What You Need to Know About Consolidations

In the coming months, the FASB expects to issue a final standard intended to improve targeted areas of GAAP that cover consolidation of legal entities such as limited partnerships, limited liability corporations, and securitization structures (i.e. collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions).

The new standard would change existing consolidation guidance that has evolved over the years.
The new standard would change existing consolidation guidance that has evolved over the years.

For example, some stakeholders—including asset managers acting on behalf of external investors—are required to reflect the consolidation of assets, liabilities, and financial performance of a legal entity, despite the fact that they have no or minimal principal risk in the legal entity.

The new guidance would change some consolidation conclusions and in some situations, eliminate disclosures that are currently required, as described further below.

Overall, the new guidance may change consolidation conclusions for public and private companies in several industries that typically employ limited partnerships or variable interest entities (VIE)—legal entities in which consolidation is not based on a majority of voting rights.

Why Did the FASB Embark on a Project to Improve Financial Reporting in This Area?

The standard will address stakeholder concerns that current guidance in certain situations, while operable, does not provide sufficiently useful information for investors.
The upcoming Accounting Standards Update addresses stakeholder concerns that current guidance in certain situations, while operable, does not provide sufficiently useful information for investors and other users of financial statements.

Stakeholders expressed concern that reporting companies were consolidating a legal entity’s economic and operational results in situations when the reporting company appeared to be directing the activity of the legal entity on the behalf of others.

Such a situation could occur, for example, when the reporting company does not have rights to act primarily on its own behalf, does not hold a majority of the legal entity’s voting rights, or is not exposed to the majority of the legal entity’s economic gains or losses.

Financial statement users have asserted that those situations have resulted in a demand for deconsolidated financial statements to better analyze the reporting company’s economic and operational results.

The Board considered these concerns in conjunction with the objective of general purpose financial reporting, which is to provide financial information about the reporting organization that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the organization.

As a result, the Board is issuing the new standard, which affects the consolidation evaluation for reporting companies, described in detail below.

What Are the Major Changes in This Update?

The Update eliminates the presumption that a general partner should consolidate a limited partnership and eliminates the consolidation model specific to limited partnerships.
The Update eliminates the presumption that a general partner should consolidate a limited partnership and eliminates the consolidation model specific to limited partnerships.

It clarifies when fees paid to a decision maker (such as an asset manager) should be a factor to include in the consolidation of VIEs, which puts greater emphasis on principal risk of loss when assessing consolidation risk.

The Update amends the guidance for how relationships of related parties (such as affiliates) affect the consolidation analysis of VIEs.

Lastly, the Update eliminates an indefinite deferral for certain investment funds, further reducing the number of existing consolidation models, and scopes certain money market funds out of the consolidation guidance.

When Will this Standard be Effective?

The new standard will be effective in 2016 for calendar year-end public companies, and early adoption will be permitted.

For calendar year-end private companies and not-for-profit organizations, the new standard will be effective in 2017 for annual periods, and for interim periods, beginning in 2018.

More information on the project can be found here.