In the first quarter of 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No 2015-02, Consolidation (Topic 810) – Amendments to the Consolidation Analysis. This ASU was issued to respond to concerns surrounding the current generally accepted accounting principles (GAAP) that may require a general partner to consolidate an investment fund in which the general partner has little equity, but directs the activities of the fund on behalf of the limited partners. Financial statement users felt that deconsolidated statements were needed to better analyze a reporting entity’s economic and operational results, and this ASU was adopted in response to these concerns.
Overall, the amendments in the ASU are considered an improvement because they simplify existing GAAP and provide more meaningful information to the financial statement users, specifically:
- The number of consolidation models will be reduced through the elimination of a prior statement (the indefinite deferral of 167)
- More emphasis will be placed on risk of loss when determining a controlling financial interest
- There will no longer be a sole focus to consolidate due to a fee arrangement with another entity
- Should result in fewer consolidations of limited partners, making general partner financial statements more meaningful to the users
As a reminder, the criteria to consolidate under the new consolidation model are focused on the Variable Interest Entity (VIE) model, or the Voting model. Under this model, entities must consider:
- Whether there is a variable interest, or whether the value of an ownership interest, a contract, or other relationship changes as the fair value of the related asset changes. Specifically, consider fee arrangements where there are management and incentive fees that change as the underlying net assets of a fund change. The fee contract is considered a variable interest, unless exempted, as noted below.
- Whether there is a VIE that focuses on the kick-out rights of the limited partners. Where a simple majority of limited partners have kick out rights, consolidation is not required.
- Identification of the primary beneficiary includes the power to direct the VIE, and the obligation to absorb losses and receive benefits of the VIE that could potentially be significant to the VIE. The new consolidation model exempts fees received from the VIE if those fees are commensurate with the level of effort required to provide those services, and the contract for those fees includes only terms that are normally found in arrangements for similar services. This change will often result in the analysis for primary beneficiary being entirely based on the equity investment by the GP in the limited partnership.
In regards to the Voting model for consolidation, the ASU eliminates the presumption that a general partner controls a limited partnership, and a general partner will not consolidate a partnership based on the voting model.
The new consolidation model will be applied to public entities for fiscal years beginning after December 15, 2015, and for all other entities, for fiscal years beginning after December 15, 2016. Early adoption is permitted, and the effect of adoption is reflected as a cumulative-effect adjustment to beginning equity in the year of adoption.
While it is anticipated that the changes to the FASB consolidation model will result in fewer consolidations, entities will be required to re-evaluate their consolidation considerations. With the effective dates drawing closer, entities may want to consider preparing for the changes that will be required to their accounting policies and documentation surrounding their consolidation considerations and conclusions. Entities may wish to begin considering the following:
- Determining the population of entities that require consideration: The revised consolidation model applies to all legal entities, and there are specific examples in the ASU regarding series funds / trusts that will likely result in each series being evaluated.
- Reviewing the rights of the limited partners: Under the new consolidation model, the rights of the limited partners (specifically kick-out rights) are an important factor in determining whether an entity should be consolidated. Those entities where limited partners have substantive kick-out rights would not be required to consolidate.
- Revisiting fee arrangements: As noted above, fee arrangements can represent variable interests, and analysis of whether these fees are normally found in arrangement for similar services is required in order to exclude these fee arrangements from the consolidation analysis.
- Revising accounting policies and related supporting documentation regarding consolidation under the new consolidation model.
Evaluating and planning for these items now should help reduce the burden on accounting departments and eliminate surprises in the year of adoption.
We will be happy to provide further information relating to this subject. For more information, contact Frank L. Varanavage at firstname.lastname@example.org or 215.441.4600.
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