Remarks before the 2014 AICPA National Conference on Current SEC and PCAOB Developments
Christopher F. Rogers
Professional Accounting Fellow, Office of the Chief Accountant
Dec. 8, 2014
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues upon the staff of the Commission.
Good morning. It is a pleasure to speak to you today. This morning I want to discuss a couple of consolidation issues recently considered by the staff and provide some current thoughts regarding the definition of a joint venture.
Within the last year, the staff has considered several practice issues regarding the application of the variable interest entity (VIE) consolidation model in Topic 810.
The first issue I would like to discuss is the application of shared power. Topic 810 provides that no party is the primary beneficiary of a VIE when power to direct the significant activities of the entity is shared by multiple unrelated parties. For purposes of illustration, assume an entity is owned equally by two unrelated parties and that there are three significant activities. Assume two of the three significant activities are “shared” in that decisions require joint consent of the owners, and that decisions regarding the third significant activity are unilaterally directed by only one of the owners.
In this example, while certain significant activities do require joint consent, it does not appear that shared power as described in Topic 810 exists. For shared power to exist, the guidance seems to suggest that all decisions related to the significant activities of the VIE require the consent of each party sharing power. When decisions related to a significant activity do not require joint consent, the staff has struggled to find a basis in the accounting literature to support that shared power can in fact exist. This is the case even when it is determined that the significant activities that require joint consent more significantly impact the economic performance of the entity than the significant activities that do not. In situations when shared power does not exist but multiple parties are directing different significant activities, the guidance provides that one party will meet the power criterion in the primary beneficiary assessment. The staff believes an extension of this principle suggests that the party with more power, relative to others, over the significant activities of the VIE should consolidate. In my example, a party’s shared decision making rights over certain significant activities along with its unilateral decision making rights over the remaining significant activity seems to provide that party with a greater ability to impact the economic performance of the VIE compared to the other owner and therefore it should consolidate the VIE.
One final thought before moving on: determining what activities most significantly impact the economic performance of a VIE is a crucial first step in the primary beneficiary analysis that should take into account the purpose and design of the VIE and the risks and rewards that the VIE was designed to create and pass along to variable interest holders. This analysis often requires a significant amount of judgment. Keep in mind, decisions relating to activities that are not considered significant should not be considered in the primary beneficiary assessment. In my example, if the activity that is unilaterally directed by one owner was not considered a significant activity, shared power would in fact exist and no party would consolidate the VIE.
Another topic recently considered by the staff is how to evaluate power when a decision maker is acting in an agency capacity. Said differently, does the VIE consolidation analysis stop if a reporting entity determines that a fee paid to a decision maker by a VIE is not a variable interest? For purposes of illustration, assume an entity forms an SPE to securitize loans. The design and purpose of the SPE is to finance the entity’s loan origination activities. The entity provides the investors in the SPE with a guarantee protecting against all credit losses. The SPE hires a third party to service the loans and to perform default mitigation activities. Assume the servicer cannot be removed without the consent of investors and its fee is not a variable interest.
In thinking through this example, the staff believes that in certain cases it may be necessary to continue the consolidation analysis when it is determined that a fee paid to a decision maker is not a variable interest and further consider whether the substance of the arrangement identifies a party other than the decision maker as the party with power. While this can require a great deal of judgment, additional scrutiny may be necessary if a decision maker is acting as an agent and one variable interest holder is absorbing all or essentially all of the variability that the VIE is designed to create and pass along. In these situations, stated power may not be substantive, and it may be appropriate to attribute the stated power of the decision maker acting as an agent to the variable interest holder absorbing the variability of the VIE. It is helpful to keep in mind that the level of a reporting entity’s economic interest in a VIE may be indicative of the amount of power that the reporting entity holds. While the VIE guidance states that this factor is not determinative in identifying the primary beneficiary, the staff does believe that the level of a reporting entity’s economics is an important consideration in the analysis and may be telling of whether stated power is substantive.
Finally, the last VIE consolidation topic I want to touch on today is how to consider power and economics when related parties are under common control. The staff has received several questions recently regarding whether the related party tie-breaker guidance always must be considered when determining which party in a common control group is the primary beneficiary of a VIE. While common control arrangements do require careful consideration to determine if stated power is in fact substantive, the staff does not believe there is a requirement to consider the related party tie-breaker guidance or that that guidance is necessarily determinative unless no party in the common control group individually meets both characteristics of a primary beneficiary.
Definition of a Joint Venture
The last topic I want to discuss today is the definition of a joint venture. Joint venture formation transactions can be complex and are a frequent topic of discussion with the staff. As I am sure many of you are aware, the formation of a joint venture is excluded from the scope of Topic 805. As a result, no guidance currently exists in U.S. GAAP on the appropriate accounting in the stand-alone financial statements of a joint venture for assets and businesses contributed to the joint venture. Practice to date has been mixed with some joint ventures recognizing full or partial step up in basis and others recognizing predecessor basis.
In evaluating joint venture formation transactions, the staff continues to believe that joint control is not the only defining characteristic of a joint venture. Rather, each of the characteristics in the definition of a joint venture in Topic 323 should be met for an entity to be a joint venture, including that the “purpose” of the entity is consistent with that of a joint venture.
Importantly, the definition of a joint venture in Topic 323 provides that “the purpose of a corporate joint venture frequently is to share risks and rewards in developing a new market, product, or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities.”
The staff has seen recent fact patterns where the primary purpose of a transaction is to combine two or more existing operating businesses in an effort to generate synergies such as economics of scale or cost reductions and/or to generate future growth opportunities. In these fact patterns, determining whether the purpose of the transaction is consistent with the definition of a joint venture as described in Topic 323 or whether the substance of the formation transaction is a merger or put together transaction that should be accounted for as a business combination under Topic 805 requires a significant amount of judgment. Given the inherent subjectivity in making this distinction, coupled with the lack of guidance in U.S. GAAP on the accounting by a joint venture, significant diversity in practice exists in accounting for these transactions. This diversity has created a lack of comparability between what are otherwise substantively similar transactions. As Jim Schnurr mentioned in his remarks earlier this morning, comparability is a hallmark of U.S. financial reporting. As a result, the staff believes it would be appropriate for the FASB to consider providing clarity on the definition of a joint venture in Topic 323, and to provide guidance on the appropriate accounting in the stand-alone financial statements of a joint venture for assets and businesses contributed to the joint venture. In the meantime, as always, we encourage registrants and auditors to come in and talk to us as they consider the appropriate accounting for joint venture formation transactions.
Thank you for your kind attention this morning, and please enjoy the remainder of the conference.
 Topic 810, Consolidation.
 The significant activities of a VIE are the activities that most significantly impact the VIE’s economic performance.
 ASC 810-10-25-38D provides that “[P]ower is shared if two or more unrelated parties together have the power to direct the activities of the 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.”
 Paragraphs A55 of the Basis for Conclusions to FASB Statement No.167, Amendments to FASB Interpretation No. 46(R), states, in part: “To the Board, it was important that decisions require the consent of each party sharing power because this would be most indicative of a group of parties that had agreed to share the power to direct the activities of a variable interest entity. The Board believes that situations in which decisions can be made without the consent of each party directing certain activities of the entity simply indicate that different parties have power over different activities, but those situations do not represent shared power over the entity.”
 Paragraph A56 of the Basis for Conclusions to Statement 167 states, in part: “The Board acknowledged that situations could exist in practice in which multiple parties are directing the activities that significantly impact the economic performance of the entity, but those parties do not need to consent to the decisions relating to those activities. The Board noted that such situations would not meet the definition of shared power… In the Board’s view, if those parties are directing different activities, then the consolidation principle in [the VIE subsection of Topic 810] requires those parties to decide if they have power to direct the activities that have the most significant impact on the economic performance of the entity (that is, the application of the principle… would result in one of those parties having the [power characteristic]).”
 The Staff believes this is directionally consistent with the principle articulated in Case H4 in ASC 810-10-55-197 and 55-198 and in paragraph A57 of the Basis for Conclusions to Statement 167 which states, in part: “The Board also observed that, in practice, there could be situations in which the parties involved with an entity have power over different activities and portions of the same activities. The Board reasoned that, in those situations, an enterprise’s power over certain activities, along with its power over portions of other activities, might identify that enterprise as the party with the power to direct activities that most significantly impact the economic performance of the entity.”
 Paragraph A76 of the Basis for Conclusions to Statement 167 provides that a decision maker is acting in an agency capacity when the fee it receives for performing services is not a variable interest.
 ASC 810-10-55-37.
 ASC 810-10-25-38G.
 ASC 810-10-25-44.
 ASC 810-10-15-13A.
 Topic 805, Business Combinations.
 ASC 805-10-S99-8.
 Topic 323, Equity Method and Joint Ventures