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2.1 Scope of consolidation guidance
Publication date: 20 Dec 2023
us Consolidation guide
Reporting entities are required to evaluate the provisions of ASC 810-10 to determine whether and how to consolidate another entity. ASC 810-10 exempts certain legal entities from consolidation, but those exceptions are relatively few.
The first step in applying the consolidation framework requires a reporting entity to consider whether the VIE model applies. Only certain specified legal entities (e.g., not-for-profit entities and life insurance entities) do not need to be evaluated using the VIE model. These entities still need to be evaluated for potential consolidation under the voting interest consolidation model discussed in CG 7.
Legal entity definition
Any legal entity, regardless of its legal form or scope of its activities, is subject to potential consolidation absent an applicable scope exception. The ASC Master Glossary provides a definition of a legal entity.
Definition from ASC Master Glossary
Legal Entity: Any legal structure used to conduct activities or to hold assets. Some examples of such structures are corporations, partnerships, limited liability companies, grantor trusts, and other trusts.
The definition of legal entity is intentionally broad. It includes all legal structures established to manage or administer activities of any kind, or to hold assets or incur liabilities. However, the term does not extend to individuals.
Concluding that an arrangement involves a legal entity requires that all relevant facts be considered. Consider the following examples:
- A franchise agreement may be entered into between a franchisor and an individual. This arrangement does not fall within the scope of the consolidation model, as the franchisee is a person. On the other hand, if the franchise agreement is between the franchisor and a legal entity (e.g., a corporation, partnership, limited liability company, or unincorporated entity), the legal entity would be subject to potential consolidation by the franchisor even when the franchisee is wholly owned by an individual.
- In the insurance industry, it is common practice to use syndicates to accept insurance business on behalf of the syndicate’s members. Depending on the legal form of the structure, some syndicates may involve a legal entity (e.g., a partnership). Other syndicate arrangements may pose no consolidation implications, as no legal structure or form is used to effect the members’ underwriting activities.
Other situations exist when multiple parties jointly undertake an endeavor that is not wholly or partially conducted through a separate legal entity. If companies are subject to the collaborative arrangements guidance in ASC 808, the VIE model does not apply. See CG 8.3 for further details on accounting for collaborative arrangements.
2.1.1 Factors impacting the legal entity determination (consolidation)
Determining whether an entity is a legal entity potentially subject to consolidation may require the exercise of judgment. The determination is often obvious, such as when there is an incorporated legal entity (e.g., a corporation). Other times it may be less clear.
Factors to consider when evaluating whether a structure is a legal entity include whether:
- It meets the definition of a legal entity in the resident country. Even if it does not, the structure may have characteristics similar to those of a legal entity in the US. For example, an unincorporated foreign joint venture may have characteristics similar to those of a US partnership or limited liability company
- It is permitted to enter into contracts under its own name (i.e., not in the name of the partners or parent company)
- It has legal standing to enforce contracts or exercise creditor rights and, conversely, can be sued on a standalone basis
- The liability of the partners or investors are limited, or the liabilities of the structure flow through to the partners
- It is recognized for tax purposes, such as if a tax return is filed in the structure’s name
- It can open a bank account in its own name
It may be necessary to seek the advice of an attorney to fully understand the legal characteristics of the structure and to clarify what activities the structure can legally undertake on a standalone basis. Additionally, it is possible that one indicator may not be conclusive in judging whether the entity is, in fact, a legal entity.
All relevant factors should be considered, and the analysis may differ depending on the structure being evaluated. For example, ASC 810-10-55-8A through ASC 810-10-55-8H illustrates mutual funds under the Investment Company Act of 1940 that are structured as separate series within an overall umbrella legal entity (trust). Each series fund is represented by a separate share class of the trust or corporation and the proceeds from the issuance of the share class are invested in assets according to the strategy of the series fund. In a series mutual fund that is subject to the 1940 Act, the trust or corporation is governed by a single board of directors that is responsible for overseeing the operations of each series fund.
In the example, each separate series 1940 Act mutual fund is determined to be a legal entity based on each series fund having its own:
- investment objectives and policies,
- custodial agreement,
- shareholders, separate from other series funds,
- unique tax identification number,
- separate tax returns filed with the Internal Revenue Service,
- separate audited financial statements, and
- investor protections in virtually all circumstances (afforded under the 1940 Act by the SEC staff’s Division of Investment Management).
These factors may not be present in other similar series structures, including in other jurisdictions. As a result, in other situations, the umbrella legal entity may be the only level at which consolidation should be considered.
Within the VIE model, a portion of a legal entity, referred to as a “silo,” may also be deemed to be subject to potential consolidation. See CG 3.8 for more information.
2.1.2 “Virtual” SPEs or portions of legal entities
ASC 810-10-15-15 affirms that “virtual SPEs” (divisions, departments, branches, or pools of assets subject to liabilities that are otherwise nonrecourse to other assets of the broader entity) are not considered separate entities for purposes of applying the VIE model. However, if the entire legal entity is deemed a VIE, there are circumstances in which a virtual SPE or “silo” may be considered a separate entity and subject to the VIE guidance, possibly resulting in consolidation. Silos are discussed in more detail in CG 3.8.
2.1.3 Consolidation of majority-owned or wholly-owned subsidiaries
ASC 810-10-15-9 clarifies that a wholly- or majority-owned subsidiary is subject to the VIE model and may be a VIE. If the subsidiary is a VIE, a reporting entity other than the subsidiary’s legal parent may be required to consolidate it under the VIE model. In this case, the subsidiary’s legal parent would not consolidate the subsidiary and instead would likely report its equity interest using other applicable GAAP (e.g., ASC 323 for equity method investments).
Example CG 2-1 illustrates a reporting entity’s VIE assessment of a majority-owned subsidiary.
EXAMPLE CG 2-1
Majority-owned subsidiaries: VIE assessment
Reporting Entity A holds all of the voting shares of Entity XYZ and has previously consolidated Entity XYZ under the voting interest entity model. During the current reporting period, Entity XYZ enters into a contractual arrangement with Reporting Entity B that conveys to Reporting Entity B certain decision-making rights with respect to, and an entitlement to economic returns from, Entity XYZ. Reporting Entity B holds no equity investment in Entity XYZ.
What are the potential consolidation implications for Reporting Entity A and Reporting Entity B stemming from the new contractual arrangement?
Analysis
Since the entities are not exempt from the VIE model, Reporting Entity A, Reporting Entity B, and other parties that hold variable interests in Entity XYZ must determine whether Entity XYZ is a VIE. Upon executing their contractual arrangement, Reporting Entity A and Reporting Entity B each must evaluate whether it should consolidate Entity XYZ. It is possible that Reporting Entity B could be required to consolidate Entity XYZ, even though it does not own an equity investment in Entity XYZ.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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