When private manufacturers own real estate or expand to new business ventures, they often set up separate legal entities to hold those properties. Current accounting rules require financial data from such “variable interest entities” (VIEs) to be consolidated on the controlling entity’s balance sheet. Fortunately, an updated accounting standard will soon allow private companies to opt out of the complicated consolidation rules.
Created to prevent another Enron
The Financial Accounting Standards Board (FASB) issued the VIE guidance in 2003 in Accounting Standards Codification Topic 810, Consolidation, on the heels of the Enron scandal.
This guidance says a business has a controlling financial interest when it has:
- The power to direct the activities that most significantly affect an entity’s economic performance
- The right to receive significant benefits from the entity
- The obligation to absorb its losses
“Enron figured out a way within the standard [that applied at the time] to create off-balance-sheet structures with financing that was completely guaranteed by the host company but yet was off the balance sheet — and the VIE guidance was written to fix that,” said Billy Atkinson, former chair of the FASB’s Private Company Council.
Public versus private
Private companies found the consolidation rules difficult to follow. They told the FASB that their business relationships aren’t structured to trick investors. Instead, their choices are made primarily for tax and estate planning purposes and to limit legal liability.
Private companies also said that combining subsidiary businesses onto a parent company’s balance sheet was frustrating to lenders, who often reversed the consolidation when reviewing company performance. In addition, in companies where family members share ownership, determining who holds the power isn’t always clear.
The lease of their concerns
In response, the FASB issued Accounting Standards Update (ASU) No. 2014-07, Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements. The update lets private companies ignore the VIE guidance for certain leasing transactions. But private companies told the FASB that problems persisted for the many transactions that didn’t involve leases.
So, in October 2018, the FASB issued ASU No. 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities. The updated standard supersedes the amendments in ASU No. 2014-07. The new exception applies to all private company common control transactions that meet certain criteria.
FASB chairman Russell G. Golden said that the update “provides private companies the choice to not apply VIE guidance to their common control arrangements — thereby reducing costs without compromising the relevance of the financial reporting information to financial statement users.”
A private company that takes advantage of this simplified alternative still must provide footnote disclosures about its involvement with, and exposure to, the legal entity under common control.
Private companies can take advantage now
The updated standard goes into effect for fiscal years beginning after December 15, 2020, and interim periods beginning after December 15, 2021. However, early adoption is permitted, and many companies plan to opt out of the consolidation rules before the effective date.
To find out whether taking advantage of this option is right for your manufacturing business, contact Weaver for a consultation.
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