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5.7 Related parties—standalone primary beneficiary does not exist
Publication date: 31 Jan 2023
us Consolidation guide
As discussed in CG 5.1, a reporting entity must first determine whether it meets power and losses/benefits criteria on a stand-alone basis. Only if the reporting entity does not meet both criteria on a stand-alone basis should it consider other variable interests held by its related parties to determine whether it is part of a related party group that collectively meets both characteristics of a primary beneficiary. If this is the case, a reporting entity should assess whether a party within that related party group should consolidate the VIE.
Figure CG 5-2 provides a general overview of the primary beneficiary analysis including related parties.
Figure CG 5-2
General overview of the primary beneficiary analysis including related parties
General overview of the primary beneficiary analysis including related parties
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(1) Power is defined as the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance.
(2) The VIE model expands the definition of related parties, as described in ASC 850, Related Party Disclosures, to include “de facto agents,” which are described in ASC 810-10-25-43 and CG 5.4.
(3) It may be necessary to also evaluate consolidation at a parent level. There may be situations involving “multi-tier structures” in which neither the reporting entity nor other “lower-tier” entities within its related party group meet the criteria to consolidate the VIE in their standalone financial statements. In these instances, there may be a parent entity that holds power and economics indirectly through its subsidiaries that should therefore consolidate the VIE.
(4) When a controlling party in a related party group designs an entity to separate power from economics for the purpose of avoiding consolidation in the separate company financial statements of a decision-maker, such separation may be nonsubstantive. If the separation of power is nonsubstantive, it should be disregarded. This is consistent with the guidance in ASC 810-10-15-13A that only substantive terms, transactions, and arrangements, whether contractual or noncontractual, should be considered by a reporting entity when evaluating whether it has a controlling financial interest.
(5) The entity on whose behalf substantially all of the activities of the VIE are conducted would consolidate the VIE.
(6) The reporting entity identified in Footnote 4 would consolidate.
5.7.1 Shared power among related parties
In certain situations, the power to direct a VIE’s most significant activities may be shared among related parties. In those situations, the related party tiebreaker should be applied to determine which party within the related party group is required to consolidate the VIE.
Excerpt from 810-10-25-44
The guidance in this paragraph shall be applicable for situations in which the conditions in paragraph 810-10-25-44A have been met or when power is shared for a VIE. In situations in which a reporting entity concludes that neither it nor one of its related parties has the characteristics in paragraph 810-10-25-38A but, as a group, the reporting entity and its related parties (including the de facto agents described in the preceding paragraph 810-10-25-43) have those characteristics, then the party within the related party group that is most closely associated with the VIE is the primary beneficiary.
In situations where power over an entity’s most significant activities is shared among related parties, a qualitative analysis is required to determine which party within the related party group is most closely associated with the VIE. The party within the related party group that is most closely associated with the VIE is the primary beneficiary and is required to consolidate and disclose the impact of the VIE. Refer to CG 5.8 for further discussion related to the application of the related party tiebreaker test.
If no single party within the related party group has stated power, and a VIE’s significant activities require the consent of two or more related parties, a reporting entity must assess whether power is shared. As discussed in CG 5.2.4, shared power exists only when the unanimous consent of all parties believed to share power over a VIE’s economically significant activities is required. This concept is illustrated in Example CG 5-13.
EXAMPLE CG 5-13
Shared power among related parties – equal equity ownership
Shared power among related parties – equal equity ownership
ABC Co., DEF Co., and XYZ Co., all related parties, each hold a variable interest in Oak Co., a VIE and manufacturer of oak furniture for wholesale distribution to retail furniture stores. Each party holds 33% of Oak Co.’s equity and obtained its equity interests in exchange for contributions of cash upon formation of Oak Co. All profits and losses of Oak Co. are allocated to the equity investors pro rata in accordance with their equity interests. Apart from their equity interests, neither party holds any other variable interests in Oak Co.
The board of directors is comprised of six directors—two each appointed by ABC Co., DEF Co., and XYZ Co. All decisions related to Oak Co.’s significant activities require approval by a two-thirds majority vote of the board of directors (i.e., four of the six directors). Without the ability to exercise two-thirds of Oak Co.’s voting rights, no single equity investor has the power to direct Oak Co.’s activities that most significantly impact its economic performance.
Oak Co. has determined that the activities that most significantly impact Oak Co.’s economic performance are:
- Purchasing raw materials
- Manufacturing
- Sales of oak furniture
Is the power to direct Oak Co.’s most significant activities shared among ABC Co., DEF Co., and XYZ Co.?
Analysis
No, power over Oak Co. is not shared because the decisions related to Oak Co.’s most significant activities do not require the unanimous consent of all equity investors, acting through their representation on Oak Co.’s board of directors. For power to be shared, the significant activities would require the approval of all equity investors. Even though the three equity investors are related and as a group would meet the characteristics of a primary beneficiary, the related party tiebreaker test would not be applied since power is not shared and the three equity investors are not under common control. We believe a reporting entity should consider the substance of the voting rights and the nature of the related party relationships before concluding that there is no primary beneficiary.
5.7.2 Common control groups—characteristics of a primary beneficiary
If the related party group has both characteristics of a primary beneficiary and is under common control, then the “related party tiebreaker” test should be performed to identify the variable interest holder within that related party group that is “most closely associated” with the VIE. The party that is most closely associated with the VIE should consolidate the VIE.
The term “common control” is not defined within U.S. GAAP. ASU 2015-02’s basis for conclusions indicates that the FASB’s intent was for subsidiaries controlled (directly or indirectly) by a common parent, as well as a subsidiary and its parent, to be considered a common control group. When determining whether a related party group is under common control, we believe a parent entity should have a controlling financial interest over the related parties involved. A controlling financial interest is generally defined as ownership of a majority voting interest by one entity, directly or indirectly, or more than 50% of the outstanding voting shares of another entity, with certain exceptions. A controlling financial interest would also exist if the parent entity consolidates its subsidiaries based on the provisions in the VIE model. Refer to BCG 7 for further discussion related to common control transactions.
We do not believe the parent entity must be a legal entity for a common control group to exist. That is, a parent could be a natural person that holds a controlling financial interest in various entities.
Example CG 5-14 illustrates the determination of whether a commonly controlled related party group meets both characteristics of a primary beneficiary.
EXAMPLE CG 5-14
Determining whether a commonly controlled related party group meets both characteristics of a primary beneficiary
Determining whether a commonly controlled related party group meets both characteristics of a primary beneficiary
Subsidiary A and Subsidiary B are under common control of their parent, Reporting Entity X. Subsidiary A is the general partner and decision maker of Partnership Y, whereby it owns a 1% general partner interest and receives a management fee that is considered at market and commensurate. Subsidiary A does not hold any other interest in the partnership. Subsidiary B has 25% of the partnership’s limited partner interests. The other limited partner interests are held by unrelated parties. Neither Subsidiary A nor Subsidiary B has an interest in each other. As the limited partners do not have substantive kick-out or participating rights over the general partner, the Partnership is determined to be a VIE.
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Does the commonly controlled related party group meet both characteristics of a primary beneficiary?
Analysis
Subsidiary analysis
No. Subsidiary A’s 1% general partner interest would not be considered more than insignificant and the management fee is at market and commensurate. Therefore, Subsidiary A does not have a variable interest in Partnership Y (unless it was determined that the partnership was structured to separate power and economics in an attempt to avoid consolidation). As a result, Subsidiary A is considered to be operating in an agency capacity and does not meet the power criterion. While Subsidiary B’s 25% limited partner interest is a potentially significant economic interest that would allow it to meet the losses/benefits criterion, neither subsidiary meets both criteria of a primary beneficiary on a stand-alone basis.
As Subsidiary A is acting in an agent capacity (i.e., it is not considered a decision maker), the related party group under common control would not meet the criteria in ASC 810-10-25-44A in order to apply the related party tiebreaker test.
Further, unless “substantially all” of the partnership’s activities involve or are conducted on behalf of Subsidiary B, Subsidiary B would also not be required to consolidate the partnership under ASC 810-10-25-44B.
While Subsidiary A’s decision-making fee is not considered a variable interest for the purposes of assessing whether Subsidiary A is the primary beneficiary, it still holds a variable interest in Partnership Y through its 1% general partner interest, and therefore both Subsidiary A and Subsidiary B should consider if they are required to make necessary VIE disclosures. See FSP 18 for discussion on disclosures.
Parent analysis
Reporting Entity X, as a parent, meets both the power criterion (through Subsidiary A) and the losses/benefits criterion (through Subsidiary B), and therefore would be the primary beneficiary of Partnership Y and would consolidate Partnership Y in its consolidated financial statements.
5.7.3 Related parties not under common control
If a single decision maker within a related party group has unilateral power, and the related party group is not under common control, then the related party tiebreaker would not apply. However, if “substantially all” of the VIE’s activities involve or are conducted on behalf of any party (excluding the single decision maker) within that related party group that meets both characteristics of a primary beneficiary, the party that has the activities conducted on its behalf is required to consolidate the VIE. This requirement is intended to prevent abuse (i.e., “vote parking” arrangements) where the decision maker’s level of economics is not consistent with its stated power.
This assessment, which is intended to be consistent with the analysis required to determine whether an entity is a VIE (refer to CG 4), should be qualitative and consider all relevant facts and circumstances.
Example CG 5-15 illustrates the application of the “substantially all” related party test.
EXAMPLE CG 5-15
Application of the “substantially all” related party test
Application of the “substantially all” related party test
Company A, Company B, and Company C formed a venture (Company X) that was determined to be a VIE. Company X’s outstanding equity interests are owned as follows:
- Company A – 5%
- Company B – 45%
- Company C – 50%
Each party participates in Company X’s profits and losses on a pro rata basis.
Company B financed Company A’s investment in Company X, therefore, Company A and Company B were determined to be related parties in accordance with the de facto agency guidance in ASC 810-10-25-43(b).
Company A, through super-voting shares, has the ability to unilaterally direct the activities that most significantly impact Company X’s performance. Neither Company B nor Company C have substantive participating rights, therefore, Company A meets the power criterion. Company A does not receive a decision-making fee, therefore, the ASC 810-10-55-37 agency test would not be applicable.
Which party should consolidate the VIE?
Analysis
Although Company A has power, it does not meet the losses/benefits criterion since it is not exposed to losses and/or benefits that could potentially be significant to the VIE. Therefore, Company A is not Company X’s stand-alone primary beneficiary. A related party group consisting of Company A (a single decision maker) and Company B (a variable interest holder with a potentially significant economic interest) does exist. Because the related party group is not under common control, the related party tiebreaker would not be applicable. However, an analysis should be performed to determine whether substantially all of Company X’s activities are conducted on Company B’s behalf. If that were the case, Company B would be Company X’s stand-alone primary beneficiary.
5.7.4 Related parties–multiple decision makers
If there are multiple decision makers in a related party group, we believe a reporting entity should consider the purpose and design of the entity, and substance of the arrangement (including the substance of voting rights or other rights held by each party) to determine whether it would be appropriate for one of the variable interest holders within the related party group to consolidate the VIE.
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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