FASB Statement 167: Challenges with Consolidating Variable Interest - - PowerPoint PPT Presentation

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FASB Statement 167: Challenges with Consolidating Variable Interest Entities

Lessons Learned From First Compliant Financials; Significant New Developments

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific WEDNESDAY, JANUARY 12, 2011

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Sherif Sakr Partner Deloitte & Touche New York Sherif Sakr, Partner, Deloitte & Touche, New York Peggy Gallagher, Director, Professional Practices Group, EisnerAmper, Edison, N.J. David Thrope, Partner, Ernst & Young, New York

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FASB Statement 167 (ASU 2009‐17): Ch ll With C lid ti Challenges With Consolidating Variable Interest Entities Webinar

• Jan. 12, 2011

Sherif Sakr, Deloitte & Touche LLP

ssakr@deloitte.com

Peggy Gallagher, EisnerAmper LLP

margaret.gallagher@eisneramper.com

David Thrope, Ernst & Young

david.thrope@ey.com

Today’s Program

Material Terms Of FAS 167 (ASU 2009-17)

[Peggy Gallagher]

Slide 6 – Slide 25 Observations from FAS 167 (ASU 2009-17) Implementations

[S herif S akr]

Slide 26 – Slide 31 Relevant And Related 2010 Guidance

[David Thrope]

Slide 32 – Slide 43

MATERIAL TERMS OF FAS 167

Peggy Gallagher, EisnerAmper LLP

MATERIAL TERMS OF FAS 167 (ASU 2009‐17)

d h Agenda For This Section

• Background and review, changes from FIN 46(R)
• Expanded definition of a VIE
• Expanded definition of a VIE
• Determining the primary beneficiary (PB)
• Power-sharing

Power sharing

• Implementation challenges
• Disclosures

7

Technical Background g

• Originally issued as SFAS 167 (now resides in ASC 810)
• Subsequently codified as ASU 2009-17, Improvement s t o

Financial Report ing by Ent erprises Involved wit h Financial Report ing by Ent erprises Involved wit h Variable Int erest s

• Affects entities that are subject to the variable interest

entity consolidation model entity consolidation model

• Increases related disclosure requirements
• Effective for fiscal years and related interim periods

beginning after Nov. 15, 2009

• Earlier application prohibited

8

Review Of VIE Consolidation GAAP

Key questions to ask: 1. Does the VIE consolidation guidance apply? 2 A h i ? 2. Are there any scope exceptions? 3. Does the reporting entity (RE) hold a variable interest? 4. Is the target entity a VIE? 4. Is the target entity a VIE? 5. Is the RE the primary beneficiary of the VIE?

S F AS 167/ AS U 09-17 primarily affect ed #2 and #5

9

Significant Changes g g

• Eliminates QSPE scope exceptions
• Revises definition of a VIE

D i i f i b fi i R l

• Determination of primary beneficiary: Replaces

quantitative assessment with a qualitative approach

• Requires ongoing, annual assessments
• Expands disclosure requirements, including financial

statement display

10

Implementation: Expanded Definition Of VIE Implementation: Expanded Definition Of VIE

SFAS 167 FIN 46(R) SFAS 167

• Kick-out rights:

Cannot consider FIN 46(R)

• Existence of any

kick-out rights unless held by a single party g indicated that equity holders at

• QSPEs: Scope

risk do not control the entity. exception eliminated

11

Impact: Expanded Definition Of VIE p p

• Modification of assessment of kick-out rights may result

in more entities being evaluated as VIEs.

• FASB predicts that many limited partnership

arrangements will be VIEs and thus evaluated for consolidation consolidation.

• A true “sleeper”; will affect all industries, not just

financial services

12

Implementation: Determination Of Primary Beneficiary Primary Beneficiary SFAS 167 FIN 46(R) SFAS 167 The PB of a VIE has (1) the power over VIE’s FIN 46(R) The PB of a VIE is the entity that absorbs a significant activities,

and (2) obligation to

absorb VIE’s losses or majority of the VIE’s expected losses, residual returns or absorb VIE s losses or the right to receive benefits that could residual returns, or both be potentially significant to the VIE

13

Impact: Primary Beneficiary p y y

• New definition of PB applies a qualitative assessment to

power and control.

• Must be re-assessed annually
• Kick-out rights are ignored unless held by a single party.

Sh d it ti t b l t d ith

• Shared power situations must be evaluated with care.

14

Power-Sharing

Power is considered shared if:

• Two or more unrelated parties have power to direct the

activities that most significantly affect the economic performance of the VIE, and p ,

• All decisions about those activities require the consent
• f each of the parties sharing power.

Practice considerations Practice considerations

• If multiple parties have power over the activity (or

activities) that most significantly affect the economic f f th VIE b t i t h d performance of the VIE, but power is not shared.

• If multiple parties have power over different activities
• f the VIE, but power is not shared.

15

Power-Sharing: “Tiebreaker Guidance” g

When: Apply the related party “tiebreaker” test only if no

• ne party in the related party group individually has a

controlling financial interest, but the related party group as a whole does. Why: Tiebreaker test identifies the related party “most closely associated” with the VIE. closely associated with the VIE. How: If one party in the related party group individually t b th diti f lid ti th th t t meets both conditions for consolidation, then that party consolidates irrespective of the tiebreaker test. Insight: A very qualitative assessment

16

Example: Power-Sharing p g

Company A and Company B form an entity to manufacture, distribute and sell a beverage. The entity is funded with $95 million of 20-year fixed- rate debt and $5 million of equity. The debt is widely dispersed among third-party investors. The equity is held by Company A and Company B. Company A and Company B are not related parties. Company A, a Company A and Company B are not related parties. Company A, a beverage manufacturer and distributor, is responsible for manufacturing the beverage. Company B, also a beverage manufacturer and distributor, is responsible for distributing and selling the beverage. C A d C B h h 50% f th ti i ht d h Company A and Company B each have 50% of the voting rights and each represents 50% of the board of directors. Decisions about the manufacturing, distributing and selling of the beverage require the consent of both Company A and Company B. All other decisions about p y p y the entity are jointly decided by Company A and Company B through their voting interests and equal board representation. Any matters that cannot be resolved or agreed upon must be resolved through a third- party arbitration process party arbitration process.

S

• urce: S

F AS 167

17

Example: Power-Sharing (Cont.) p g ( )

1. Who are the variable interest holders? 2. Which activities most significantly affect the entity’s economic activities? economic activities? 3. Who has the power to direct those activities? Is there power-sharing? 4. Who is the primary beneficiary? 5. What if Company A instructed where Company B could distribute and sell the beverage? 6. What if B’s board representation increased to 70%?

18

Example: Power-Sharing, Insights p g, g

• If the joint consent of A and B was needed for directing

activities, power is considered shared.

• If power is not shared but:

The significant activities are directed by multiple – The significant activities are directed by multiple unrelated parties, and – The nature of the activities that each party are directing is the same directing is the same, – Then the party, if any, with the power over the majority of those activities shall be considered to h h d h f h have the power to direct the activities of the VIE. Identifying significant activities requires consideration

• f the primary purpose, and risks, VIE was designed

to address.

19

Impact: Annual Assessment p

• Distinct from reconsideration of VIE status, which is

required only upon triggering events.

• FASB added a new triggering event, related to loss of

power to direct VIE’s activities that most significantly p g y affect VIE’s performance.

• PB assessment must be reconsidered on an annual basis.
• FASB expects most VIEs to have PBs (fewer “orphans”)
• FASB expects most VIEs to have PBs (fewer orphans ).
• Timing of annual assessment is not specified.
• Assessing “power” involves layers of qualitative

judgments.

• FASB is skeptical of an imbalance between a reporting

entity’s economic interest vs. its economic power. y p

20

Implementation Challenges For PBs p g

• Developing consolidation processes and related

technology

• Accessing financial information in a timely manner
• Accessing financial information in a timely manner
• Public companies – Sarbanes-Oxley considerations
• Developing policies for monitoring and identifying

triggering events or transactions triggering events or transactions

• Developing a robust annual assessment process

21

Implementation Challenges For PBs: Consolidation Consolidation

• Balance sheet
• Income statement
• Statement of changes in equity
• Statement of cash flows
• Measurement
• Comparability of financial information guidance is only
• Comparability of financial information – guidance is only

applied prospectively.

22

Balance Sheet: Separate Presentation Requirement Requirement

• Assets and liabilities of VIE that are restricted to the

VIE’s use and responsibility only should be segregated on the face of balance sheet/

• FASB did not provide detailed implementation guidance.
• Practice has evolved to include parenthetical displays,

separate line items, and “mini” balance sheets.

• “Collapsing” all such assets and liabilities is not

appropriate.

23

Measurement Issues

• GAAP says assets and liabilities being consolidated

should be brought over at their carrying amounts.

• However if that is not “practicable ” they shall be
• However, if that is not practicable,

they shall be measured at fair value. – “Practicable” is not defined. – Election of fair value option – Initial fair value measurement Unpaid principal balance method for lending related – Unpaid principal balance method for lending related activities

24

Implementation Challenges: Disclosures p g

• VIEs or potential VIEs scoped out due to scope

exceptions (non-profits, valid business, etc.)

• All reporting entities involved with a VIE but are not its
• All reporting entities involved with a VIE but are not its

PB

• All reporting entities that are the PB of a VIE
• For entities with multiple VIEs some aggregation of

For entities with multiple VIEs, some aggregation of disclosures is permitted. All dd l h f f

• Allow additional time to gather information for

disclosures

25

OBSERVATIONS FROM FAS 167

Sherif Sakr, Deloitte & Touche LLP

OBSERVATIONS FROM FAS 167 (ASU 2009‐17) IMPLEMENTATIONS

This presentation contains general information only and Deloitte is not, by means

• f this presentation, rendering accounting, business, financial, investment, legal,

tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates and related entities shall not be ibl f l t i d b h li thi t ti responsible for any loss sustained by any person who relies on this presentation.

A d i hi d “D l i ” D l i & T h LLP b idi f D l i LLP Pl As used in this document, “Deloitte” means Deloitte & Touche LLP, a subsidiary of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. 27

O i Overview

• Adoption of ASU 2009-17 (FAS 167) affected most industries, not just financial

services

Banking & Securities

Industry impact

Consolidated VIE Assets

Travel & Hospitality Energy Asset Management Insurance Banking & Securities

• Broader implementation challenges
• Accounting interpretations

Fi i l i

2 4 6 8 10 12 14 Other

Multiple by which consolidated VIE assets of the industry (as a percentage of total assets) increased* * Based on Deloitte’s May 2010 survey of a sample of

• Financial reporting
• Operational

Based on Deloitte s May 2010 survey of a sample of 40 SEC registrants across different industry sectors.

28

Accounting Interpretations Matters

• Interpretation challenges related to the two criteria for primary beneficiary

1) The power to direct the activities that most significantly affect the VIE’s economics, and 2) The right to receive benefits or the obligation to absorb losses that

could potentially be significant to the VIE.

• Determination of “power” is less than straightforward in some structures.
• Operating partnerships, joint ventures, certain securitization and asset-

backed financing structures (e.g., re-remics, credit linked notes, etc.)

• Unilateral kickout and/or participating rights
• Intepretations of terms “potentially significant” and “more than insignificant”
• Service provider’s fee (principal vs. agent)
• Implications for asset management industry: ASU 2009-17 (FAS 167) deferral

h h i f ASU 2010 10 through issuance of ASU 2010-10

29

Fi i l R i M Financial Reporting Matters

• Prospective application of provisions of ASU 2009-17 (FAS 167)

Prospective application of provisions of ASU 2009 17 (FAS 167)

• Implications for comparability to prior years
• Significant increases to balance sheets’ sizes

― Debt covenants, regulatory capitals, etc.

• Separate presentation of consolidated assets
• Measurement of newly consolidated assets and liabilities
• Carrying amounts, unpaid principal balance, fair value
• ption

p ― Fair value option: Determination of fair value of assets and liabilities

• Presentation of statement of cash flows

30

O i l M Operational Matters

• Timing of adoption for public entities with November and

December year-ends

• Varied operational undertakings depending on nature of reporting

Va ed ope at o al u de ta gs depe d g o atu e o epo t g entity and type of involvement with the VIEs

• Downstream implications

S t i t l t l l ti t

• Systems, processes, internal controls, valuations, etc.
• Timely access to financial information
• Reliance on financial information prepared by service providers

Reliance on financial information prepared by service providers

31

RELEVANT AND RELATED 2010

David Thrope, Ernst & Young LLP

GUIDANCE

Agenda For This Section

► ED 10

FASB ti

► FASB reaction ► Questions

David N. Thrope david.thrope@ey.com +1 212 773 0930 This presentation is for educational purposes and is not intended to b d h ld b li d i d i h d/ be, and should not be, relied upon as accounting advice; research and/or professional consultation should be performed or obtained before applying the literature described herein to an actual or proposed transaction

IASB ED 10 and related developments Page 33

transaction.

IASB Exposure Draft 10: “Consolidated Financial Statements”

Background

► Originally a joint project with FASB ► Originally, a joint project with FASB

► IASB exposure draft issued December 2008: ► Words differed from FAS 167 ► Words differed from FAS 167 ► IASB staff indicated results in same consolidation conclusions as

FAS 167 for all FAS 167 examples

IASB ED 10 and related developments Page 35

Current Status

► September 2010 ► Updated IASB staff draft of proposed standard posted on IASB

Web site (www.ifrs.org)

► IASB now moving ahead independently of FASB

g p y

► Final standard expected first quarter of 2011 ► Effective date of final standard: Not known

IASB ED 10 and related developments Page 36

Key Staff Draft Provisions

► All entities covered by same consolidation model ► No VIEs ► Consolidate when “control” through: ► Rights giving current ability to direct activities significantly affecting ► Rights giving current ability to direct activities significantly affecting

entity returns

► Exposure, or right, to entity variable returns with potential to vary

as a result of entity performance, and as a esu t o e t ty pe o a ce, a d

► Ability to use power to affect returns ► Decision maker does not have power if acting on behalf of another ► Decision-maker does not have power if acting on behalf of another

party (i.e., as “agent”)

IASB ED 10 and related developments Page 37

Key Staff Draft Provisions (Cont.)

► Principal vs. agent, consider: ► Scope of decision-making authority ► Rights held by other parties

agent when removal rights:

► Rights held by other parties – agent when removal rights: ► Exist ► Can be exercised without cause ► Decision-maker remuneration ► Decision-maker exposure to variability of returns from other

interests held

► The greater the exposure, the more likely decision-maker is not

agent.

IASB ED 10 and related developments Page 38

Staff Draft Vs. Current U.S. GAAP

► Staff draft (not U.S. GAAP) allows “power”: ► Through substantive potential voting rights (¶B20) such as: ► Options ► Forwards ► Convertibles ► With < majority voting rights ► Investment company does not consolidate investees. ► Consistent with current U S GAAP ► Consistent with current U.S. GAAP ► Change from current IFRS ► Parent that consolidates investment company must consider

consolidation of investment company investees consolidation of investment company investees.

► Inconsistent with current U.S. GAAP ► FASB to inform IASB it does not agree with proposal.

IASB ED 10 and related developments Page 39

FASB Reaction

Roundtable

N 22 2010

► Nov. 22, 2010

► Joint FASB and IASB consolidation roundtable ► At FASB office

► Constituent observations

► Single consolidation model ► Control with less than a majority of voting rights ► Potential voting rights ► Potential voting rights ► Principal vs. agent ► Kick-out rights

IASB ED 10 and related developments Page 41

Investment Company Deferral (ASU 2010-10)

► Was pending completion of IASB/FASB consolidation project

p g p p j

► Currently applies when: ► Investee: ► Investee: ► Has attributes of an “investment company” (ASC 946-10-15-2) ► Is not a securitization or asset-backed financing entity ► No investor obligation to fund losses, unless investee is money

market fund or operated under similar rules.

► FASB schedule to address: ► Exposure draft: Second quarter 2010 ► Final standard: Fourth quarter 2010

IASB ED 10 and related developments Page 42

► Final standard: Fourth quarter 2010

Other FAS 167 Changes

► FASB is to consider whether to proceed with an exposure draft on

certain conforming changes.

► Timing is open.

IASB ED 10 and related developments Page 43