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2.2 Scope exceptions to the consolidation guidance
Publication date: 20 Dec 2023
us Consolidation guide
The consolidation guidance in ASC 810 does not apply to certain legal entities. ASC 810-10-15-12 clarifies that a reporting entity should not apply the consolidation guidance to (1) employers ’ interests in employee benefit plans (see CG 2.2.1), (2) investment companies (see CG 2.2.2), (3) governmental organizations (see CG 2.2.3), and (4) money market funds (see CG 2.2.4).
2.2.1 Employers' interests in employee benefit plans
An employer that sponsors an employee benefit plan is exempt from consolidating that plan.
Non-leveraged employee stock ownership plans (ESOPs) are defined contribution plans and are similar in important respects to pension arrangements covered by ASC 715, Compensation—Retirement Benefits (ASC 715). Consequently, we believe that non-leveraged ESOPs are also excluded from the consolidation model under this scope exception.
This scope exception does not apply to a service provider who is not the sponsoring employer to an employee benefit plan. The service provider is obligated to perform its consolidation evaluation applying the applicable VIE or VOE consolidation model.
Although an employer that sponsors an employee benefit plan is not required to consolidate that plan, the exception does not extend to an employee benefit plan itself. However, defined-benefit plans that fall within the scope of ASC 960, Plan Accounting—Defined Benefit Pension Plans (ASC 960), and defined-contribution plans that fall within the scope of ASC 962, Plan Accounting—Defined Contribution Pension Plans (ASC 962), should continue to follow the guidance of ASC 960 and ASC 962, respectively. We do not believe that it is intended to require employee benefit plans to consolidate entities in which they invest.
2.2.2 Investment companies
Investment companies are not generally required to evaluate their investees for consolidation.
Except as discussed in paragraph 946-810-45-3, an investment company within the scope of Topic 946 [Financial Services-Investment Companies] shall not consolidate an investee that is not an investment company.
This scope exception only applies to investments that are reported at fair value and are owned by a reporting entity that qualifies as an investment company under the guidance of ASC 946.
The scope exception does not apply to reporting entities that hold interests in an investment company. An investor, investment adviser, or any other party having an interest in an investment company entity under ASC 946 must evaluate whether it should consolidate the investment company.
A reporting entity that consolidates an investment company retains the investment company’s specialized accounting in the reporting entity’s consolidated financial statements, as noted in ASC 810.
For the purposes of consolidating a subsidiary subject to guidance in an industry-specific Topic, an entity shall retain the industry-specific guidance applied by that subsidiary.
2.2.3 Governmental organizations
Governmental organizations assessing whether they should consolidate another entity should follow the guidance established by the Governmental Accounting Standards Board.
It is generally not appropriate for a non-governmental reporting entity to consolidate a governmental organization or a financing entity established by a governmental organization. There may be limited circumstances when consolidation of a financing entity established by a governmental organization may be appropriate, as discussed in ASC 810-10-15-12(e).
A reporting entity shall not consolidate a governmental organization and shall not consolidate a financing entity established by a governmental organization unless the financing entity meets both of the following conditions:
- Is not a governmental organization
- Is used by the business entity in a manner similar to a VIE in an effort to circumvent the provisions of the Variable Interest Entity Subsections.
The term governmental organization is described in the AICPA Audit and Accounting Guide.
Excerpt from the AICPA State and Local Government Audit Guide 1.01
Public corporations and bodies corporate and politic are governmental entities. Other entities are governmental if they have one or more of the following characteristics:
- Popular election of officers or appointment (or approval) of a controlling majority of the members of the organization’s governing body by officials of one or more state or local governments;
- The potential for unilateral dissolution by a government with the net assets reverting to a government; or
- The power to enact and enforce a tax levy.
Furthermore, entities are presumed to be governmental if they have the ability to issue directly (rather than through a state or municipal authority) debt that pays interest exempt from federal taxation. However, organizations possessing only that ability (to issue tax-exempt debt) and none of the other governmental characteristics may rebut the presumption that they are governmental if their determination is supported by compelling, relevant evidence.
Excerpt from AICPA State and Local Government Audit Guide 1.02
Organizations are governmental or nongovernmental for accounting, financial reporting, and auditing purposes based solely on the application of the preceding criteria; other factors are not determinative. For example, the fact that an entity is incorporated as a not-for-profit organization and exempt from federal income taxation under the provisions of IRC Section 501 is not a criterion in determining whether an organization is governmental or nongovernmental for accounting, financial reporting, and auditing purposes.
Whether an entity is a governmental organization or a financing entity established by a governmental organization requires careful consideration. Examples of governmental entities that would not be subject to consolidation include, but are not limited to:
- A governmental organization (or a financing entity established by a governmental organization) that issues tax-exempt debt to finance the construction of an asset leased to the reporting entity
- A tax-increment financing entity established by a municipality to finance certain infrastructure assets on land owned by the reporting entity (commonly referred to as industrial development bonds)
In practice, the governmental scope exception can be difficult to apply, particularly when dealing with an entity established by a governmental organization to finance a project of the reporting entity. If an entity does not meet the definition of a governmental organization, further consideration should be given to whether the entity is, in substance, a financing entity established by a governmental organization. This analysis is subjective and requires an understanding of all of the facts and circumstances.
Although not intended to be all inclusive, some of the factors that may warrant consideration when making the determination of whether an entity is a governmental organization include:
- What was the extent and nature of the government’s involvement in establishing the entity?
- What role, if any, did the government play in selecting the entity’s board members (and/or selecting individuals responsible for directing the activities of the entity)?
- Does the government have the right to unilaterally dissolve the entity?
- What percent (or relative magnitude) of the entity’s activities are conducted on behalf of the government?
- What are the terms of the contract between the government and the entity?
- Do the assets revert back to the government at the end of the contract term?
- Did the government provide any guarantees to the entity?
In addition, consideration should be given to whether the entity was set up to circumvent the VIE model for the purpose of obtaining off-balance sheet treatment for the reporting entity. When making this assessment, the intent and purpose of the entity, as well as whether the reporting entity was involved in the entity’s design should be considered.
Example CG 2-2 illustrates the application of the governmental scope exception.
EXAMPLE CG 2-2
Governmental organization scope exception
Governmental organization scope exception
Entity A was formed through a competitive bidding process (overseen by a governmental entity) to issue revenue bonds to finance the construction of a power plant (the “facility”). Although Entity A legally owns the facility, the facility was constructed for the sole benefit of a governmental entity.
The equity investors (i.e., owners) of Entity A are in the business of building and managing power plants. The facility was constructed on government-owned land, with the land being leased to Entity A for the estimated life of the facility. At the end of the land lease term, title to the facility will automatically transfer to the governmental entity.
At the inception of the land lease, the governmental entity simultaneously entered into an arrangement with Entity A that requires the governmental organization to purchase 100% of the output of the facility (i.e., electricity) on a long-term basis. The governmental entity also holds a fair value purchase option that allows it to purchase the facility from Entity A at any time during the lease term.
As part of a competitive bidding process, Company X, a party that is unrelated to both Entity A and the governmental entity, entered into an arrangement with Entity A to guarantee the revenue bonds. Company X was not involved in the design of Entity A and there are no indications that Entity A was established in an effort to circumvent the provisions of the VIE guidance.
Does Entity A qualify for the governmental organization scope exception?
Analysis
Factors that suggest Entity A is a financing entity established by a governmental organization include (1) the governmental entity was integral in the design and is a party to all the critical agreements of Entity A, (2) Entity A was established to finance and construct a power plant whose entire output is intended to be sold to that governmental entity, and (3) it is intended that the governmental entity will ultimately own Entity A’s assets. As a result, even though Entity A would not meet the GASB or Federal Accounting Standards Advisory Board definition of a governmental organization, it is likely that Company X would conclude that Entity A is a financing entity established by a governmental organization and, therefore, would qualify for the governmental organization scope exception. Therefore, Company X would not be required to consolidate Entity A.
2.2.4 Money market funds
The money market funds scope exception applies to all investors and other variable interest holders in a qualifying fund.
A reporting entity shall not consolidate a legal entity that is required to comply with or operate in accordance with requirements that are similar to those included in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds.
- A legal entity that is not required to comply with Rule 2a-7 of the Investment Company Act of 1940 qualifies for this scope exception if it is similar in its purpose and design, including the risks that the legal entity was designed to create and pass through to its investors, as compared with a legal entity required to comply with Rule 2a-7.
- A reporting entity subject to this scope exception shall disclose any explicit arrangements to provide financial support to legal entities that are required to comply with or operate in accordance with requirements that are similar to those included in Rule 2a-7, as well as any instances of such support provided for the periods presented in the performance statement. For purposes of applying this disclosure requirement, the types of support that should be considered include, but are not limited to, any of the following:
i. Capital contributions (except pari passu investments)
ii. Standby letters of credit
iii. Guarantees of principal and interest on debt investments held by the legal entity
iv. Agreements to purchase financial assets for amounts greater than fair value (for instance, at amortized cost or par value when the financial assets experience significant credit deterioration)
v. Waivers of fees, including management fees.
Registered money market funds are required to invest in securities issued by entities with minimal credit risk with a short duration (considering individual securities and the average maturity of the portfolio). In addition, they are subject to constraints related to credit risk and diversification.
Unregistered money market funds that operate in a manner similar to registered money market funds are also eligible for the scope exception. Determining whether an unregistered money market fund is similar to a registered money market fund will require judgment. The unregistered money market fund’s purpose and design, as well as the risks it was designed to create and pass along to its interest holders, should be considered in assessing whether the fund operates in a manner similar to a registered money market fund. The structure and intended outcome of the fund may also be relevant factors to consider.
Therefore, in assessing whether an unregistered fund is similar to a registered fund, the quality, maturity, and diversification of the fund’s portfolio should be considered. Figure CG 2-1 poses helpful questions to consider in this assessment.
Figure CG 2-1
Assessing unregistered money market funds
Assessing unregistered money market funds
Characteristic |
Description |
Portfolio quality |
Does the fund invest in high-quality, short-term securities with credit risk similar to those held by registered money market funds? |
Portfolio maturity and diversification |
Are the fund’s objectives consistent with the objectives of a registered money market fund? In particular, with regard to the:
(1) credit quality of its eligible investments,
(2) diversification of the portfolio,
(3) maximum maturity of eligible investments, and
(4) average maturity of the portfolio.
|
ASC 810-10-15-12(f) requires reporting entities that have provided, or have explicit arrangements to provide, financial support to entities subject to this exception to provide specified disclosures. See FSP 18 for disclosure requirements.
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