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FASB's consolidation exposure draft ... explained.

On Nov. 3, 2011, the Financial Accounting Standards Board issued an Exposure Draft (ED) on consolidation that, if adopted as a final standard, will provide expanded U.S. generally accepted accounting principles guidance on differentiating a principal from an agent as well as consolidation decisions by entity managers.

The ED's guidance for determining principal versus agent relationships is intended to address concerns raised by fund managers with interests in variable interest entities (VIEs) when the previous VIE consolidation literature (e.g., FAS 167) was issued. As a result, the ED would remove the FAS 167 deferral for investments in certain investment companies.

The ED will impact consolidation analyses for all entities as it changes the definitions of "kick-out" "participating" and "protective" rights and conforms analysis of these rights under the VIE and voting interest entity (VOE) consolidation models.

The ED also changes certain aspects of the determination of whether an entity is a VIE and who consolidates a VIE (in other words, its primary beneficiary), as well as certain consolidation guidance for certain VOEs.

While all reporting entities will be required to reassess current consolidation conclusions using the ED's provisions, the ED is expected to be particularly relevant to investment managers and other parties involved with investment companies and partnerships.

ED comments are due Feb. 15, 2012. The ED's effective date will be determined during FASB's redeliberations of comments received on the ED. If adopted, it will bring U.S. GAAP and International Financial Reporting Standards closer by aligning GAAP's VIE consolidation model with the International Financial Reporting Standards 10's single consolidation model that applies to all entities.

Changes Affecting VIEs and VOEs

The ED requires decision-makers to evaluate qualitative factors to determine if they are acting as a principal or as an agent. A decision-maker (a board of directors, an asset manager or a general partner, for example) acting as an agent on behalf of, and for the benefit of, another party or parties generally would not be deemed to control and would not consolidate.

To determine if a decision-maker is a principal or an agent, the ED requires consideration of all of the factors in the table below. The factors are to be weighed based on facts and circumstances, considering the purpose and design of the entity evaluated for consolidation; updated analysis is required upon a change in entity purpose and design.

In evaluating these factors, a decision-maker is to consider its direct and indirect (those held through related parties) interests in the entity being evaluated. For example, if a decision-maker has a 50 percent interest in a related party that owns 50 percent of the entity being evaluated, the decision-maker's indirect interest would be equivalent to a 25 percent direct interest.

Changes Affecting Only VIEs

Under existing U.S. GAAP (unchanged by the ED):

1. In addition to other factors, an entity is a VIE if its equity holders, as a group, lack power to direct entity activities most significantly impacting entity economic performance.

2. A reporting entity with a VIE variable interest evaluates if it is the VIE's primary beneficiary (the party required to consolidate the VIE) based on a qualitative assessment of VIE power and benefits.

The ED requires use of the principal-agent guidance discussed above in determining if equity holders, as a group, have power to direct activities most significantly impacting entity economic performance. While delegating decision-making to an agent would not prevent equity holders, as a group, from having that power, delegation to a principal would.

A reporting entity may conclude no one party, by itself, meets the criteria of VIE primary beneficiary, but that as a group, the reporting entity and its related parties and de facto agents do.

In this case, consistent with current U.S. GAAP, the group member "most closely associated" with the VIE is its primary beneficiary and consolidates the VIE.

The ED requires that group members consider power exercised by all group members, regardless of whether they are principals or agents. As a result, a related-party agent could be the party "most closely associated" with, and be required to consolidate, a VIE.

Changes Affecting Only VOEs

Under current U.S. GAAP (unchanged by the ED), owning a majority of VOE voting interests is a controlling financial interest and usually results in consolidation. This can be overcome when noncontrolling shareholders have "substantive participating" rights allowing them to participate in significant decisions expected to be made in the "ordinary course of business."

Under current U.S. GAAP, noncontrolling shareholder participation in a single significant ordinary course decision (e.g., approving the operating budget) precludes majority shareholder consolidating. The ED requires noncontrolling shareholders to participate in each activity that "most significantly impacts the entity's economic performance" for those rights to be deemed substantive participating rights that preclude majority consolidation.

Changes Affecting Only VOE Limited Partnerships and Similar Entities

Existing U.S. GAAP for VOE limited partnerships and similar entities requires general partner consolidation unless the vote of no more than simple majority vote of non-related limited partners can result in general partner removal without cause and without barriers to exercise of that removal right, or nonrelated limited partners have substantive participating rights.

Under the ED, a general partner would evaluate its decision-making capacity using the principal-agent guidance described above and would consolidate only when acting as a principa



David Thrope ( is a partner in Ernst & Young LLP's Financial Services Office in New York. Rena Spencer ( is a senior manager in Ernst & Young LLP's Financial Services Office, also in New York.
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Title Annotation:FINANCIAL REPORTING; Financial Accounting Standards Board
Author:Thrope, David N.; spencer, Rena M.
Publication:Financial Executive
Geographic Code:1USA
Date:Jan 1, 2012
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