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5.5 Primary beneficiary—losses/benefits criterion
Publication date: 31 Jan 2023
us Consolidation guide
If a reporting entity has met the power criterion, it will need to determine whether it has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. A reporting entity must meet both the power criterion and the losses/benefits criterion to be the primary beneficiary of the VIE.
5.5.1 Losses/benefits criterion—qualitative analysis
Determining whether a reporting entity has the obligation to absorb losses of or the right to receive benefits from the VIE that could be potentially significant to the VIE does not have to be based on a quantitative expected loss/expected residual return calculation. Rather, this assessment is intended to be a qualitative judgment that considers all facts and circumstances, including the terms and characteristics of the variable interest(s), the purpose and design of the VIE, and other involvement that the reporting entity may have with the VIE.
This qualitative analysis should consider all variable interests held by the reporting entity and other variable interest holders that are involved with the VIE. If the reporting entity has other forms of involvement with the VIE that are not variable interests, those relationships should be ignored when assessing the losses/benefits criterion.
5.5.2 Losses/benefits criterion—potential to be significant
All scenarios, irrespective of probability, should be considered in assessing whether the right to receive benefits or the obligation to absorb losses could be potentially significant to the VIE. Even when a reporting entity concludes that it is remote that it will be exposed to benefits or losses that could potentially be significant to the VIE, it would meet the losses/benefits criterion given the requirement to consider all possible scenarios.
Although a reporting entity may not have obligations or rights that are currently significant, its variable interest may provide it with obligations or rights that may become significant to the VIE in the future even under seemingly improbable scenarios. These considerations are critical because obligations or rights that could potentially be significant often identify the reporting entity that explicitly or implicitly has the power to direct the activities that most significantly impact the economic performance of the VIE.
5.5.3 Losses/benefits criterion—significance
Over time, the FASB has received requests for additional guidance on the losses/benefit criterion, specifically in interpreting “potentially significant to the VIE.” The FASB continues to reaffirm its decision not to provide additional guidance for fear such guidance would provide “bright lines” that would be used inappropriately in practice as the sole factor when determining whether obligations or rights could potentially be significant to the VIE. Determining whether the losses/benefits of a VIE that are absorbed/received by a reporting entity could potentially be significant to a VIE can be judgmental and should be based on the individual facts and circumstances presented.
Examples illustrating the factors that should be considered when identifying the party that is the primary beneficiary are discussed in ASC 810-10-55. These examples do not explicitly state how a reporting entity should determine whether it has the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. The guidance provided does, however, confirm that all variable interests should be considered when making this determination.
We have observed reporting entities develop policies regarding how to assess when an economic interest in a VIE is potentially significant. Some reporting entities have established a policy that ownership of an interest that could potentially expose a variable interest holder to benefits and losses of 5% or less is not significant. When the variable interest(s) being evaluated potentially expose the holder to benefits and losses between 5% and 10%, we believe this could potentially be significant depending on facts and circumstances. In circumstances when a variable interest exposes the holder to 10% or more of a VIE’s potential benefits and losses, we have observed very few instances when the reporting entity concluded such interests were not potentially significant.
When assessing whether a decision maker or service provider’s fee is a variable interest, a reporting entity must consider the significance of its other economic interests (including indirect interests). If the decision maker’s other economic interests are more than insignificant, its decision maker or service provider fee is a variable interest. However, the threshold for significance differs when a decision maker is assessing whether they are the primary beneficiary of a VIE. A decision maker is the primary beneficiary of a VIE if its economic interest is potentially significant. Because the concept of “more than insignificant” allows for consideration of probability and the concept of “potentially significant” does not, a more than insignificant interest will always be potentially significant since it is a lower threshold.
The following factors may be helpful when qualitatively assessing whether a variable interest is potentially significant:
- The overall purpose and design of the VIE, including the risks and rewards the VIE was designed to create and pass along to its variable interest holders. For example, the primary risks and sources of the VIE’s variability should be considered.
- The terms of the VIE’s interests and capitalization structure, including the risks absorbed and the rewards received by each variable interest holder. For example, it is more likely that a variable interest holder’s right to benefits would be considered significant if the rights have unlimited “upside” (e.g., through a residual interest in the entity). These rights may not be significant in the case of a senior interest that earns a fixed return and has no right to participate in the entity’s earnings beyond that fixed return. It’s important to note that every type of interest of a VIE, including a senior interest, could be potentially significant, depending on the terms of the interest and the purpose and design of the VIE.
- The percentage of the class of interest held by the reporting entity. As the reporting entity’s ownership of a class of interests issued by a VIE increases, it becomes more likely that its variable interest is potentially significant. The reporting entity should also consider whether it holds a “vertical slice” or a “horizontal slice” of the financing or capital structure of the VIE. For example, consider a VIE with two classes of equity, common stock and preferred stock. If a reporting entity owned only a portion of the preferred stock it would be deemed to have a horizontal slice of the capital structure. On the other hand, if the reporting entity owned identical portions of both the common and the preferred stock it would be deemed to own a vertical slice of the capital structure.
In some cases, a variable interest holder may own a 100% equity interest in a VIE, but that equity interest may be small in comparison to the VIE’s overall capitalization. While that investor’s exposure to losses may be limited to the amount invested, it has the ability to receive benefits from its equity investment that could potentially be significant to the VIE.
5.5.4 Decision maker or service provider fee arrangements
If a decision maker or service provider’s fee arrangement qualifies as a variable interest, its fees may be excluded from the losses/benefits criterion if the arrangement is considered to be “at market” and “commensurate” in accordance with ASC 810-10-25-38H.
For purposes of evaluating the characteristic in paragraph 810-10-25-38A(b), fees paid to a reporting entity (other than those included in arrangements that expose a reporting entity to risk of loss as described in paragraph 810-10-25-38J) that meet both of the following conditions shall be excluded:
- The fees are compensation for services provided and are commensurate with the level of effort required to provide those services.
- The service arrangement includes only terms, conditions, or amounts that are customarily present in arrangements for similar services negotiated at arm’s length.
As discussed in CG 3.4.1, a reporting entity may consider the following factors, among other items, to determine if the fee arrangement is “at market” and “commensurate”:
- Whether the VIE is owned by substantive third-party investors
- Whether the decision maker holds other variable interests (beyond its fee arrangement) that are unique as compared to variable interests held by the VIE’s other investors
After considering these factors, a reporting entity may be unable to qualitatively conclude that the arrangement is at market and commensurate. As a result, additional analysis may be necessary. ASC 810-10-25-38I indicates that a reporting entity should compare the arrangement being evaluated to similar arrangements between third parties. This comparison may not be possible if (1) the fee arrangement relates to a unique or new service (i.e., no comparable arrangements could be identified), or (2) the fee reflects a change in what is considered customary.
As described in ASC 810-10-25-38J, when the arrangement is designed to expose the decision maker to a principal risk of loss, the arrangement would not be eligible for exclusion from the losses/benefits criterion. The following list, which is not intended to be all inclusive, provides examples of fee arrangements that are prohibited from qualifying for this exclusion:
- Fee arrangements where a portion of the fee relates to guarantees of the value of the VIE’s assets or liabilities that the decision maker has provided
- Obligations to fund operating losses
- Payments associated with written put options on the VIE’s assets
- Similar obligations, such as some liquidity commitments or agreements (explicit or implicit) to protect holders of other variable interests from suffering the VIE’s losses.
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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