .................................................................................................... 317

18.1.6 Changes in a parents ownership interest in a consolidated VIE .................................... 318

18.1.7 Chart summarizing the accounting for changes in ownership ....................................... 318

18.1.8 Income tax considerations ......................................................................................... 318

18.1.9 Noncontrolling interests in a common control transaction ........................................... 318

18.2 Examples ........................................................................................................................... 319

18.2.1 Consolidation at the acquisition date .......................................................................... 319

18.2.2 Consolidation in year of combination .......................................................................... 321

18.2.3 Consolidation after parent purchases an additional interest ......................................... 323

18.2.4 Consolidation after parent sells a portion of its interest ............................................... 324

18.2.5 Consolidation after subsidiary issues additional shares ................................................ 325

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19 Loss of control over a subsidiary or a group of assets .............................................. 327

19.1 Scope (updated September 2017) ...................................................................................... 327

19.2 Circumstances that result in a loss of control ....................................................................... 333

19.2.1 Real estate transactions (updated September 2017) .................................................. 334

19.2.2 Deconsolidation through multiple arrangements ......................................................... 335

19.2.3 Deconsolidation through a bankruptcy proceeding or governmentally imposed restrictions (updated September 2016) ........................................................ 336

19.2.4 Deconsolidation of a variable interest entity ............................................................... 336

19.3 Calculation of a gain or loss ................................................................................................ 337

19.3.1 Measuring the fair value of consideration received ...................................................... 339

19.3.1.1 Accounting for contingent consideration ........................................................... 339

19.3.2 Measuring the fair value of any retained noncontrolling investment ............................. 342

19.3.2.1 Accounting for a retained creditor interest ........................................................ 342

19.3.2.2 Subsequent accounting for a retained noncontrolling investment ...................... 343

19.3.3 Assignment of goodwill upon disposal of all or a portion of a reporting unit .................. 343

19.3.4 Accounting for accumulated other comprehensive income .......................................... 343

19.3.4.1 Foreign currency translation adjustments ......................................................... 344

19.4 Classification and presentation of a gain or loss (updated September 2016) ......................... 344

19.5 Income tax considerations related to the loss of control over a subsidiary ............................. 345

19.6 Transfers between entities under common control .............................................................. 345

19.7 Examples ........................................................................................................................... 345

19.7.1 Deconsolidation by selling entire interest .................................................................... 346

19.7.2 Deconsolidation by selling a partial interest ................................................................ 347

20 Combined financial statements ............................................................................... 350

20.1 Purpose of combined financial statements .......................................................................... 350

20.1.1 Common operations and management ....................................................................... 350

20.2 Preparing combined financial statements ............................................................................ 351

21 Parent-company financial statements ..................................................................... 353

21.1 Purpose of parent-company financial statements ................................................................ 353

21.1.1 Investments in subsidiaries ........................................................................................ 353

21.1.2 Investments in non-controlled entities ........................................................................ 354

21.1.3 Disclosure requirements ............................................................................................ 354

22 Consolidating financial statements .......................................................................... 355

22.1 Purpose of consolidating financial statements ..................................................................... 355

22.2 Guarantor financial information prepared under Rule 3-10................................................... 355

22.2.1 Form and content of guarantor financial information .................................................. 355

22.2.2 Investments in subsidiaries ........................................................................................ 359

22.2.3 Cash flow information ............................................................................................... 361

22.2.4 Disclosure requirements under Rule 3-10 ................................................................... 362

22.2.5 Example condensed consolidating financial information under Rule 3-10 ..................... 363

23 Presentation and disclosures .................................................................................. 369

23.1 Presentation of VIEs .......................................................................................................... 369

23.2 Disclosures for VIEs ........................................................................................................... 371

23.2.1 Disclosure objectives ................................................................................................. 371

23.2.2 Primary beneficiaries of VIEs ..................................................................................... 372

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Financial reporting developments Consolidation | x

23.2.3 Holders of variable interests in VIEs that are not primary beneficiaries ......................... 373

23.2.4 All holders of variable interests in VIEs ....................................................................... 374

23.2.5 Scope-related VIE disclosures .................................................................................... 375

23.2.6 Aggregation of certain VIE disclosures ....................................................................... 375

23.2.7 Public company MD&A VIE disclosure requirements .................................................... 377

23.2.8 Private company accounting alternative (updated September 2017) ........................... 377

23.2.9 Measurement alternative for consolidated collateralized financing entities ................... 377

23.3 Other procedures and disclosure requirements related to consolidation ................................ 378

23.3.1 Consolidated statements of net income and comprehensive income presentation ........... 379

23.3.2 Reconciliation of equity presentation ......................................................................... 379

23.3.2.1 Presentation of redeemable noncontrolling interests in the equity reconciliation ......................................................................................... 380

23.3.2.2 Interim reporting period requirements .............................................................. 380

23.3.3 Consolidated statement of financial position presentation ........................................... 381

23.3.4 Consolidated statement of cash flows presentation ..................................................... 381

23.3.4.1 Presentation of transaction costs in the statement of cash flows........................ 382

23.3.5 Disclosures for deconsolidation of a subsidiary in the scope of ASC 810 ....................... 382

23.4 Example ............................................................................................................................ 384

24 Effective dates and transition ................................................................................. 390

24.1 Effective dates (updated September 2017) ......................................................................... 390

24.1.1 Effective date of ASU 2015-02 .................................................................................. 390

24.1.2 Effective date for ASU 2016-17 (added September 2017) .......................................... 390

24.1.3 Effective date for ASU 2017-02 (added September 2017) .......................................... 391

24.2 Transition (updated September 2017) ................................................................................ 391

24.2.1 Transition for ASU 2015-02 ...................................................................................... 391

24.2.2 Transition for ASU 2016-17 (added September 2017) ................................................ 393

24.2.3 Transition for ASU 2017-02 (added September 2017) ................................................ 393

24.3 Recognition (updated September 2017) ............................................................................. 394

24.4 Initial measurement when a reporting entity consolidates an entity (updated September 2017) ................................................................................................ 395

24.4.1 Reconsideration events (updated September 2017) ................................................... 396

24.4.2 Fair value option (updated September 2017) .............................................................. 397

24.4.3 Practicability exceptions (updated September 2017) .................................................. 398

24.5 Initial measurement when a reporting entity deconsolidates an entity (updated September 2017) ................................................................................................ 400

24.6 Retrospective application (updated September 2017) ......................................................... 402

24.6.1 SEC reporting implications (updated September 2017) ............................................... 403

24.7 Effective date and transition for measurement alternative for consolidated collateralized financing entities ........................................................................................... 403

24.8 Effective date and transition for consolidation of development stage entities (added September 2017) ................................................................................................... 405

A Abbreviations used in this publication ...................................................................... A-1

B Index of ASC references in this publication ............................................................... B-1

C Summary of important changes ............................................................................... C-1

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Financial reporting developments Consolidation | xi

D Expected losses and expected residual returns ......................................................... D-1

D.1 Introduction ....................................................................................................................... D-1

D.2 Expected losses, expected residual returns and expected variability ...................................... D-1

D.3 Calculating expected losses and expected residual returns .................................................... D-2

D.3.1 Effect of variable interests in specified assets or silos ................................................... D-5

D.4 Allocation of expected losses and expected residual returns .................................................. D-5

D.5 Reasonableness checks ..................................................................................................... D-10

D.6 Approaches to calculate expected losses and expected returns ........................................... D-11

D.6.1 Fair value, cash flow and cash flow prime methods .................................................... D-12

D-D.6.1.1 Fair value method ........................................................................................... D-12

D.6.1.2 Cash flow method ........................................................................................... D-13

D.6.1.3 Cash flow prime method .................................................................................. D-13

D.7 Inability to obtain the information ...................................................................................... D-17

D.8 Example analysis of sufficiency of equity ............................................................................ D-17

E Private Company Council alternative for lessors in common control leasing arrangements ......................................................................................................... E-1

E.1 Overview and scope (updated September 2017) .................................................................. E-1

E.1.1 Definition of a private company and public business entity ........................................... E-3

E.2 Evaluating common control ................................................................................................. E-4

E.3 Identifying a leasing arrangement ........................................................................................ E-4

E.4 Evaluating whether activities relate to the leasing activities ................................................... E-4

E.5 Evaluating a guarantee or collateralization of a leasing entitys obligations ............................ E-5

E.6 Illustrations ........................................................................................................................ E-5

E.7 Disclosure .......................................................................................................................... E-7

E.8 Elimination of implicit variable interest guidance applicable to all entities ............................... E-8

E.9 Effective date and transition (updated September 2016) ...................................................... E-9

F Affordable housing projects ..................................................................................... F-1

F.1 Summary of the tax credit ................................................................................................... F-1

F.2 Summary of the investment ................................................................................................ F-1

F.3 Primary beneficiary considerations ...................................................................................... F-3

G Investment companies ............................................................................................ G-1

G.1 Overview ............................................................................................................................ G-1

G.1.1 Attributes of an investment company .......................................................................... G-1

G.2 Consolidation by an investment company ............................................................................. G-2

G.2.1 Master/feeder and fund of funds structures ................................................................. G-5

G.2.1.1 SEC staff views on consolidation in master/feeder and fund of funds structures ................................................................................................ G-7

G.3 Consolidation of investment companies ............................................................................... G-8

H Lot option contracts ............................................................................................... H-1

H.1 Introduction ....................................................................................................................... H-1

H.2 Background ........................................................................................................................ H-1

H.3 Determining whether a homebuilder has a variable interest in the entity ................................ H-2

H.3.1 Variable interests in specified assets ........................................................................... H-2

H.3.2 Other considerations .................................................................................................. H-2

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Financial reporting developments Consolidation | xii

H.4 Determining whether the entity is a VIE ................................................................................ H-3

H.4.1 The entity does not have sufficient equity to finance its activities without additional subordinated financial support .................................................................... H-3

H.4.2 The equity holders, as a group, lack the characteristics of a controlling financial interest ........................................................................................................ H-3

H.4.2.1 The power through voting rights or other rights to direct the activities on an entity that most significantly impact the entitys economic performance ........ H-3

H.4.2.2 Obligation to absorb the entitys expected losses ................................................ H-4

H.4.2.3 Right to receive the entitys expected residual returns ........................................ H-4

H.4.3 Entity established with non-substantive voting rights ................................................... H-4

H.5 Determining whether the homebuilder is the primary beneficiary .......................................... H-5

H.5.1 Power........................................................................................................................ H-5

H.5.2 Benefits ..................................................................................................................... H-5

H.6 Reconsideration events ....................................................................................................... H-6

H.7 Recognition and measurement ............................................................................................ H-6

H.8 Disclosures ......................................................................................................................... H-6

Contents

Financial reporting developments Consolidation | xiii

Notice to readers:

This publication includes excerpts from and references to the FASB Accounting Standards Codification

(the Codification or ASC). The Codification uses a hierarchy that includes Topics, Subtopics, Sections

and Paragraphs. Each Topic includes an Overall Subtopic that generally includes pervasive guidance for

the topic and additional Subtopics, as needed, with incremental or unique guidance. Each Subtopic

includes Sections that include numbered Paragraphs. Thus, a Codification reference includes the Topic

(XXX), Subtopic (YY), Section (ZZ) and Paragraph (PP).

Throughout this publication, references to guidance in the Codification are shown using these reference

numbers. References are also made to certain pre-Codification standards (and specific sections or

paragraphs of pre-Codification standards) in situations in which the content being discussed is excluded

from the Codification or to distinguish the Variable Interest Model under ASU 2015-02 and FAS 167

from FIN 46(R).

This publication has been carefully prepared, but it necessarily contains information in summary form

and is therefore intended for general guidance only; it is not intended to be a substitute for detailed

research or the exercise of professional judgment. The information presented in this publication should

not be construed as legal, tax, accounting or any other professional advice or service. Ernst & Young LLP

can accept no responsibility for loss occasioned to any person acting or refraining from action as a result

of any material in this publication. You should consult with Ernst & Young LLP or other professional

advisors familiar with your particular factual situation for advice concerning specific audit, tax or other

matters before making any decisions.

Portions of FASB publications reprinted with permission. Copyright Financial Accounting Standards Board, 401 Merritt 7, P.O.

Box 5116, Norwalk, CT 06856-5116, U.S.A. Copies of complete documents are available from the FASB.

Financial reporting developments Consolidation | 1

1 Overview

ASC 810 defines a subsidiary as an entity in which a parent has a controlling financial interest, either through

voting interests or other means (such as variable interests). When a reporting entity has a controlling financial

interest in an entity, it accounts for the assets, liabilities and any noncontrolling interests of that entity in

its consolidated financial statements in accordance with the consolidation principles in ASC 810-10-45.

These principles are the same for entities consolidated under the Voting Model and Variable Interest Model.

Under the traditional Voting Model, ownership of a majority voting interest is the determining factor for a

controlling financial interest. However, the Voting Model is not effective in identifying controlling financial

interests in entities that are controlled through other means. Under the Variable Interest Model, reporting

entities may be required to consolidate entities in which the power to make decisions comes from a variety

of equity, contractual or other interests, collectively known as variable interests.

By describing the model and highlighting some common misconceptions in this overview, we hope to help you

navigate through the complexity of the Variable Interest Model. Throughout this publication, we refer to the

entity evaluating another entity for consolidation as the reporting entity and the entity subject to consolidation

as the entity. Comprehensive guidance on applying the model is included in the chapters that follow.

1.1 The models

There are two primary consolidation models under US GAAP: (1) the Variable Interest Model and (2) the

Voting Model.

The Variable Interest Model applies to an entity in which the equity does not have characteristics of a

controlling financial interest. An entity that is not a variable interest entity (VIE) is often referred to as a

voting interest entity.

1.1.1 Variable Interest Model

Consolidation evaluations always begin with the Variable Interest Model, which was designed to enable a

reporting entity to determine whether an entity should be evaluated for consolidation based on variable

interests or voting interests. Regardless of what type of entity a reporting entity is evaluating for consolidation,

it should first consider the provisions of the Variable Interest Model. The Variable Interest Model applies to all

legal entities, including corporations, partnerships, limited liability companies and trusts1. Even a majority-

owned entity may be a VIE that is subject to consolidation in accordance with the Variable Interest Model.

Misconception: Operating entity

The Variable Interest Model does not apply to the entity I am evaluating because the entity is an

operating entity.

A common misconception is that the Variable Interest Model does not apply because the entity being

evaluated for consolidation is a traditional operating entity (e.g., a business). Many tend to associate

the evaluation of an operating entity with the Voting Model. The Variable Interest Model, however,

applies to all legal entities. The Codification defines a legal entity as any legal structure used to

conduct activities or to hold assets and is intentionally broad. Therefore, a traditional operating entity

must first be evaluated using the Variable Interest Model and may be a VIE.

1 There are five scope exceptions specific to the Variable Interest Model: (1) not-for-profit organizations, (2) separate accounts of life insurance companies, (3) lack of information, (4) certain legal entities deemed to be businesses and (5) a private company accounting alternative. See Section 4.4 for further details.

1 Overview

Financial reporting developments Consolidation | 2

Entities subject to the Variable Interest Model include the following:

Corporations

Partnerships

Limited liability companies

Other unincorporated entities

Majority-owned subsidiaries

Grantor trusts

Arrangements that, while established by contract, are not conducted through a separate entity are not

subject to the Variable Interest Model.

Illustration 1-1: No legal entity

Assume two companies enter into a joint marketing arrangement. They agree to collaboratively

produce marketing materials and to use their existing sales channels to market each others products

and services. Each company contractually agrees to share a specified percentage of the revenues

received from the sale of products and services made under the joint marketing arrangement to

customers of the other company. However, no separate entity is established to conduct the joint

marketing activities, and each company retains its own assets and continues to conduct its activities

separate from the other.

Analysis

Although the companies have contractually agreed to the joint arrangement, the provisions of the

Variable Interest Model do not apply to the arrangement because no separate entity has been

established to conduct the joint marketing activities.

1.1.2 Voting Model

The Voting Model generally can be subdivided into two categories: (1) consolidation of corporations and

(2) consolidation of limited partnerships and similar entities. Consolidation of corporations is based upon

whether a reporting entity owns more than 50% of the outstanding voting shares of an entity. This, of

course, is a general rule.

There are exceptions, such as when the entity is in bankruptcy or when minority shareholders have

certain approval or veto rights. Consolidation based on a majority voting interest may apply to entities

other than corporations. However, we use the term corporation to distinguish from the approach

applied to limited partnerships and similar entities.

For limited partnerships and similar entities (e.g., limited liability companies) that are not VIEs, generally,

only a single limited partner that is able to exercise substantive kick-out rights will consolidate the entity.

A general partner generally would not consolidate a limited partnership.

In addition to the Variable Interest and Voting Models, ASC 810-10 also includes a subsection,

Consolidation of Entities Controlled by Contract. This subsection provides guidance on the consolidation

of entities controlled by contract that are determined not to be VIEs. However, we believe application of

this guidance is limited because entities controlled by contract generally are VIEs. See Appendix C for

further guidance on the Voting Model and entities controlled by contract.

1 Overview

Financial reporting developments Consolidation | 3

The following chart illustrates how to generally apply consolidation accounting guidance.1

1 See Section 2.7 for a summary on recent standard setting activity associated with potential changes to the indirect interest considerations in the Variable Interest Model. 2 Consolidation is not required; however, evaluation of other US GAAP may be relevant to determine recognition, measurement or disclosure. 3 The Variable Interest Model does not apply. However, the General Subsections (i.e., the Voting Model) or the Consolidation of Entities Controlled by Contract Subsections or Subtopic 810-30 on

research and development arrangements may be relevant. 4 The ASU says a legal entity is a VIE if any of the following conditions exist:

a. The total equity investment at risk is not sufficient to permit the legal entity to finance its activities without additional subordinated financial support provided by any parties, including equity holders.

b. As a group, the holders of the equity investment at risk lack any one of the following three characteristics of a controlling financial interest:

i. The power, through voting or similar rights, to direct the activities of a legal entity that most significantly impact the entitys economic performance.

For all legal entities other than limited partnerships and similar legal entities, investors lack that power through voting rights or similar rights if no owners hold voting rights or similar rights (such as those of a common shareholder in a corporation).

For all limited partnerships and similar legal entities, partners lack that power through voting rights or similar rights if both (1) a single limited partner, a simple majority, or a lower threshold of partners voting interests with equity at risk are unable to exercise substantive kick-out rights (including liquidation rights) over the general partner(s) and (2) limited partners with equity at risk are not able to exercise substantive participating rights over the general partner(s).

ii. The obligation to absorb expected losses

iii. The right to receive expected residual returns

c. The equity investors voting rights are not proportional to the economics and substantially all of the activities of the entity either involve or are conducted on behalf of an investor that has disproportionately few voting rights.

Yes Consolidate entity

Apply other US GAAP, which may include the Voting Model3

Is there a single decision maker or is power shared?7

No

Shared Single

Yes

Start

Is the entity being evaluated for consolidation a legal entity?

No

Yes

No

Yes

Yes

No

Does a scope exception to consolidation guidance (ASC 810) apply? Employee benefit plans Governmental organizations Certain investment companies Money market funds

Does a scope exception to the Variable Interest Model apply? Not-for-profit organizations Separate accounts of life insurance companies Lack of information Certain businesses Private company accounting alternative

Does the reporting entity have a variable interest in a legal entity?

Consider whether fees paid to a decision maker or service provider represent a variable interest

Do not consolidate. Apply other US GAAP2

Do not consolidate. Apply other US GAAP2

Consider whether silos exist or whether the interests or other contractual arrangements of the entity (excluding interests in silos) qualify as variable interests in the entity as a whole2

Yes No

Is the reporting entity the primary beneficiary (i.e., does the reporting entity individually have both power and benefits)?5

Variable Interest Model

No

Do the noncontrolling shareholders or partners hold substantive participating rights, or do certain other conditions exist (e.g., legal subsidiary is in bankruptcy)?

No Yes

Do not consolidate6

No Yes

Do not consolidate2 Consolidate entity

Voting Model

Does the reporting entity, directly or indirectly, have greater than 50% of the outstanding voting shares (consider other contractual rights)?

Yes

Does the related party group collectively have characteristics of a primary beneficiary?

Apply most closely associated test

No party consolidates2

No

Does decision maker have benefits (considering both direct and indirect interests)?

Does the decision makers related party group collectively have the characteristics of the primary beneficiary?

No

Are the decision maker and its related party or parties under common control?

Yes

No

Yes

Single VI holder (not the decision maker) consolidates

Yes

No

* This provision does not apply to certain entities that invest in qualified affordable housing projects through limited partnerships

Yes

No

Are substantially all of the VIEs activities conducted on behalf of a single variable interest holder that is related party of the decision maker?*

Is the legal entity a variable interest entity? 4 Does the entity lack sufficient equity to finance its activities? Do the equity holders, as a group, lack the characteristics of

a controlling financial interest? Is the legal entity structured with non-substantive voting rights

(i.e., anti-abuse clause)?

1 Overview

Financial reporting developments Consolidation | 4

5 Power refers to the power to direct the activities of a VIE that most significantly impact the VIEs economic performance (810-10-25-38A(a)), and economics refers to the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE (810-10-25-38A(b)). For purposes of determining whether it is the primary beneficiary of a VIE, a reporting entity with a variable interest shall include its direct economic interests in the entity and its indirect economic interests in the entity held through related parties (810-10-25-38D through 38E) and shall exclude fees paid to the reporting entity that satisfy both of the following conditions: a. The fees are compensation for services provided and are commensurate with the level of effort required to provide those services. b. The compensation arrangement includes only terms, conditions or amounts that are customarily present in arrangements for similar services negotiated on an arms-length basis.

6 The Voting Model does not apply. However, the Consolidation of Entities Controlled by Contract Subsections or Subtopic 810-30 on research and development arrangements may be relevant. 7 If power is not shared but the activities that most significantly impact the VIEs economic performance are directed by multiple unrelated parties, and each party directs different activities, a reporting

entity must identify the party that has power to direct the activities that most significantly impact the entitys economic performance. That is, one party has the power (see Section 8.2.3.6).

1.2 Navigating the Variable Interest Model

As shown in the flowchart above, it helps to evaluate the Variable Interest Model in an orderly manner by

asking the following questions:

1. Does a scope exception to consolidation guidance (ASC 810) apply?

2. Does a scope exception to the Variable Interest Model apply?

3. If a scope exception does not apply, does the reporting entity have a variable interest in an entity?

4. If the reporting entity has a variable interest in an entity, is the entity a VIE?

5. If the entity is a VIE, is the reporting entity the primary beneficiary of that entity?

1.2.1 Step 1. Does a scope exception to consolidation guidance (ASC 810) apply?

There are four scope exceptions to the consolidation guidance in ASC 810:

Employee benefit plans An employer should not consolidate its sponsored employee benefit plans

that are subject to the provisions of ASC 712 or 715.

Governmental organization A reporting entity should not consolidate a governmental organization.

A reporting entity also should not consolidate a financing entity established by a governmental

organization, unless the financing entity is not a governmental organization and the reporting entity

is using it in a manner similar to a VIE to circumvent the Variable Interest Models provisions.

Certain investment companies Reporting entities that are investment companies are not required

to consolidate their investments under ASC 810. That is, investments made by an investment

company are accounted for at fair value in accordance with the specialized accounting guidance in

ASC 946 and are not subject to consolidation.

Money market funds Reporting entities are exempt from consolidating money market funds that

are required to comply with or operate in accordance with requirements that are similar to those in

Rule 2a-7 of the Investment Company Act of 1940 (the 1940 Act).

It is important to note that investment companies themselves are subject to consolidation under the

Variable Interest Model. In other words, reporting entities investing in or providing services to an

investment company entity (e.g., an asset manager) are required to evaluate the investment company for

consolidation. However, entities subject to the Securities and Exchange Commission (SEC) Regulation S-X

Rule 6-03(c)(1)2 are not required to consolidate an entity that is subject to that same rule.

2 Entities subject to Regulation S-X Rule 6-03(c)(1) include, but are not limited to, Regulated Investment Companies, Unit Investment Trusts, Small Business Investment Companies and Business Development Companies. Generally, an investment company is required to register with the SEC under the 1940 Act if either (1) its outstanding shares, other than short-term paper, are beneficially owned by more than 100 persons or (2) it is offering or proposing to offer its securities to the public.

1 Overview

Financial reporting developments Consolidation | 5

1.2.2 Step 2. Does a scope exception to the Variable Interest Model apply? (updated September 2017)

There are five other scope exceptions specific to the Variable Interest Model:

Not-for-profit (NFP) organizations NFP organizations should not evaluate an entity for consolidation

under the Variable Interest Model. Likewise, a for-profit reporting entity should not evaluate an NFP

organization for consolidation under the Variable Interest Model.3

Separate accounts of life insurance reporting entities Separate accounts of life insurance reporting

entities as described in ASC 944 are not subject to the provisions of the Variable Interest Model.

Lack of information A reporting entity is not required to apply the provisions of the Variable

Interest Model to entities created before 31 December 2003 if the reporting entity is unable to

obtain information necessary to (1) determine whether the entity is a VIE, (2) determine whether the

reporting entity is the primary beneficiary or (3) perform the accounting required to consolidate the

entity. However, to qualify for this scope exception, the reporting entity must have made and must

continue to make exhaustive efforts to obtain the information.

Certain entities deemed to be a business See the business scope exception below.

Private company accounting alternative A private company is not required to evaluate lessors in

certain common control leasing arrangements under the provisions of the Variable Interest Model if

certain criteria are met. See Section 4.4.5 and Appendix E for further information.

Note: In June 2017, the FASB issued an exposure draft proposing a new private company alternative in

US GAAP that would allow private companies to make an accounting policy election to not apply the Variable

Interest Model to certain common control arrangements. The proposal would replace the private company

alternative for common control leasing arrangements that the FASB created in 2014 (ASC 810-10-15-17AB).

We encourage readers to monitor developments in this area. For additional information, see our To the

Point publication, The FASB proposes more changes to the consolidation guidance.

Business scope exception

A reporting entity is not required to apply the provisions of the Variable Interest Model to an entity that is

deemed to be a business (as defined by ASC 805) unless any of the following conditions exist:

The reporting entity, its related parties or both, participated significantly in the design or redesign of

the entity, suggesting that the reporting entity may have had the opportunity and the incentive to

establish arrangements that result in it being the variable interest holder with power. Joint ventures

and franchisees are exempt from this condition. That is, assuming the other conditions below do not

exist, a reporting entity that participated significantly in the design or redesign of a joint venture or

franchisee is not required to apply the provisions of the Variable Interest Model.

The entity is designed so that substantially all of its activities either involve or are conducted on

behalf of the reporting entity and its related parties.

The reporting entity and its related parties provide more than half of the total equity, subordinated

debt and other forms of subordinated financial support to the entity based on an analysis of fair

values of the interests in the entity.

The activities of the entity are primarily related to securitizations or other forms of asset-backed

financing or single-lessee leasing arrangements.

3 However, if a reporting entity is using a NFP organization to circumvent the provisions of the Variable Interest Model, that NFP organization would be subject to evaluation for consolidation under the Variable Interest Model.

1 Overview

Financial reporting