ASC 810 Consolidation for Private Companies: Voting Interests, VIEs and the Common-Control Alternative

Consolidation questions come up constantly at owner-managed private companies. The owner holds an operating company, a real estate entity that leases the building to it, a captive insurance or equipment entity, and a few other LLCs. Whether those statements are consolidated, and whether the auditor agrees, depends on ASC 810, Consolidation.

This guide walks through the two models, the private company alternative for common-control arrangements, the mechanics of preparing consolidated statements, and what auditors test.

The starting point: control of a legal entity

Consolidated financial statements present the parent and its subsidiaries as a single economic entity. The usual condition for consolidation is a controlling financial interest. ASC 810 applies two models, and the first question is always which one applies to the entity under evaluation.

1. Variable interest entity (VIE) model. Applies if the legal entity is a VIE. The holder with a controlling financial interest, the primary beneficiary, consolidates.
2. Voting interest model. Applies if the entity is not a VIE. In general, ownership of more than 50% of the outstanding voting shares gives a controlling financial interest.

The VIE evaluation comes first. Only if the entity is not a VIE, and is not otherwise scoped out, does the voting interest model decide.

Step 1: determine whether the entity is a VIE

A legal entity is a VIE if, in general terms, any of the following is true:

• Insufficient equity at risk. The total equity investment at risk is not sufficient to finance the entity's activities without additional subordinated financial support.
• Equity holders lack the characteristics of a controlling financial interest. For example, the equity holders as a group lack the power, through voting rights or similar rights, to direct the activities that most significantly affect the entity's economic performance, or they lack the obligation to absorb expected losses or the right to receive expected residual returns.
• Voting rights not proportional to economic interests. The voting rights of some investors are not proportional to their obligations to absorb losses or rights to residual returns, and substantially all of the entity's activities are conducted on behalf of an investor with disproportionately few voting rights.

For limited partnerships and similar entities, limited partners generally lack power if they do not have substantive kick-out rights over the general partner or substantive participating rights. This catches many real estate and investment partnerships.

A reporting entity with a variable interest must evaluate whether the entity is a VIE and, if it is, whether the reporting entity is the primary beneficiary. Variable interests include equity, debt guarantees, certain fees, leases with residual value guarantees and purchase options, and other arrangements that absorb variability.

Step 2: the primary beneficiary

A reporting entity is the primary beneficiary of a VIE if it has both of the following:

1. Power to direct the activities of the VIE that most significantly affect the VIE's economic performance.
2. The obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE.

Both conditions must hold. If power is shared among unrelated parties so that no single party has it, no one consolidates. If a related party group exists, the related party tiebreaker tests within ASC 810 may apply, so work through the related party provisions when the decision is not otherwise clear.

The primary beneficiary assessment is made when the reporting entity first becomes involved with the entity and then reconsidered on an ongoing basis as facts and circumstances change, for example when governing documents are amended or a variable interest is acquired or disposed of.

The private company alternative for common-control arrangements

Private companies frequently have a real estate entity, owned by the same family or owners, that leases property to the operating company. Without relief, the lease and often a guarantee would make the lessor a VIE and the operating company the primary beneficiary, resulting in consolidation of an entity the operating company does not own.

The FASB Private Company Council addressed this in two steps:

• ASU 2014-07 introduced an alternative for private companies under common control, limited to leasing arrangements. A private company lessee could elect not to apply the VIE guidance to a lessor under common control if specific conditions were met.
• ASU 2018-17 later expanded that alternative beyond leasing. A private company can elect, as an accounting policy, not to apply the VIE guidance to legal entities under common control that meet the criteria. For private companies, ASU 2018-17 is effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021, with early adoption permitted. Private companies that had elected the 2014-07 leasing alternative move to the broader alternative.

Under ASC 810-10-15-17AD, the criteria are that the reporting entity and the legal entity are under common control, that they are not under common control of a public business entity, that the legal entity is not itself a public business entity, and that the reporting entity does not directly or indirectly have a controlling financial interest in the legal entity under the general (voting interest) guidance, without applying the VIE guidance to make that call. The election is a policy applied to all legal entities that meet the criteria, so it cannot be used for some common-control entities and not others. The alternative is not available to public business entities, not-for-profit entities or employee benefit plans.

Points to work through when applying it:

1. Whether "common control" is met. The facts about who holds the votes in both entities matter.
2. The required disclosures: the nature and risks of the involvement, how it affects financial position, performance and cash flows, the carrying amounts and classification of related assets and liabilities, and the maximum exposure to loss (or a statement that it cannot be quantified).
3. How the election interacts with the voting interest model. If the operating company controls the other entity by voting interests, the alternative does not apply and the entity is consolidated under that guidance.
4. Transition. ASU 2018-17 is applied retrospectively with a cumulative-effect adjustment to retained earnings at the beginning of the earliest period presented, so adoption can change which entities are consolidated.

If the alternative applies and is elected, the lessor is not consolidated and the lessee accounts for the lease under ASC 842. See the ASC 842 guide for the lease accounting.

Voting interest model

For an entity that is not a VIE, a reporting entity generally consolidates if it holds a majority of the voting rights, directly or indirectly. Points to examine:

• Substantive rights of minority holders. Substantive participating rights held by noncontrolling shareholders, such as approving the budget or key management, can overcome the presumption of control.
• Limited partnerships. The general partner generally controls unless limited partners have substantive kick-out or participating rights.
• Less than 50% but control. ASC 810 recognizes that control can arise with a smaller ownership percentage through a contract, a lease, an agreement with other stockholders or a court decree, so read the agreements.
• Majority owner without control. A majority-owned entity is not consolidated when control does not rest with the majority owner, for example when the subsidiary is in legal reorganization or bankruptcy, or operates under foreign exchange restrictions or other governmental controls so severe that they cast significant doubt on the parent's ability to control it.

Consolidation mechanics

Once the answer is consolidate, the mechanics are straightforward but easy to get wrong.

• Eliminate intercompany balances and transactions, including intercompany revenue, expense, receivables, payables, loans, interest and dividends. Unrealized intercompany profit in inventory or fixed assets is eliminated.
• Uniform accounting policies. Adjust subsidiary information to the parent's policies where needed, such as depreciation methods or inventory costing.
• Fiscal year-end differences. When the subsidiary's fiscal period differs from the parent's, the usual approach is to use a closing date close to the parent's. The codification allows the subsidiary's closing date to differ when the gap is no more than about three months, with recognition (by disclosure or otherwise) of the effect of intervening events (ASC 810-10-45-12).
• Noncontrolling interest. The portion of equity not attributable to the parent is presented within equity, separate from the parent's equity, and net income is attributed to both.
• Changes in ownership. Transactions that change the parent's ownership interest without loss of control are equity transactions. Loss of control triggers deconsolidation with a gain or loss measured at fair value of any retained interest.
• For VIEs, the primary beneficiary consolidates assets and liabilities at their carrying amounts or at fair value depending on the circumstances at initial consolidation, and presents additional disclosures about the VIE.

What auditors test

Risk assessment and scoping

Understand the organization chart, the ownership of all related entities and their relationships, and identify which are included or excluded from the statements. An excluded entity that should have been evaluated is a risk to look for. Cross-check with the related party inquiries in AU-C 550 for entities under common ownership. If the consolidation includes components audited by others, AU-C 600 applies.

Consolidation conclusion

• Obtain management's consolidation analysis, with the VIE and voting interest conclusions for each entity.
• Read the operating agreements, leases, guarantees, loan agreements and any side agreements that might create variable interests.
• Evaluate whether the common-control alternative was properly elected, the conditions met and the disclosures made.
• Confirm reassessment when events occurred during the year.

Mechanics

• Agree the consolidating schedule to the trial balances of each entity.
• Test eliminations: intercompany balances agree on both sides and net to zero.
• Test the noncontrolling interest and its allocation.
• Review the consolidation entries on the journal entry testing list, because manual top-side entries are a risk area.
• Consider each entity's cutoff and the effects of any different year-end.

Presentation and disclosure

Test the policy note on principles of consolidation, any election and the disclosures for unconsolidated entities or VIEs. Use the GAAP disclosure checklist.

Common issues

• No documented VIE analysis. A conclusion not to consolidate needs a documented evaluation.
• Common control alternative applied without checking conditions or without the disclosure.
• Guarantees overlooked. The owner or the operating company guarantees the real estate entity's mortgage.
• Intercompany items not fully eliminated, especially loans and interest.
• Year-end differences ignored.
• No reassessment after an amendment to the lease or governing documents.

FAQ

What are the two consolidation models in ASC 810?

The variable interest entity model and the voting interest model. The VIE evaluation comes first. If the entity is a VIE, the primary beneficiary consolidates. If not, the voting interest model applies, generally requiring more than 50% of the voting rights.

What makes someone the primary beneficiary of a VIE?

Having both the power to direct the activities that most significantly affect the VIE's economic performance and the obligation to absorb losses or right to receive benefits that could be significant to the VIE.

Can a private company avoid consolidating a related real estate entity?

Possibly, through the private company alternative for legal entities under common control, but only if its conditions are met and it is elected as a policy with the required disclosures.

Does the alternative apply only to leasing arrangements?

It started as a leasing-only alternative under ASU 2014-07. ASU 2018-17 broadened it to legal entities under common control generally, subject to the criteria in ASC 810-10-15-17AD.

What does the auditor look at first?

The list of related entities and the management analysis of each, compared with the operating agreements, leases and guarantees. An entity that was never evaluated is the main exposure.

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Sources

• FASB ASC 810-10, Consolidation, Overall (voting interest model, variable interest entity model, 810-10-15-17AD common control alternative, 810-10-45-12 differing fiscal periods)
• FASB ASU 2014-07, Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements
• FASB ASU 2018-17, Targeted Improvements to Related Party Guidance for Variable Interest Entities
• FASB ASC 842, Leases
• AICPA, AU-C Section 230, 240, 550 and 600

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error