Remarks before the 2019 AICPA Conference on Current SEC and PCAOB Developments
Professional Accounting Fellow, Office of the Chief Accountant
Dec. 9, 2019
The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.
Good morning. It’s a pleasure to speak to you today. This morning I want to share some observations from recent consultations with OCA on two topics: the first topic is the application of the revenue standard to a sale-leaseback transaction, and the second topic is two consultations related to determining whether a registrant is the primary beneficiary of a variable interest entity (“VIE”).
Sale and Leaseback Transactions
Beginning with the sale-leaseback transaction, in this consultation, a registrant transferred its fixed assets into a VIE in exchange for 100% of the VIE’s equity interest. The VIE entered into a master prepaid lease with a third party, which included a substantive fixed price purchase option to acquire the underlying assets at the end of the lease term. As a result of the master prepaid lease, the third party gained a controlling financial interest in the VIE. Additionally, the registrant simultaneously entered into an agreement with the third party to lease back a physically distinct portion of the leased assets for a fixed term. Based on the substance of the transaction, the registrant evaluated the sale and leaseback guidance to determine whether the third party gaining a controlling financial interest in the VIE should be accounted for as a sale of the assets. This required the registrant to consider if the third party obtained control of the assets, as defined in the revenue standard.
The registrant concluded that the third party obtained control of the leased assets primarily for two reasons: (1) it was currently obtaining the benefits of the underlying assets through its master prepaid lease; and (2) it was able to prevent other parties from obtaining the benefits of the leased assets by holding the substantive purchase option.
The staff objected to the registrant’s conclusion that the third party obtained control of the assets. Control of an asset is the ability to direct the use of, and obtain substantially all of the remaining benefits from an asset. However, an entity’s ability to prevent others from directing the use of and obtaining the benefits from the asset does not in and of itself establish control. In this fact pattern the registrant’s ability to prevent others from directing the use of and obtaining the benefits of an asset was due to a purchase option. The staff observed that control had not transferred because if the purchase option was not exercised the registrant would regain its controlling financial interest in the VIE.
Power to Direct the Most Significant Activities
Moving to my second topic. Identifying the party with the power to direct the activities that most significantly impact a VIE’s economic performance is an area of judgment that requires a careful evaluation of the entity’s purpose and design and the variability that the entity is designed to create and pass along to its interest holders.
The staff recently considered a consultation where a registrant contributed its investable assets into a newly-formed limited partnership in exchange for limited partnership interests. The limited partnership met the definition of a VIE and the VIE’s primary purpose was to manage the investable assets pursuant to broad investment guidelines. The registrant was significantly involved in establishing the investment guidelines and had the contractual right to modify certain aspects of the guidelines. A general partner, who held a variable interest in the VIE, had the unilateral discretion to make investment decisions in accordance with the investment guidelines. The registrant concluded the activity that most significantly impacted the VIE’s economic performance was making investment decisions and that the registrant did not have power over this activity.
The staff evaluated the investment guidelines to determine if the registrant had power over investment decisions through its ability to modify certain aspects of the investment guidelines or whether the general partner had power over the investment decisions through its day-to-day management rights. The staff observed that while the registrant could modify certain aspects of the guidelines, it did not have the ability to significantly limit the general partner’s discretion over current and future investment decisions. Rather, the guidelines were designed to provide the general partner with significant discretion to make day-to-day investment decisions. Accordingly, the staff did not object to the registrant’s conclusion that it did not control the VIE’s most significant activity.
Continuing with the second consultation on identifying the primary beneficiary, a VIE may have multiple risks and multiple activities that impact the entity’s economic performance. However, the importance of each risk and each activity to the consolidation analysis is not necessarily identical. The staff recently considered a consultation regarding a VIE that was designed to serve as a single-asset LLC whose primary purpose was to lease its single property to a registrant for substantially all of the property’s economic life and to provide a return to its investors through the lease payments and sale of the property at the end of the lease. The lease obligated the registrant to operate and maintain the property, including any significant structural maintenance. Additionally, the VIE had the right to sell the property at the end of the lease. The registrant, or lessee, concluded that it had multiple variable interests in the VIE but did not have power over the activities that most significantly impacted the VIE’s economic performance and therefore did not consolidate the VIE.
Based on the VIE’s purpose and design, the risks that caused variability included: lease negotiation risk, lessee credit risk, residual value risk, and operation and maintenance risk. Activities related to lease negotiation risk were not the VIE’s most significant activities, primarily because the lease term covered substantially all of the property’s economic life. Activities related to lessee credit risk were not the VIE’s most significant activities because the registrant’s financial condition and the property’s strategic importance mitigated credit risk. Rather, the staff determined that activities related to residual value risk and operation and maintenance risk were the VIE’s most significant activities. The staff observed that operation and maintenance decisions made by the registrant during the lease term would most significantly impact the VIE’s economic performance. Therefore, the staff objected to the registrant’s conclusion that it did not have power over the VIE’s most significant activities.
Thank you for your time and attention.
 Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“Topic 606”).
 FASB ASC Subtopic 842-40, Sale and Leaseback Transactions (“Subtopic 842-40”).
 FASB ASC Topic 810, Consolidation, specifically ASC 810-10-25-38A.
 The registrant no longer held a controlling financial interest in the VIE as a result of the master prepaid lease, but continued to hold 100% of the VIE’s equity.
 Subtopic 842-40.
 See ASC 606-10-25-25.
 ASC 810-10-25-22.
 ASC 810-10-25-38A(a) focuses on the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance.