Toward the end of 2018, manufacturers and other private businesses got some much-needed financial reporting relief in the form of Accounting Standards Update (ASU) 2018-17. Intended to reduce the cost and complexity of financial reporting associated with consolidation of variable interest entities (VIEs), the standard currently goes into effect for private companies for fiscal years beginning after December 15, 2020. That means that implementation should be underway this year. Here’s what you need to know.

A Brief History of Consolidation Accounting Standards

In the early 2000s, the Financial Accounting Standards Board (FASB) began requiring both public and private companies to consolidate their financials with legal entities with whom they had common ownership. A response to the WorldCom, Enron, and Tyco scandals of the time, this focus on consolidation led the FASB to look more and more closely at VIEs.

Variable Interest Entities exist when entity control is determined by contractual arrangements rather than voting rights. When a reporting entity can influence the VIE’s economic performance and lay claim to the VIE’s profits, it is deemed to have a controlling financial interest in the VIE — whether or not it has voting rights. And under the accounting guidelines of the early 2000s, reporting entities were required to consolidate their financials with those of the entities they controlled.

In the decade that followed, private companies and their investors pushed back, stating that consolidation requirements were too burdensome and that the VIE’s financial attributes distorted the operating entity’s true economic position.

The FASB responded in 2014 by releasing ASU 2014-07. This accounting standard did alleviate consolidation reporting burdens, but only for private companies in specific leasing arrangements. The consolidation standard remained in effect for most other business arrangements.

The Latest on Variable Interest Entities

The FASB’s most recent release, ASU 2018-17, is what private companies have been lobbying for. Under the new consolidation accounting standard, private companies that control VIEs need not consolidate the VIE’s financials into their own if all the following criteria are met:

  1. The reporting entity and the VIE are under common control.
  2. The reporting entity and the VIE are not owned by a public business entity.
  3. The VIE is not a public business entity.
  4. The reporting entity does not own more than 50% of the VIE’s voting shares.

To follow the new consolidation rules, entities must elect into this new treatment. Those that make the election will be able to produce simple and straightforward financial reports that are independent of their VIE investment activity. Companies can continue to consolidate Variable Interest Entities into their financials if they wish, but if they do, they must apply the VIE principles across the board. They cannot pick and choose which entities to bring into the fold and which to leave out.

Companies that elect to follow this new standard must disclose in the footnotes to their financial statements any risks they have with respect to the VIE, how the VIE would affect their financial position, and what their exposure is to losses sustained by the VIE.

How This Impacts Stakeholders

Stakeholders will see a change to private entities’ financial statements on annual reports for fiscal years that begin after December 15, 2020, and then on interim reports for fiscal years that begin after December 15, 2021.

Although there will be exceptions, many stakeholders will view this as a positive change. Investors in private companies want to see financial reports for the operating entity in isolation. In fact, stakeholders lobbied for this change so that they could see true performance numbers rather than numbers that were muddied up by assets or liabilities held by VIEs.

Segregating VIEs from their controlling entities will also impact lenders. Banks and other financial institutions will likely see a change in entities’ asset and liability balances when this new standard takes effect. If they want to see financial reports of the operating entity combined with those of the VIEs, they must request that information separately or combine the reports themselves.

If you have questions about this or any other new accounting standard, or if you want to discuss how this new VIE reporting opportunity affects your manufacturing business, reach out to your CRI professional.