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10.4 Identifying the primary beneficiary
Publication date: 20 Jul 2016
us Utilities guide
10.4.1 The primary beneficiary model
Under ASC 810, the determination of the primary beneficiary focuses on control of the activities of the VIE that most significantly impact its economic performance. The approach requires judgment in the determination of the primary beneficiary and, as a result, who consolidates the VIE.
10.4.1.1 Definition of the primary beneficiary
Excerpt from ASC 810-10-25-38A
A reporting entity shall be deemed to have a controlling financial interest in a VIE if it has both of the following characteristics:
a. The power to direct the activities of a VIE that most significantly impact the VIE’s economic performance
b. The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.
ASC 810 is specific that only one party can have the power to direct the most significant activities of a variable interest entity. In practice, this is typically the key factor that determines the primary beneficiary as it would be rare for a variable interest holder not to have a potentially significant financial interest in the VIE.
ASC 810-10-25-38B through 25-38G provide further guidance on the approach to evaluating which party has the characteristics of the primary beneficiary as summarized in Figure 10-8.
Figure 10-8
Factors in determining the primary beneficiary
Factors in determining the primary beneficiary
Most significant activities (ASC 810-10-25-38B)
The identification of the most important activities of the VIE and who has the power to direct those activities (irrespective of whether those powers are exercised) is the pivotal factor in the analysis.
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Kick-out rights and participating rights (ASC 810-10-25-38C)
Unilateral kick-out rights and participating rights may affect the determination of who has the power to direct the most significant activities. However, protective rights held by others do not preclude a variable interest holder from being the primary beneficiary.
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Shared power (ASC 810-10-25-38D)
If power is shared among multiple unrelated parties, then no party is the primary beneficiary. Shared power requires consent of the parties for significant decisions. If power is not shared, but the most significant activities are directed by multiple unrelated parties and the nature of the activities is the same, then the party with the power over a majority of the activities has the power to direct.
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Power over different activities (ASC 810-10-25-38E)
If the most significant activities are directed by multiple unrelated parties and the nature of the activities is different, then the party with the power to direct the activities that most significantly impact the economic performance of the VIE has the power to direct. It is expected that only one party will have that power.
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Involvement in design of the VIE (ASC 810-10-25-38F)
Significant involvement in the initial design of a VIE does not automatically provide a reporting entity with the power to direct the most significant activities. However, that involvement may indicate that the reporting entity was provided the opportunity to establish arrangements giving it that power.
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Disproportionate economics (ASC 810-10-25-38G)
If a reporting entity has economic interests in a VIE that are disproportionately greater than its stated power to direct the significant activities, the level of economic interest may indicate the amount of power actually held by the reporting entity.
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Each of these factors is discussed in the following sections.
10.4.1.2 Most significant activities
A reporting entity must identify which activities most significantly impact the VIE’s economic performance and determine whether it has the power to direct those activities. A reporting entity’s ability to direct the activities of an entity when circumstances arise or events happen constitutes power if that ability relates to the activities that most significantly impact the economic performance of the VIE. A reporting entity does not have to exercise its power in order to have power to direct the activities of a VIE.
The primary beneficiary of a VIE is the variable interest holder with the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance. The significant activities of a single power plant entity evolve and mature over the life of the power plant and, as a result, the party controlling those activities may also change over time. The life cycle of a typical power plant is depicted in Figure 10-9:
Figure 10-9
Typical power plant life cycle
Typical power plant life cycle
The primary beneficiary should also have a significant financial interest; however, this is not typically a key consideration because most variable interest holders will meet this criterion. Multiple parties may have potentially significant financial interests, but only one party can have the power to direct the most significant activities. Therefore, the identification of the most significant activities impacting the economic performance of the entity and evaluation of who controls these activities are critical steps in the determination of the primary beneficiary.
A single power plant entity is engaged in different activities over its life cycle (i.e., the activities are generally linear), and each significant activity is contingent on the prior significant activity. As a result, a reporting entity’s evaluation of which activities are most significant should focus on the uncertainty of completing each stage as well as the activities in each stage that will most significantly impact the economic performance of the entity. If there is uncertainty that the entity will achieve the next stage of its operations, usually only the significant activities in the current phase are considered. However, once the uncertainty regarding achieving progress to additional phases has lapsed, the reporting entity should evaluate which powers are most significant considering the remaining life cycle of the entity.
Once the reporting entity identifies which activities most significantly impact the economic performance of the VIE, it should determine which party controls these activities. Contractual arrangements often dictate which party, if any, has the power to direct activities that are most significant to the economic performance of a VIE. In completing this analysis, a shift in which party holds a specific power as a result of changes in contractual arrangements or counterparties should not be considered until those changes are in effect. This analysis may result in changes in the primary beneficiary over the life cycle as control of significant activities moves among the parties involved with the power plant and the VIE. For example, a purchase option embedded in an operations and maintenance agreement might lead to a change in the party with control, but the party with the option is not deemed to have control until the point at which the option is exercised. However, a reporting entity can anticipate how those changes are likely to impact the primary beneficiary conclusion and should make sufficient disclosures for potential material changes in the future. Figure 10-10 provides a summary of activities that may require consideration in determining the significant activities over the life of a typical power plant.
Figure 10-10
Significant activities during a power plant’s life cycle
Significant activities during a power plant’s life cycle
Typical activities
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Evaluation points
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Development stage
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Construction stage
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Operations stage
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Post-operation/ decommissioning
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The evaluation points in Figure 10-10 are based on typical activities and common contractual arrangements. A reporting entity should consider its specific facts and circumstances in completing the primary beneficiary analysis.
Question 10-9
How do changes in significant activities over the life of the power plant impact the primary beneficiary determination?
How do changes in significant activities over the life of the power plant impact the primary beneficiary determination?
PwC response
The significant activities of a single power plant entity during its life cycle are generally sequential: beginning with development, then construction, followed by operations, with a final wind-down and decommissioning. In evaluating the relative significance of the powers during each stage, the parties should focus on the purpose and design of the entity, the significance of the activities throughout the life of the entity, the ability of the variable interest holders to impact the completion of each phase, and the likelihood the phases will be successful.
Factors to consider include:
- Development
Significant uncertainty is often present during the development stage while the entity identifies a location, obtains permits and financing, and potentially contracts for output of the plant. All other activities of the plant (construction and operation) are contingent on the completion of development, and entities do not always advance beyond this stage. Due to this uncertainty, the parties would generally conclude that the power to control strategy and development, as well as arranging financing, are the most important powers during this stage of the life cycle.
- Construction
Once the entity has obtained all required permits and financing and has executed a construction contract, there is generally a high degree of certainty that the power plant will be completed and that operations will commence. As such, in evaluating the most significant activities during this stage, the parties may consider the powers that will impact economic performance over the entire remaining life cycle of the power plant. This may lead to the conclusion that the powers held during the operations phase are more significant than the powers during construction. Note that this conclusion may change if there is more uncertainty during construction (e.g., experimental technology) or if there is uncertainty about the operations phase (e.g., power contracts, operations and maintenance agreements, or other service contracts are not yet executed). Any uncertainty about successful completion of the project would lead to a focus on construction activities only in completing the evaluation during this stage.
- Operations
The key activities identified during the operations phase will often have the most significant overall impact on the economic performance of the entity over its life-cycle (once uncertainty about reaching the construction phase has been resolved). Therefore, once there is a high level of assurance that construction will be achieved, the evaluation generally focuses on which parties control key operating decisions. See UP 10.6 for examples of application of by-design in the evaluation of potential variable interests in a single power plant entity.
The consideration of who controls the significant activities is judgmental, and specific facts and circumstances can result in different conclusions. Factors that may influence the conclusion are discussed in the following sections.
Question 10-10
Does contract length factor into the evaluation of the primary beneficiary?
Does contract length factor into the evaluation of the primary beneficiary?
PwC response
Generally, no. When considering a contract that is a variable interest, the term of the contract is generally not important to the holder’s power relative to the VIE. Holding powers provided by the contract for a longer period should therefore not impact the conclusion as to which party is the primary beneficiary.
Thus, in general, we do not believe that contract length is a defining factor in determining which variable interest holder controls activities that are most significant to the entity. As discussed above, once development is completed and construction begins, the evaluation is typically focused on which party holds the most significant powers during the operations phase (unless there is significant uncertainty regarding construction). If the party holding those powers shifts over time, the primary beneficiary analysis is performed based on who has the power to direct the most significant activities as of the reporting date, without incorporating the impact of expected future contractual changes (e.g., expiration of certain contractual arrangements). Therefore, the length of a contract would not impact this analysis. However, in some cases contract length may impact the determination of whether a contract is a variable interest (see the response to Question 10-6).
10.4.1.3 Kick-out and participating rights
Excerpt from ASC 810-10-25-38C
A reporting entity’s determination of whether it has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance shall not be affected by the existence of kick-out rights or participating rights unless a single reporting entity (including its related parties and de facto agents) has the unilateral ability to exercise those kick-out rights or participating rights. . . . Protective rights held by other parties do not preclude a reporting entity from having the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance.
As discussed in UP 10.3.1.2, power purchase agreements and debt agreements common in single power plant entity structures generally do not incorporate kick-out rights or other participating rights. However, these contracts frequently include protective rights that may be exercised only in the event of default. As noted in ASC 810-10-25-38C, the presence of protective rights does not preclude another party from having a particular power. The impact of protective rights needs to be considered only in the event the rights are exercised, which may result in a change in control.
Even though kick-out and participating rights are not common in power purchase or financing agreements, other agreements (such as equity agreements) may include them. Therefore, the terms of all significant contractual arrangements and the rights of all parties involved should be considered when determining which party is the primary beneficiary. Although one party may appear to have control over the most significant activities of the VIE, the existence of kick-out or participating rights that may be exercised unilaterally will likely change that conclusion.
10.4.1.4 Shared activities
Excerpt from ASC 810-10-25-38D
If a reporting entity determines that power is, in fact, shared among multiple unrelated parties such that no one party has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, then no party is the primary beneficiary. Power is shared if two or more unrelated parties together have the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and if decisions about those activities require the consent of each of the parties sharing power.
For some VIEs, the number of significant activities may be limited and the analysis of which party has control may be fairly straightforward. However, this is generally not the case when evaluating a single power plant entity where multiple parties direct different activities. ASC 810 contemplates that power may be shared among multiple parties, including cases where power over the same activities is shared or where different parties control different activities. There is no primary beneficiary if no one party controls the significant activities. As illustrated in Figure 10-11, the determination of which party controls the activities that have the most significant impact over economic performance can be complex when activities are shared in various ways.
Figure 10-11
Shared activities
Shared activities
Structure |
Evaluation |
Power is shared among multiple unrelated parties such that no one party has the power to direct. |
There is no primary beneficiary (power is shared if more than one party must agree). |
Activities are directed by multiple unrelated parties and the nature of those activities is different. |
The primary beneficiary is the party that directs the activities that most significantly impact economic performance. See UP 10.4.1.5. |
Activities are directed by multiple unrelated parties and the nature of those activities is the same. |
The primary beneficiary is the party with the power over the majority of activities. |
In a single power plant entity, it is not typical for multiple parties to direct activities of the same nature, so that scenario is not further discussed in this chapter. However, there can be circumstances where power over certain activities is shared or where multiple parties direct activities of a different nature, as discussed below.
Power is shared
If two or more unrelated parties have the power to direct the significant activities of a VIE, such that no single party has the power to direct those activities alone, power is considered to be shared, and the VIE would not have a primary beneficiary. Such circumstances may be present in a joint venture arrangement.
Joint ventures, by definition, are separate and specific businesses for the mutual benefit of their members. Because a joint venture usually involves an arrangement through which each member may participate, directly or indirectly, in the overall management, consent of all members is required on decisions impacting the joint venture’s economic performance. In the power and utility industry, power plant joint ventures (e.g., renewable energy projects, coal power plants) typically include many operational, financial, and strategic decisions that are shared by the parties to the arrangement through a management committee or similar structure.
For power to be shared in a joint venture or other arrangement, all key decisions must require mutual consent. If significant activities are not controlled by mutual consent, further analysis to determine the primary beneficiary will be required. For example, if a power project with two members includes six important decisions and each individual member has exclusive discretion over three of those decisions, that would not be considered shared control. Determination instead must be made as to which of the important decisions grants one member power to direct the most significant activities. See UP 10.4.1.5.
Question 10-11
Is power considered shared if there is a management committee responsible for strategic direction and other decision making?
Is power considered shared if there is a management committee responsible for strategic direction and other decision making?
PwC response
It depends. Power plant joint ventures and other single power plant entities often include a management committee or similar organization as part of the decision-making process. In some cases, power is shared because all significant (participating) decisions require consent of a representative from each party. However, in other situations, one party may effectively control because it has responsibility for day-to-day decisions and ongoing execution. Control may also be vested with only one of the parties if decisions requiring consent of one or more members of the committee are protective in nature, or if one of the parties has veto rights over significant decisions.
As such, joint decision making as part of the overall corporate governance function does not automatically result in a conclusion that power is shared. In evaluating the impact of this type of shared power on control of the significant activities of a VIE, reporting entities should carefully evaluate the nature of the powers held by the management committee. See CG 7.2.6 for further information about evaluating protective versus participating rights.
10.4.1.5 Multiple parties control different activities
If the activities that impact the VIE’s economic performance are directed by multiple unrelated parties, and the nature of the activities that each party is directing is not the same, then a reporting entity shall identify which party has the power to direct the activities that most significantly impact the VIE’s economic performance. One party will have this power, and that party shall be deemed to have the [power to direct the activities of a VIE that most significantly impact the VIE’s economic performance].
In many single power plant entity VIEs, control of significant operational factors is dispersed among different parties. For example, it is common for the operator to control operations and maintenance while the off-taker controls fuel and dispatch. In such cases, factors to consider in determining which of the activities is
most
significant include:- Is the power purchase agreement a lease?
If so, the substance of the arrangement is the use of property and risks associated with the inputs (e.g., fuel) and outputs from the plant (e.g., energy and capacity) are generally considered to be outside the design of the VIE. However, in some cases, the VIE may retain fuel risk or may have responsibilities for related activities, such as operations and maintenance, through a service contract or in some other form within the structure of the lease arrangement. In those cases, an analysis of which activities is most significant should be performed.
- What is the expected financial impact of the activity? What is the relative impact compared with other significant activities?
For example, if capacity payments (which are dependent on operations and maintenance) are expected to be $40 million per month, and payments for energy (based on dispatch) are expected to range from $10 million to $20 million per month, the parties may conclude that operations and maintenance activities are more important.
- Is there a wide range of possible economic outcomes (suggesting control may be more important in influencing economic performance) or are all potential outcomes within a narrow range?
For example, a decision to lock in the cost of fuel supply or float with the market when the power plant has a fixed-price power purchase agreement may have a wide range of possible outcomes, with differing and significant impacts on financial performance.
- Are there related party relationships?
As further discussed below, power controlled by related parties may need to be considered as a group.
- Have all significant activities been appropriately considered?
Depending on contractual arrangements, once a power plant is in operation, fuel supply, dispatch, and operations and maintenance will likely be important activities. A review of the risks identified in the evaluation of design will be helpful in determining the most significant activities.
The list above provides some of the factors that should be considered in determining which activity is most significant. See CG 5.2.2 for further information on factors to consider in evaluating which activities most significantly impact economic performance.
Question 10-12
How should reporting entities consider operations and maintenance given the potentially pervasive impact on economic performance?
How should reporting entities consider operations and maintenance given the potentially pervasive impact on economic performance?
PwC response
For an operating power plant, the operations and maintenance function is one of the primary activities with a significant impact on the VIE’s economic performance. Considerations in evaluating its impact include:
- Operations and maintenance activities are a basic requirement to keep the power plant running. Poor execution by the party responsible for operations and maintenance may lead to subpar plant performance (e.g., high heat rate, lower than expected availability) and in a worst case scenario, plant shut-down. This may have a significant negative impact on the entity’s economic results.
- Operations and maintenance activities may not be complex, and for some power plant types are easily duplicated or outsourced, and/or are available from multiple service providers. However, the right or responsibility to perform this function provides the responsible party with a high degree of control.
- Although operations and maintenance activities directly impact the power plant’s availability (and thus the level of capacity payments, if any), there is a relatively narrow expected outcome that results from the activities. That is, superior operations and maintenance services would be expected to impact results only minimally compared with services that are at a satisfactory level. In contrast, exceptional management of dispatch or fuel may have a more meaningful impact on the overall economic results.
In considering the importance of operations and maintenance, one view is that operations and maintenance is a defining factor because of its baseline impact on a power plant’s economic performance—without strong operations and maintenance activities there will be no other operations. However, operations and maintenance performance may be relatively easily achieved, and thus have minimal impact on the expected variability of the plant’s economic performance. In such cases, the overall strategy of a plant, including decisions such as contracting, dispatch, and fuel supply, may have a more significant impact on the incremental profitability of the plant’s operations.
We would generally expect that control of operations and maintenance, whether directly or through the ability to determine the operations and maintenance provider, will be a key factor in the primary beneficiary conclusion. However, a final determination in each case will be based on the facts and circumstances of the single power plant entity. For example, the nature and type of power plant (fossil versus renewable, contracted versus merchant, base load versus peaker) as well as the type of and specifics within the contractual arrangement(s) involved, may impact the analysis.
10.4.1.6 Involvement in design
Excerpt from ASC 810-10-25-38F
Although a reporting entity may be significantly involved with the design of a VIE, that involvement does not, in isolation, establish that reporting entity as the entity with the power to direct the activities that most significantly impact the economic performance of the VIE. However, that involvement may indicate that the reporting entity had the opportunity and the incentive to establish arrangements that result in the reporting entity being the variable interest holder with that power.
ASC 810-10-25-38F states that reporting entities should consider whether they (or another party) have been significantly involved with the initial design of the VIE and whether that involvement conveys the power to direct the most significant activities. Involvement in the initial design may provide the reporting entity with the ability to structure the entity to provide it with the power over the most significant activities. For example, the initial developer of a power plant project may ensure that it retains control over key performance determinants when executing financing and other arrangements.
10.4.1.7 Disproportionate economics
Excerpt from ASC 810-10-25-38G
Consideration shall be given to situations in which a reporting entity’s economic interest in a VIE . . . is disproportionately greater than its stated power to direct the activities of a VIE that most significantly impact the VIE’s economic performance. Although this factor is not intended to be determinative in identifying a primary beneficiary, the level of a reporting entity’s economic interest may be indicative of the amount of power that reporting entity holds.
In accordance with ASC 810-10-25-38G, reporting entities should consider economic interests as another factor in the evaluation of the primary beneficiary; this has been an area of SEC staff focus. A significant economic interest may be an indication of the amount of power held by a variable interest holder, even in cases where its stated powers to direct significant activities are less. When evaluating single power plant entities and the powers held by variable interest holders, reporting entities should be cautious in situations where a party that has significant economic interests does not also hold the power to direct the most significant activities. This provision is similar to the requirement to assess whether the economics are disproportionate in the determination of whether there is a VIE, as discussed in ASC 810-10-15-14(c).
10.4.2 Related parties
A reporting entity must first determine whether it meets the 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 or consider whether it is part of a related party group that collectively meets both characteristics of a primary beneficiary.
If the related party group has both characteristics of a primary beneficiary and either power over the significant activities is shared within the related party group or the related party group 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. Refer to CG 5.8 for guidance on the application of the related party tiebreaker.
If a single party 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 within that related party group that meets both characteristics of a primary beneficiary (excluding the single decision maker), then 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.
Single power plant entities may involve multiple related parties (e.g., equity holder, operations and maintenance service provider, construction contractor, energy trading company). In such cases, the reporting entity should carefully evaluate the related party relationships, especially for the stand-alone financial statements of the subsidiaries or related parties involved.
10.4.3 Ongoing reconsideration of the primary beneficiary
In accordance with the guidance in ASC 810, reporting entities should perform the primary beneficiary assessment on a recurring basis, including an ongoing determination of who has the power to direct the most significant activities of the entity. In adopting this guidance, the FASB acknowledged that the primary beneficiary of an entity may change over time and concluded that the requirement for ongoing assessments will provide users of the financial statements with more relevant and reliable information. The potential triggers for a change in the primary beneficiary include a change in significant activities, a change in who has control over those activities, and any new variable interests. Examples of these types of changes are depicted in Figure 10-12.
The requirement to reassess the primary beneficiary each reporting period may be a challenge for reporting entities, especially those involved with multiple VIEs. However, in most cases, as part of the initial VIE evaluation, the reporting entity should be able to identify potential triggers that could result in a change in the primary beneficiary. Documentation of the key conclusions reached during the initial assessment could include those factors that may trigger a change in the primary beneficiary, helping facilitate the review in subsequent periods.
Figure 10-12
Reasons for a change in the primary beneficiary
Reasons for a change in the primary beneficiary
Evaluation of the significant activities and when and how they may change is a key component of the ongoing evaluation of the primary beneficiary. See Example 10-9 for an illustration of evaluating a potential change in the primary beneficiary.
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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