Consolidation refers to the preparation and presentation of consolidated financial statements by an entity. When a parent consolidates a subsidiary, the parent presents its results of operations and financial position as if the parent and its subsidiary were a single entity. Any company controlling another entity is subject to the consolidation guidance in the Codification.
The purpose of consolidation is to provide meaningful financial information to stakeholders. There is a presumption that presenting the financial information for a consolidated group is a fairer and more relevant representation of a parent entity to its shareholders and creditors than a series of stand-alone financial statements (transactions with subsidiaries, for instance, are eliminated).
Consolidation is a complex Topic in the FASB Codification. The consolidation guidance is complicated and includes specific terminology and intricate rules. Nuances are important. Historically, some entities tried to structure transactions in a way to avoid consolidation, either to prevent assets or liabilities from being reported on the parent’s balance sheet or to isolate losses in a separate entity. Over time, the consolidation guidance has evolved to prevent abuses and it is still evolving. Accounting Standards Update (ASU) No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, is becoming effective now and is making a number of significant changes to Topic 810, Consolidation.
The decision to consolidate can be particularly complex, especially when potential variable interest entities are involved. A good understanding of the rules and recent changes is paramount.
In the past, many stakeholders criticized the FASB’s consolidation rules because they did not always lead to the most accurate depiction of the economics of certain relationships and so did not yield the most useful financial information. To address these criticisms, in February 2015 the FASB issued ASU No. 2015-02.
ASU No. 2015-02 becomes effective for public business entities for annual reporting periods beginning after December 15, 2015, and interim periods within those annual periods, which means it is effective now for public business entities with a calendar year-end. ASU No. 2015-02 is effective for all other entities for annual reporting periods beginning after December 15, 2016, and interim periods included within annual reporting periods beginning after December 15, 2017. Early adoption is allowed.
Some of the more significant changes required by this ASU to the analysis to determine if an entity must be consolidated include:
- Revisions to the analysis for interests in limited partnerships and similar entities (partners in limited partnerships and similar legal entities must now have substantive kick-out or participating rights for the entity to meet the definition of a voting interest entity and the prior presumption that the general partner is the party who must consolidate the entity is eliminated).
- Changes to how fees and related party relationships affect the analysis of interests in variable interest entities (the ASU removes three of the six criteria that a decision-maker fee must meet for the fee to be a variable interest and it reduces the number of situations in which the related-party tie-breaker must be applied.); and
- A new scope exception for interests in legal entities subject to Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds.
ASU No. 2015-02 has more significant effects in certain industries than in others, but all entities that own a variable interest in another entity will have to reassess their consolidation decisions.
While the whole VIE model does not change, the ASU introduces a few changes that can have significant consequences for entities involved with VIEs. The ASU also modifies certain rules that apply to voting interest entities.
The amendments made by ASU No. 2015-02 are primarily the result of stakeholder concerns regarding consolidation of limited partnerships by asset managers; these amendments, however, also apply to reporting entities across all industries. If a reporting entity holds a variable interest in a legal entity, the reporting entity must consider possible changes to its consolidation analysis. Some reporting entities may be required to consolidate a legal entity for the first time. Conversely, other reporting entities may be required to deconsolidate a legal entity that was consolidated in reporting periods prior to the issuance of ASU No. 2015-02.
ASU No. 2015-02 should not be overlooked. It will require parent companies to rethink some of their past consolidation decisions and may have to consolidate new entities and deconsolidate some starting this year. Asset managers will be primarily affected, but all other industries may see changes as a result of ASU No. 2015-02 becoming effective.
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Checkpoint Catalyst: US GAAP – Consolidation is designed to help practitioners navigate the accounting intricacies related to this topic and includes a number of practice aids to make some of the analyses easier.
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