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Back to basics: Consolidation—Getting started
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Get a refresher on consolidation accounting, including an overview of the consolidation framework, the variable interest entity (VIE) and voting interest entity (VOE) models, and key scope considerations. This episode is part of our new Back to Basics series that revisits core accounting topics.
This episode lays the foundation for our next three Back to basics episodes on consolidation. We’ll take a deeper look at identifying a VIE, determining which party, if any, should consolidate it, and consolidation presentation and disclosure. Stay tuned as the remaining episodes are released over the next two weeks.
Looking for more guidance on consolidation accounting? See PwC’s Consolidation guide. Additionally, follow this podcast on your favorite podcast app and subscribe to our weekly newsletter to stay in the loop.
About our guests
Matt Sabatini is a deputy chief accountant in PwC's National Office who helps clients and engagement teams navigate the accounting and financial reporting for complex transactions. He specializes in the accounting for M&A, consolidations, corporate reorganizations, recapitalizations, joint ventures, and other investments.
Alexander Martin is a partner in PwC's Deals practice with over a decade of deals experience, helping clients solve complex accounting, financial reporting, and other business issues that arise from transaction-driven events such as mergers and acquisitions, divestitures, and capital raises.
About our host
Heather Horn is the PwC National Office Sustainability & Thought Leader, responsible for developing our communications strategy and conveying firm positions on accounting, financial reporting, and sustainability matters. In addition, she is part of PwC’s global sustainability leadership team, developing interpretive guidance and consulting with companies as they transition from voluntary to mandatory sustainability reporting. She is also the engaging host of PwC’s accounting and reporting weekly podcast and quarterly webcast series.
Transcripts available upon request for individuals who may need a disability-related accommodation. Please send requests to us_podcast@pwc.com.
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Thought Leadership from PwC's National Office.
SPEAKER_03Hello, and welcome to PWC's Accounting Podcast. I'm Heather Horn. I'm excited to introduce our new Back to Basics series where we'll revisit some of the foundational accounting topics that are important to understand, whether you're learning them for the first time or just looking for a refresher. And with people heading back to school and getting back into that learning mindset, we thought there's no better time to launch the series. We're starting with consolidation accounting and in particular variable interest entities or VIEs. It's a topic that can get very complicated very quickly. So we're going back to a few of our favorite conversations with Matt Sabatini, a deputy chief accountant in PWC's national office, and Alexander Martin, a partner in PWC Steel's practice, that break the framework down step by step. Over the next four episodes, we'll start with an overview of the consolidation models and the VIE framework, then take a deeper dive into how to identify a VIE and determine which party, if any, should consolidate it. We'll wrap up the series with an episode focused on consolidation presentation and disclosures. In this first episode, Matt and Alexander start at the beginning, including some helpful background on why we have two consolidation models under US GAP before walking through their overall framework and scope considerations. And I will say anecdotally, these are a few of my favorite episodes. So I'm so glad you're tuning in. With that, let's listen back to my conversation with Matt and Alexander. So with all of that background, Alexander, can you get us started?
SPEAKER_00Yep, absolutely. And thanks so much for having us back to talk about VIEs. I'm probably going to lose some friends here, but it's easily my favorite topic to talk about. So I'm amped to be part of that.
SPEAKER_03Yeah, I'm not sure that's something to brag about. But no, definitely good to have you on.
SPEAKER_00Well, I mean, with that, I'm a VIE apologist, right? So I'm going to say right off the bat that I think they get a bad rap. I I like to think about them as like the duckbilled platypus of accounting standards, right? They're they're a little bit ugly and kind of weird to look at, but it's really just a function of how the guidance has evolved over the years.
SPEAKER_03All right. So hopefully we don't have any advocates for duckbilled platypuses on that are going to be offended. You said they were ugly, but anyway, with that. Let me finish. Okay.
SPEAKER_00My youngest daughter thinks that they're very cute. Right. And so we're our job today is we're going to try to make them warm and cuddly, and you could see how great the platybi are.
SPEAKER_03That might be the only time those words have been used on this podcast, but keep going.
SPEAKER_00Um so maybe to do
Background on the two consolidation models
SPEAKER_00that right, I think Matt Matt and I's goal really, we're going to demystify the model a little bit. And so I'll start with what it looks like today. Um, I want to preface it by saying what we're going to talk about is the model that's used for profit entities. So not-for-profit entities that are subject to ASC 958, they have a separate model that we're not going to talk about today. So for the for-profit folks, right, under US GAAP today, we have two models of consolidation. We have our traditional voting interest model, or sometimes called the VOE model. Um, this is where we basically, in order to figure out who consolidates, we look to the traditional voting interests and see who holds a majority of those, right? If so, then you're viewed as controlling the entity. So then you have to consolidate it. Right. And then we have our big scary VIE or variable interest entity model, right? And this is where we have to look beyond the voting equity interest to figure out who actually controls and therefore should consolidate the entity. Right. And so before I kind of dive into the VIE model specifically, I think it actually might be helpful to have a little bit of a background and talk about how we got to the dual model in the first place.
SPEAKER_03Yes, so I'm assuming we're going to start with FIM46, unless you're going further back than that. Maybe you are. But wait, before you do that, I do have one question. So you mentioned uh the VOE model and the fact that's based on the majority of the voting equity. Do we see under even that model that you could have less than the majority of the equity, but you could still wind up consolidating, or is that only under the VIE model?
SPEAKER_00You do see it under the VOE model as well. And, you know, Matt, feel free to jump in, but it's really in limited circumstances, right? They have this idea of being able to be controlled by a contract. Um, but most of the time, if that guidance is going to apply, you're actually probably gonna be in the VIE model anyway. And so you're gonna consolidate it under the VIE framework.
SPEAKER_02Yeah, I'm just gonna enjoy my role of nodding along as you come.
SPEAKER_03So although nodding doesn't work on a podcast. So maybe at least say and I agree.
SPEAKER_02It's working really well for me. We'll have a bell that you can ring if you all right.
SPEAKER_03But basically, the key thing there is the in the VOE model that you have the control.
SPEAKER_02Yeah, we're gonna dive into that in a little bit more detail in a bit too.
SPEAKER_03So perfect. Thank you. See, you you do have more of a role than just nodding. All right. So, Alexander, you sort of shook your head when I mentioned FIM46. So I imagine you are going further back than that. So, where are we starting?
SPEAKER_00A long time ago in a galaxy far, far away. Um, yeah, so I'm gonna go back to the beginning, right? So the current framework that we actually have, right, actually can be traced back to an original accounting research bulletin that was issued back in 1959, right? This is even pre-FASB, pre-accounting principles board, pre-Matt Sabatini, right? Uh, this goes way back, right? But the the bulletin, which is called ARB 51, uh, this basically established the whole idea that if a reporting entity has control over another entity, then it's more meaningful to present consolidated financial statements, right? So, so even back then, the whole idea was that if I control another entity, then I should be including that entity in my financial results.
SPEAKER_03So it's interesting. We talk, we have talked previously here on the podcast about ARB 43, but I don't know that we've talked a lot about ARB 51. So it's good, it's a good little bit of history there to know that.
SPEAKER_00So treading treading new ground.
SPEAKER_03Yeah, exactly.
SPEAKER_00So the the model still had the idea of this controlling financial interest being the predicator for some consolidation. And so the the next natural question is, okay, well, how do I know if I have control over another entity? Right. And so at the time, the answer was, hey, just look at the voting equity interests, right? Whoever owns a majority of the vote means that they control the entity, means that they should consolidate. Easy peasy. Um, so this model hung around for a while. Like it worked really well. You know, so there were some minor tweaks and clarifications over the years, but for the most part, it was basically 40 years of having a really solid voting interest model that was used for consolidation. Fast forward from the late 50s to the late 1990s, early 2000s, and then we started to have some companies that were setting up what was referred to as special purpose entities or SPEs and basically structuring them in a way to avoid consolidation under that voting model. Right. Some people remember it, it was kind of a kind of a Yeah.
SPEAKER_03So I think if we uh refer our listeners to Enron, they may know exactly the type of entities we're talking about.
SPEAKER_02They wrote books and movies, right?
SPEAKER_03Yes, exactly.
SPEAKER_02Exactly.
SPEAKER_00So basically, what they were doing to achieve that non-consolidation was they were separating the economics in the entity from the from the voting interests themselves, right? Obviously, this was viewed as a whole in the guidance when people started to see that it could be abusive, right? And so in response in 2003, this is where the FASB came out with Fin 46, right? And that was basically a whole new landscape that they put together, right? They they created the concept of a variable interest entity or a VIE. And they also created this new framework for evaluating who actually controlled these uh special purpose entities, right? Or these highly structured type of entities. And the idea was really, hey, given the unique design of these SPEs and the way that they're structured, uh, evaluating consolidation based solely on the voting equity doesn't really work, right? It won't tell me who actually controls the entity, right? So instead, I need a new model or a different model to evaluate these things, right? And so that's how we settled on having a separate VIE framework, right? It was really in response to the high structured entities that kind of set the ball in motion here.
SPEAKER_03And actually, if you think about it, so Enron, I think went into bankruptcy like the tail end of 2001, beginning of 2002, sometime around that timeframe. So the fact they were able to come out with this entirely new model that quickly is impressive. But I know you're going to get to some changes to the model, or maybe Matt, this is when you jump in. But nonetheless, the concept of variable interest entity, you know, still persists. So yeah.
SPEAKER_02And I don't want to take away the glory that you're giving to the FASB for working quickly, but they had been working on a new consolidation model for 10 years leading up to Enron.
SPEAKER_03So then at least they were anticipating what may happen.
SPEAKER_02So it did result in kind of a right-hand turn, right? So they had to quickly adjust and they did. Um what they ended up with was uh what you referred to as FIN46, right? It was a financial, sorry, it was a FASB interpretation. Um, and we were there, you know, what Fin 46 was, right? In response to Enron and some of these other accounting schedules. And it was really meant to deal with special purpose entities, like Alexander said, although it applied a little bit more broadly. Um and it was really a risk-based model, right? So it really focused on who had the majority of the economic risks and rewards with these type of entities, and that entity would be the one who was deemed to have a controlling financial interest. So that's really how Fin 46 worked for a while. The premise behind it was if you were willing to take on exposure to a majority of the risks of ownership of an entity, that likely came with control. So that was a kind of neat way to figure out who had a controlling financial interest in entities where it wasn't all that clear. Um, that that model lasted for a couple of years, um, and it's you know, evolved, is what I'll say. Kind of like the duckbill platypose, right? Going back to that analogy. It's evolved over several years to where we are today, right? Where we are today is we still have this economic interest concept, but it's not whether or not you have a majority of the economic interest, it's whether you have an economic interest along with power. So it's kind of a hybrid between the old voting model and the Fin 46 risk and rewards model that focuses on both power and economics. It's kind of similar to where IFRS is today, too, focusing on whether you have power and economics. Just a fun fact, right? They even though the models changed and we're in a different place than we were in early 2000s, a lot of the terminology stayed the same. So if you hear us say like the primary beneficiary, that's the party who we consolidate, a VIE. And generally it makes sense when you're thinking about if you have a majority of the risks and rewards, you would be the primary beneficiary with error quotes that I'm making that you can't see, right? Um, today, right, you would be the primary beneficiary if you have power in economics. You don't have to have a majority, though. So it's a term that we still use that doesn't necessarily fit the current model, but is is remnant of the old model.
SPEAKER_03All right. And obviously, listeners, we're going to get into more detail there. And Matt, you mentioned IFRS. And actually, uh, right when I walked in the room, I made the point that IFRS doesn't have this VIE concept, but it sounds like in some cases you could come to similar. This is not a podcast about IFRS, but I at least want to mention because I know we have a a lot of non-US listeners. Yes.
SPEAKER_02So there are more similarities than there are differences in the consolidation models between US GAAP and IFRS. The terminology is completely different. So there's no VIEs, there's no primary beneficiary in IFRS. And if you start using that terminology with somebody over in Europe, they're going to look at you like you have two heads. Um but the the basic concept of having power and an economic interest is really how they determine consolidation overseas and how how we do it here.
SPEAKER_03All right, that maybe it's a fourth episode, but not for today. So, all right, so then kind of with that background, now we've given our uh listeners some accounting trivia in case you know there's a question they get at some trivia contest, maybe not that likely. But nonetheless, I do think it's helpful to sort of understand how this grew up because there are some things about the model that maybe a clean sheet of paper, you'd say, hmm. But it's so it's kind of helpful to understand that evolution.
SPEAKER_02Exactly. And and and since then, right, that was in 2009 where we changed to this power and economics model. Since then, there have been a couple of tweaks around um related party guidance, around decision maker fees, so tweaks around the edges. And we're and I call them tweaks. They were actually pretty significant changes if you deal with the model on a regular basis, but they weren't a major overhaul. So, and you do see it when you're trying to apply certain chapters or certain paragraphs of the guidance in certain scenarios where maybe it doesn't always like read like it was one coherent standard that was put out at the same time. And that's because of this evolution and these modifications over time.
SPEAKER_03Well, and I think, Matt, the other point that's extremely important that you made there is the fact that even though the terminology has changed, some of the definitions haven't. So people maybe who aren't dealing with this model every day, they may have dealt with it at some point, and things have evolved since then. So it's very important to make sure A, you're listening, but B then that you're looking at the most recent guidance.
SPEAKER_02That's right. And you can always call one of us for help.
SPEAKER_03Exactly. All right. Hotline to Alexander and that. So
The overall consolidation framework
SPEAKER_03with all of that then, now maybe we should dive in, at least at a high level, to the detail. That's that's sort of an oxymoron. But anyway, Alexander, can you start walking us through the framework?
SPEAKER_00Yeah, sure. So um, you know, we where we're starting now. We got to we have this new fancy VIE model, right? But that's not really the end of the story just yet. Um, you know, the whole idea of having the VIE model was really to address these highly structured SPEs, but that didn't necessarily mean that the voting model was broken entirely, right? And so for the most part, there's a lot of entities where applying a voting model makes sense. The the vote is is correlated with the control. Um, so what the FASB decided to do, and this is why we have this dual model, is they retained the voting model and they basically said you can apply it to these plain vanilla type of entities, right? And so uh the way that they decided to operationalize that was really establishing a what I'll call a guilty until proven innocent approach, right? Where everybody has to start by evaluating the VIE model first, and then you determine if you're kicked out of the VIE model, right? So I can get kicked out by either having a scope exception or I can evaluate the entity and say, hey, it's not really designed in a way or structured in a way that it meets the definition of a VIE. So then I would just go and apply the voting model instead. And that's how our guidance works today.
SPEAKER_03Although I do think from a practical point of view, people often jump to the voting model. So it's helpful maybe to remind people what this VIE model is so that they can make sure they sort of quote run those traps.
The variable interest entity model
SPEAKER_03So what is the model?
SPEAKER_02Right. So yeah, I'll start with a light touch over the model at a very high level.
SPEAKER_03It's hard to do that. I know that's another oxymoron, I think. Exactly.
SPEAKER_02But just like three simple steps. All right. So number one, determine if the entity meets a scope exception for either consolidation in general or for VIE um consolidation. Number two, um, if it doesn't meet a scope exception, you determine whether or not the entity is a VIE. We're gonna teach you how to do that, I promise. Number three, if it is a VIE, you determine who the primary beneficiary is. And like I said before, that's the party who ends up consolidating the VIE. So that's it in a kind of nutshell, but I'll go into each step in a little bit more detail. I'm gonna skip number one, self-explanatory scope exceptions. We're gonna come back to that a little bit later. Number two, determine if the entity is a VIE. So this is what Alexander was explaining before, which is really what we're trying to do with the VIE model is identify situations in which it doesn't make sense to rely on the voting interests to determine who should consolidate an entity. Right. So what we're really looking for is there are five characteristics that the guidance lays out, five criteria. And what they're all really focused on is trying to figure out if the equity in the entity is really behaving like traditional equity.
SPEAKER_03All right. So air quotes around traditional. And what exactly do we mean when we say that? Right.
SPEAKER_02So it does it does warrant an explanation. I think that's fair. Um so what I mean by that is when you're thinking about the voting model, which again was the model that existed for 40 years, it was very much dependent or predicated on voting rights associated with common stock or the most residual interest in an entity. And in order to distinguish between maybe an entity that it makes sense to rely on the voting model versus a variable interest entity, you're gonna look for situations in which maybe the residual equity isn't really behaving like real equity, right? And what do I mean by that? Well, maybe that voting rights aren't all that substantive. Maybe the equity owners don't really have the power. So that'd be a situation where you could look at the voting rights, but they're kind of irrelevant. Um, or situations where the residual equity is not um exposed to losses or in enjoying the upside of an entity, right? So that again, it's typically you expect residual or common equity to get unlimited upside and be exposed to first dollar loss. And in situations where that doesn't happen, then maybe the variable interest entity makes more sense. Um so that's really what the five characteristics are doing. And we're gonna tell you what all five of them are, and we're gonna walk you through some detail on how to do it. But if you keep that in the back of your head, it always helps to make those characteristics um resonate a little bit more.
SPEAKER_03Yeah, I mean, it sounds like in a way you're talking about entities that are structured. Is that fair? Or is that making it too narrow?
SPEAKER_02Yeah. I mean, remember when I said the FASB had been working for 10 years and trying to identify a new consolidation model, they were marching down a path of really trying to identify what a structured entity is. And it was hard, and that's why it took them 10 years. So it does apply, the model does apply more neatly to structured entities. Um, and it makes more sense when you're looking at structured entities. We're gonna get into scope. It applies to all legal entities. Um, but yeah, I mean, I what you are looking for is other contracts, other interests, or other um kind of designs or structure around the entity that are gonna stop the residual equity from behaving like equity. So I think it's fair.
SPEAKER_03All right. So now I'm totally taking us off track. We still haven't even given the high level of step three. So what's that?
SPEAKER_02I didn't get to three yet. So three is you determine who should consolidate the VAE. And like I said, that's the primary beneficiary. That's the party that generally has meets two criteria, right? So remember I said power in economics. What we mean by power is it's the party that has the power to make the decision decisions over the most significant activities of the entity. And what I mean by economics is it's somebody who's exposed to at least a significant amount of economics in the entity. Um, so again, not the majority, but a significant um economic interest in the entity. You have to meet both in order to be the primary beneficiary. So you have to have power and economics. So there are lots of people that might have economic interests in an entity, and lots of people who may have more than insignificant economic interests. But only one will generally have power. So only one will generally have both. Um and so the only other thing I'll I'll add here is you don't if you conclude that you're not the primary beneficiary, it's not necessarily a uh get out of jail free card, right? You have to look to see whether or not you and your related parties um might meet the definition of a primary beneficiary as a group. And then when that happens, um, oftentimes you'll identify one of the related parties who should consolidate the entity. Sometimes not, but oftentimes there is a related party who should consolidate.
SPEAKER_03Well, and even if you're not the primary beneficiary, you do have disclosure requirements, which I'm sure we're gonna get to at some point. But it's again, you can't just say, oh, I'm not the primary beneficiary, so I'm done with this entity. Correct. All right. So I do remember something from my old days of doing consolidation. So with all of that said, then, I think one of the key things to talk about here is the fact that if we're thinking about whether or not you're the primary beneficiary, this is not a one-time evaluation, but maybe Alexander, you can provide some more perspective on that.
SPEAKER_00Yeah, that's right. So it's the the primary beneficiary or PB, you know, we typically call it for us cool VIE guys call it for short.
SPEAKER_03So we can be part of the cool kids if we use that.
SPEAKER_00Yeah, welcome to the cool kid club. Um, but yeah, the the primary beneficiary determination is ongoing, right? So basically every reporting period, you have to relook at your answer and and make sure that it still makes sense, right? But that's only for the primary beneficiary, right? You you don't go and you don't have an ongoing reassessment of your determination of whether an entity is or isn't a VIE unless there's a triggering event, right? So like a recapitalization or like a change in the design or structure of the entity, that would trigger a reassessment of the VIE determination, but the the PB test is an ongoing analysis.
SPEAKER_03I do think a key point here is that you need controls in place to make sure you're identifying those triggering events. And I will say I was a specialist on what engagement where my whole role every quarter was to make sure the client had done properly their assessment of all their VIEs and making sure whether or not they were still the primary beneficiary. So there you go. All right.
The voting interest entity model
SPEAKER_03So with all that said then, uh I think we'll get into some more detail on what those triggers are. So going back to the overall model, we mentioned you could either get a scope exception or you could determine that's not a VIE. If one of those two things happened, they sort of jump off our flow chart and you move to the voting model. Is that correct?
SPEAKER_02That's right. So you're not completely off the consolidation flow chart, you're just off the VIE flow chart. Right. So the voting model, like, congratulations, it's a little bit easier. Um, so you don't have to understand all of the terminology that we're using, like PB and VI and all that stuff, right? So it's the model that's been around for uh 50, 60 years now, right? Longer than I have, according to Alexander. Um again, it's predicated on um having a majority of the voting rights. Um so when you have a majority of the voting rights, usually that comes with unilateral control. Um, that's not always the case. Um, but generally, if you have a majority of the voting rights, you're gonna be um you're gonna be the party with the controlling financial interest, but you're also gonna look to see who else is invested in the entity uh and what rights they might have. Um so a lot of times these are called minority rights or um or veto rights or blocking rights, right? So you're looking to see I might be a 60% owner of a legal entity, but the 40% owner has the ability to approve the annual budget or the ability to approve the appointment and compensation of senior management. And those might be significant blocking rights that would prevent the 60% majority owner from consolidating or from having control. Um so it's it's more straightforward, but you do have to do a little bit of work to understand who's involved with the entity in terms of a voting perspective and who's got what kind of consent rights. Um, another another situation in which maybe a majority of the voting interest wouldn't result in a controlling financial interest would be if the legal entity goes into bankruptcy. So that could happen where you have a parent who doesn't go into bankruptcy and a subsidiary that does, or both go into bankruptcy. Generally, at that point, you might still own a majority of the common shape. Shares, but the bankruptcy court takes control of the entity itself. So in those situations, you might end up having had a controlling financial interest and losing your controlling financial interest and deconsolidating at that point. So this is generally the model for corporations, for partnerships. It's a little bit more complicated. We're not going to go into a huge amount of detail, but generally, if most partnerships are going to end up being variable interest entities, and Alexander's going to explain why I think on the next episode. But if you end up in the voting model with a partnership, the general partner is never going to end up consolidating just because of the way the model works. And a limited partner would only consolidate if they hold unilateral kick out rights that are substantive and they can they can actually exercise them. So that's how it works for partnerships under the voting model, although I expect that to be, you know, very rare circumstances.
SPEAKER_03All right, so cliffhanger that people have to tune in next time to hear how to account for partnerships under the VIE model. Correct. All right. So
Consolidation scope exceptions
SPEAKER_03with all that said, I think anyone who's dealt with VIEs is probably sort of chomping at the bit to talk about scope and scope exceptions, because pretty much anyone who's dealt with VIEs is hoping they will fall out of scope or into one of the scope exceptions. So maybe, Alexander, you can walk us through those.
SPEAKER_00Sure. And I'm going to start by being the wet blanket here. Generally speaking, you're not going to get out of the VIE model based on a scope exception, right? But we're going to talk about them because stranger things have happened.
SPEAKER_03Yes, in the power and utilities industry, this could happen sometimes.
SPEAKER_00Yes, it definitely does happen. Uh not as often as people want.
SPEAKER_03Maybe you're that's that's a fair point. And I needed to mention the power and utilities industry as Matt knows. I can't have a podcast without at least mentioning every time. Every time it's funny. Yes.
SPEAKER_00Um, so so the the scope exceptions, there's probably two categories of it. I think Matt had kind of alluded to it. So the the first one is if you have a scope exception from ASE 810 overall. Um the other one, there's some specific scope exceptions from the VIE model as well. So you have to look at that. And if you meet one of those, then you you get your get out of jail free card that Matt mentioned. Um, but first and foremost, right, you know, we'll we'll go through the ASE 810 scope exceptions. And our starting point is actually legal entities, right? So I'm using my air quotes here as well, right? ASC 810 only applies to legal entities, and that's a defined term, right? So it's it's a little bit weird because it's an accountant's definition of a legal entity. So, you know, kind of gives you swirly eyes, and I think it breaks a couple of laws of physics there. But so what I when I'm talking about an ASC 810 legal entity, I'm gonna call it an accounting legal entity, right? But the that definition of an accounting legal entity is any legal structure used to conduct activities or to hold assets, right? It's a very broad definition and intentionally so, right? Um, but a good rule of thumb is it if it's a true legal entity, so something like a corporation, partnership, LLCs, trusts, they're gonna meet the definition of an accounting legal entity, right? And most of the time it's pretty straightforward. The only time we really see this come up is when you have um activities that are conducted through a contract where they don't set up an actual legal entity or a true legal entity. So something like a collaborative arrangement where Matt and I go into business, we don't want to pay the money to establish an LLC, so we just have a contract between us. We don't have a legal entity for either legal purposes or accounting purposes. So there's no entity in ASC 810 for me to evaluate or consolidate. Instead, I would just apply a different model.
SPEAKER_03Which model? Or is that too complicated?
SPEAKER_00Uh so something like that. We have ASC 808, which applies to collaborative arrangements, and that typically will give you a direction, but then that becomes a little bit of a rat's nest as well. That I'm not sure.
SPEAKER_03Okay, so another episode, but I had to at least ask the question because you kind of left it hanging there.
SPEAKER_02Yeah, I mean, and just to follow up, the only other I think complication with legal entities could be if you're dealing with um entities that are created in foreign jurisdictions where maybe either uh the reporting entity or the reporting entity is legal counsel like doesn't have a really a good grasp as to how those regulations work or what type of entity that would be the equivalent to in the US. And that can make that assessment a little bit more difficult.
SPEAKER_03All right, that's helpful because you're saying that the obviously it's US gap, so it is written from a sort of US legal entity perspective. That's right. Yep. All right. So then if we kind of get through all of that, then we'd say, okay, to the point you made earlier, most entities or arrangements are going to meet that. So then we would be looking to the 810 scope exceptions or these VIE scope exceptions. So what do we find?
SPEAKER_02So for the 810 scope exceptions, we're talking about the consolidation model.
SPEAKER_03Oh, overall. Okay. So let's start there.
SPEAKER_02Yeah. So yeah. So for 810 scope exceptions, again, this is the one where these are probably the better scope exceptions or the more exciting scope exceptions because you do get to walk away from the consolidation model in general. You don't have to then go to the voting interest entity. Um, but these are very specific um scope exceptions, and they really only focus on situations where there's already other gap that applies. So it wouldn't make any sense to apply AAC A10. So those specific scope exceptions include employer-sponsored employee benefit plans. Um, those are covered under AAC 712 or 715 investment companies that are in the scope of ASC 946, so they have to meet the definition of an investment company. And generally, it's only their investments in the in the investee entities that are scoped out. So if you have situations like fund-to-funds or uh master feeder structures, you have to be a lot more careful because consolidation rules might might apply. Uh, and then government organizations. So if you're a reporting entity and you have an interest or an affiliation with a government entity or like a government financing entity, those are scoped out unless they're being used to circumvent the consolidation rules. So if you're doing some kind of highly structured transaction with a government financing entity in order to avoid consolidation, you're right back in. Um, so those are the specific ones. I think lastly, like registered money market funds also exempt. Um, so those are the specific ones.
SPEAKER_03All right. So then if you get completely out of consolidation, then to your point, you don't apply either model, VOE or VIE. That's right. All right. So then let's
VIE model scope exceptions
SPEAKER_03assume you don't meet any of those. So then let's jump into the actual scope exceptions to the VIE. That will take you straight to the VOE. So Alexander, I'll go back to you.
SPEAKER_00Yeah, sure. So um maybe I'll start again, similar to what Matt said, like there's not a lot of specific VIE scope exceptions either, right? So don't get too excited. But it it should make intuitive sense now that you have the history behind the standard, right? The whole reason for the VIE model was basically a net to try to catch these entities we're using a voting model won't work. So it really wouldn't make sense to then have a bunch of scope outs from the VIE guidance, right? But there are a couple, right? So there's industry-specific ones like not-for-profit entities under ASC 958 that I mentioned before. Um, then there's one for separate accounts of life insurance entities under ASC 944. And the one that I do want to talk about, because we do get questions on it, is the so-called business scope exception. Right. And so this exception was really included as a practical expedient for when you have an interest in a legal entity that meets the definition of a business. Right. And so, of course, people hear that and all of a sudden they're they're turning the volume up right now because they're getting pretty excited. Like, tell me more about this. The response is don't get too excited yet. Right. There's there's requirements that need to be met on top of just meeting the definition of a business. And most of the time when people are evaluating consolidation, they won't meet those. Right. So how does it work? It basically says you can apply the business scope exception. If the entity meets the definition of a business under ASC 805, I heard there's a really good podcast on that. If people need a refresher, right? And you don't meet several other conditions, right? If so, then you get to apply the scope exception. But people tend to forget that and part and they think, oh, if I have, if the entity meets a definition of a business, then I get to apply the business scope exception, and it's not that straightforward.
SPEAKER_03So I have to admit, I'd like to jump in and say, well, I don't think it's quite as bad as you're making it out, but why don't you go through the ends and then I will evaluate if I would like to make that comment?
SPEAKER_00Absolutely. And to be completely fair, this is like selection bias, because typically things that come to me are matte, right? Yeah, there are. Yeah, no, absolutely. And just to your point, right, the whole purpose of putting that scope exception there is for like the the no-duh answers that come up, right? If I buy one share in a Fortune 500 company and you know it's an existing operating entity, I'm probably not gonna why would I have to go through the VID model?
SPEAKER_03Well, even if I buy the entire Fortune 500 company, likely I'm going to meet this exception, and I would think, but why don't you run through what these ends are?
SPEAKER_00So the ands, there's four of them, right? And and they can get complicated and spiral out of control, but really in a nutshell, the guidance basically says if you or any of your related parties were either involved in designing or redesigning the entity or capitalizing the entity, or substantially all of the activities involve you, or they involve um highly structured arrangements like leasing arrangements or securitizations, then you can't apply this business scope exception, even if it is a business. This should make intuitive sense again, right? The the guidance is basically presuming look, if you had a hand in setting up the entity, right, or if it's highly structured, then you should be applying the VIE framework. That's what it was meant to do. Right. So, all in all, again, selection bias. I don't see this applied as often as sometimes people think it is when it comes across our desk.
SPEAKER_03Right. But I think from the point of view, I mean, we talked about ASC 005 business combinations, like there are a lot of business combinations that involve a business. And so in which case, maybe you would be able to get out because it's a long, um, long-running, well-established business that you're involved with.
SPEAKER_02And and whether you get out under the business scope exception or you actually quickly evaluate the five characteristics and conclude it's not a VIE, you end up in the same place. Oh, it doesn't really matter.
SPEAKER_03That's a fair, really good point. Right.
SPEAKER_02So, and and we do also often have to encourage or you know, kind of walk our clients and our teams through that, right? Holding their hand and saying, listen, just because you're doing the five characteristics in the evaluation, it's not always that hard. So you might not get the business scope exception, but guess what? Your VIE analysis is going to be super straightforward in certain cases.
SPEAKER_03Oh, so that's actually really a fair point. That might be easier to just skip to that. So, okay, definitely a fair point to talk about. And then I definitely completely agree with you that as soon as someone says there's a legal entity, they think, oh, business exception, I have a legal entity, it must be a business. And that's clearly not the case, hence why you guys are emphasizing that. But I know you also mentioned, and I don't want to skip over this, going back to you, Matt, I think that there's a VI, there's an additional scope exception for the VIE model that private companies could take advantage of. And so what can you just highlight that as well?
SPEAKER_02Yeah, sure. And this was one of those tweaks that happened subsequent to 2009. So it was one of the good changes, particularly if you're a private company, um, that introduced a little bit of ease to the consolidation model in the effort of simplification, right? So private companies are are not required to apply the VIE guidance for legal entities that are under common control as long as they meet certain requirements, right? So the the three requirements that you need to meet are number one, you have to have a common parent with the entity you're looking at. So that's common control. The way the guidance works in that area is it needs to be the reporting entity and the entity that we're we're evaluating or not evaluating for consolidation of the VIE model. They need to have a common parent, but only in in in terms of majority voting interest. And the reason I'm pointing that out is because it can get very confusing if you're saying, well, how do I determine if it's under common control if I have to use a VIE model to do it? And that gets very circular, and then you're stuck in like an inception model. Um and we don't want to be there, right? So they were they were very clear that said your common control definition is majority voting interest. Number two, um, the reporting entity, the the legal entity that you're evaluating for potential consolidation and the parent all have to be private companies. So none of them can be public business entities. Um number three is that the reporting entity that you're talking about can't itself own a majority of the voting interest of the entity that we're trying to get the scope exception for. It would seem like you should consolidate so and you would anyway, because even if you get out onto the private company scope exception, you got to go to the voting model. So it's only a scope exception for the VIE model. So either way, you'd you'd end up consolidating that. Um, this ends up being an accounting policy choice. So you don't get to cherry pick kind of which legal entities you want to apply the private company scope exception to. Uh, if you meet the criteria and you've decided to do it for one, you have to do it for all. Um, then the only other thing I'll mention is there are specific disclosures. So it's a it's a definitely a simpler way to um do your consolidation analysis if you're a private company, but it does come with a little bit more disclosure.
SPEAKER_03So all right, that's definitely helpful. And so I'm just reflecting and picturing in my mind the list of scope exceptions in 810. I feel like it's longer than what we've talked about here, but is that the case that just from your experience you don't see those scope exceptions, other scope exceptions applied very often?
SPEAKER_02Yeah, there might be two or three more, some of which have dated out already, um, because some of which were based on the effective dates of the of the guidance, one of which we used to call the information out.
SPEAKER_03So if you couldn't get the information, um, we don't really I mean there could still be an entity that was subject to that exception. I definitely saw a lot of these.
SPEAKER_02Sure, sure, sure. Um, so we yeah, I mean, I'd say that we probably don't get any questions. I want to say we get a couple, but I don't even think we do in some of those at all.
SPEAKER_03So I mean, in theory, if someone was really focused on trying to get out, they could look at those other exceptions, but to your point, but I'm pretty on that.
SPEAKER_02It's always a good reminder to people that we're doing a podcast at a high level, right? Yes. We have tons of guidance on this in our guide, right? In the consolidation guide or in the codification itself, um, where you can go look at the actual list of scope exceptions. Um, but it makes for boring podcasts.
SPEAKER_03Well, also, I was just gonna say, hopefully, no matter how great a guest you guys are, hopefully no one is doing their actual accounting based on just listening to this podcast. It's just a teaser. Okay, Matt's making a faces at me. He's hoping that you are. No, I'm just kidding. So definitely read the guide as well. But I think so, maybe to just bring this all back together and get a little more serious. So, long story short, we have two models, VIE and VOE. You start with the VIE model, and the first step in that is to see if you qualify, if you're in scope or if you qualify for a scope exception. Fair?
SPEAKER_02Correct.
SPEAKER_03All right. So then once you've done that, then you go on to step two, which if I look quickly at my notes, is to determine whether or not the entity is a VIE. That's right. All right, so perfect place to stop for our next episode.
SPEAKER_02I think so. Yes.
SPEAKER_03All right, well, I always have one more question. So you can mentally prepare because I'll probably ask a similar one again. But if dealing with scope and scope exceptions, I feel like you've given probably your best advice in terms of be skeptical. But what other advice do you give to companies when they're sort of first approaching this guidance and in particular if they haven't dealt with the VIE model before? So, Matt, you first.
SPEAKER_02Yeah, I mean, I I think the the part where Alexander was talking about that it only applies to legal entities, comes up more than you would think. Um, because I think folks are always thinking about relationships with partners or with large public companies, and like, do I have VIE considerations? And the answer is usually not, right? Usually, usually the answer is if you're dealing with a smaller entity, if you're dealing with a highly structured entity, if you're dealing with uh an investee of some kind, either through loans or through other financial interests, that's generally kind of the kind of legal entity we're talking about. But if you have a partnership like through contracts with a Fortune 500 company, generally not invoking the VIU model that you're not going to consolidate, you know, a company ABC that's listed on the on the I mean, it could happen, but generally that's not what we're talking about.
SPEAKER_03Yeah, even maybe companies slightly smaller than the Fortune 500. So all right, and Alexander, how about from your point of view?
SPEAKER_00Yeah, probably building on that. I mean, I think it's it's two extremes, right? Some people either come over prepared, maybe to Matt's point, where they're trying to boil the ocean and overthinking it, right? And it's really like, hey, step back if you understand the concepts of the model, that that should give you enough direction to know what the answer probably should be, right, within scope or not. And then there's the people that I want to give the caveat to where they underthink it, right? Where they just do a cursory look of the five bullets or you know, the things that we're talking about, but don't actually kind of read, oh, this exception only applies if X, or you know, you can only apply this if Y. And so that's where it's a trying to find that Goldilocks, the middle of the road to figure out scoping.
SPEAKER_02Yeah. Can I do one more? Of course. I just want to remind the private companies that you have this scope exception because we get a lot of calls from private company teams or clients that are have already done the entire analysis and forgot that they can, you know, adopt an accounting policy where they didn't really have to do all that work. It's way simpler again to just make the disclosures if that, if that uh election is available to you.
SPEAKER_03All right, definitely a great reminder and maybe something we should even put in the beginning or our introduction so people or you know, maybe they just want to learn about the whole history of VIE accounting, even if it's not applicable to them. So, all right, uh, maybe just one last question. If people do want to read more, uh, where should they go look?
SPEAKER_00We have the best consolidation guide in the world.
SPEAKER_03All right, very good. And with that, just want to thank you guys for joining me today. And it's always a pleasure to have you.
SPEAKER_02Thanks. Thank you.
SPEAKER_03That's our show for today. Tune in next week for more fresh episodes. So that you never miss any of our audio content. Follow the PWC Accounting Podcast wherever you listen to your podcasts. And to stay up to date on all our latest accounting and reporting news, sign up for our newsletter at viewpoint.pwc.com. From Thought Leadership at PWC, I'm Heather Horn. Thanks for tuning in.
SPEAKER_01This podcast is brought to you by PWC, All Rights Reserved. PwC refers to the U.S. member firm or one of its subsidiaries or affiliates, and they sometimes refer to the PWC network. Each member firm is a separate legal entity. Please see www.pwc.com slash structure for further details. This podcast is for general information purposes only and should not be used as a substitute for consultation with professional advisors, including accountants and lawyers.
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