Consolidation issues continue to pose challenges for preparers of financial statements and practitioners performing attest engagements on the financial statements.
In the world of private company financial reporting, the guidance associated with whether reporting entities are considered to be primary beneficiaries of variable interest entities (VIEs) has proven to be particularly problematic in practice. The guidance is in the Financial Accounting Standards Board’s Accounting Standards Codification (FASB ASC) Topic 810, Consolidation.
To address one area of concern, the staff of the American Institute of CPAs released new technical practice aid (TPA) guidance in April 2012. The particular issue addressed relates to the situation in which reporting entity management does not perform required assessments of affiliated entities to determine whether they are VIEs that need to be consolidated in the financial statements.
Primarily because of cost-related issues, management often does not engage practitioners to help with the required VIE assessments. Questions have bubbled up as to what management can expect in its compilation or review reports and how practitioners should handle this matter when they are compiling or reviewing financial statements. To that end, the TPA guidance should be helpful.
U.S. GAAP requirements. Using the provisions of FASB ASC 810, management of reporting entities with variable interests in VIEs needs to assess whether the reporting entity has a controlling interest in the VIEs and, therefore, is their primary beneficiary.
This requirement includes assessing characteristics of the reporting entity variable interests and other involvements in the VIEs, if any (including involvement of related parties and de facto agents), as well as involvement of other variable interest holders. Management assessments also need to consider the purpose and design of VIEs, including the risks that the VIEs were designed to create and pass through to their variable interest holders.
Compilation and review requirements. Practitioners who are engaged to compile or review financial statements may become aware of departures from U.S. generally accepted accounting principles (U.S. GAAP), including note disclosure deficiencies or omissions, that are material to the financial statements.
If reporting entity management does not revise the financial statements, practitioners will need to consider whether modification of their compilation reports would be adequate to disclose the departures.
Importantly, practitioners are not required to determine the effects of U.S. GAAP departures when management has not done so, as long as their reports include the stipulation that the effects of the departures on the financial statements have not been determined.
The TPA guidance. The TPA guidance should be helpful in resolving the above-noted practice issue. The conclusion in the guidance is that, because management is required to perform the assessments of affiliated entities to comply with U.S. GAAP requirements, failure to perform the required management assessments – along with management instructions to practitioners not to perform the assessments – results in financial statements that include a departure from U.S. GAAP requirements.
This conclusion is significant: Practitioners do not need to consider the failure by management to perform the required assessments to fall under the umbrella of refusing to provide information to practitioners or a scope limitation, either of which would result in the default requirement for practitioners to withdraw from either compilation or review engagements.
With the conclusion, practitioners should consider whether modification of their compilation or review reports would be adequate to disclose the departures, as discussed earlier.
The TPA guidance includes illustrative report wording that should be helpful to practitioners. It addresses the frequently encountered issue in which management does not perform the required assessments needed to determine whether VIEs need to be consolidated.
Management of reporting entities can expect report wording similar to the following:
Accounting principles generally accepted in the United States of America require management to assess whether the Corporation has a controlling interest in any entities in which the Corporation has a variable interest in order to determine if those entities should be consolidated. Management has not performed the required assessment and, therefore, if there are variable interest entities for which the Corporation is the primary beneficiary, has not consolidated those entities. Although the effects on the financial statements of the failure to perform the required assessment have not been determined, many elements in the financial statements would have been materially affected had management determined that the Corporation is the primary beneficiary of any variable interest entities.
Practitioners need to understand their obligations in this reporting arena when they compile or review financial statements. And, the hope is that the management of reporting entities will benefit from understanding this issue by knowing how reports received from practitioners will be written.