It has been approximately 10 years since preparers of financial statements have been required to consolidate entities that may not have common ownership in excess of 50% (first required with the issuance of FIN 46-R).
This 50% rule was more formally recognized in regard to control through a quantitative measure of voting interest greater than 50%. The reasons for the additional requirement in 2003 had as much to do with entities that were accounted for “off balance sheet” in comparison to those entities in which the more-than-50% threshold existed between common ownership entities.
Keep in mind that FIN 46-R was an interpretation of ARB 51 which replaced FIN 46.
And yes, what we commonly refer to as “FIN 46” is all incorporated in the guidance within FASB Codification Topics 810, 805.
Some of the more discussed reasons for expanding the requirements included:
- Loans and/or notes receivable
- Certain insurance contracts
- Derivative contracts
- Service or management agreements
The requirements became more qualitative as compared to the previous guidance which was based on a quantitative measurement requirement, i.e., the 50% rule.
The new requirements in 2003 were met with much disagreement and confusion as to why – and how – these new requirements should be applied.
A great part of the confusion was the application of the term variable interest entity. Many preparers of financial statements simply applied the consolidation guidance to any VIE. Then and now, not all VIEs are necessarily required to be consolidated. The term primary beneficiary became more robust in its use and application by preparers of financial statements. As preparers of financial statements came to terms that all VIEs may not be required to be consolidated, they also came to realize that every VIE may not even have a primary beneficiary. This created confusion as well, with the application of the then-NEW requirements.
Also, there were many financial statement preparers who chose to not even consider the VIE consolidation requirement by using an OCBOA framework such as the “income tax basis” to avoid the VIE consideration for consolidation or not.
So, with all of that said (and it can be said in many different ways), have financial statement preparers properly and consistently applied the consolidation requirements of FIN 46, e.g. the appropriate Codification Topic?
I believe preparers in the vast majority of VIE accounting transactions have properly recorded those VIEs that are required to be consolidated, and not consolidated those VIEs properly excluded from the consolidation requirements.
Where are preparers today in regard to the VIE consolidation question?
I believe the question is more easily answered, including the application of the correct accounting guidance than say, 9-10 years ago.
But that is not to say, that sometimes the identification of a VIE and whether or not to consolidate is an easy accounting path to follow. Any improvement is still an improvement, and I believe the accounting and financial statement reporting of VIEs is better for financial statement users.
Art Winstead is the Director of Accounting and Auditing Services for CPAmerica International. He has over 30 years of experience with Davenport, Marvin, Joyce & Co., LLP. He manages technical resources, engagement support, audit practice matters, reviews A&A publications for CPAmerica and is a part of the Expert Services team.