Remarks before the 2020 AICPA Conference on Current SEC and PCAOB Developments

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.

Introduction

Good afternoon. It is a pleasure to speak to you today. I would like to share some observations on two topics. The first topic relates to determining the primary beneficiary of a variable interest entity (“VIE”), and the second topic relates to a customer’s accounting for consideration received from a vendor or supplier.

Evaluating Power in the VIE Model

OCA staff continues to receive consultations regarding determining whether a registrant is the primary beneficiary of a VIE. Identifying the party with the power to direct the activities that most significantly impact a VIE’s economic performance continues to be 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.[1]

Consider a fact pattern presented to OCA staff where the registrant invested in a VIE and began operating the VIE together with another party who had held an interest in the VIE since its formation. Due to its only customer choosing not to renew its contract, the VIE was winding down its activities, including performing under the remaining term of the existing contract. Following the final cessation of operations of the VIE, the registrant agreed to buy out the other party pursuant to a fixed-price buyout agreement.

The registrant considered the guidance under the VIE consolidation model to determine if it was the primary beneficiary of the VIE.[2] The registrant concluded that the activities that significantly impact the VIE’s economic performance included: (1) approving the annual budget, (2) approving suppliers to be used in fulfillment of the contract, and (3) appointing, removing, or replacing the CEO. These activities required a majority vote of the VIE’s board of directors and required approval from both the registrant and the other party. The registrant believed this provided both the registrant and the other party with the ability to block actions proposed by the VIE. Therefore, the registrant concluded that it had shared power over the most significant activities of the VIE.

The registrant also considered if it was a related party with the other party, including if a de facto agency relationship existed.[3] Specifically, the registrant considered whether the buyout agreement was akin to a loan from the registrant funding the other party’s interests in the VIE.[4] The registrant concluded that the buyout agreement was not economically equivalent to a loan based on the substance of the agreement because (1) the other party’s equity interest was not directly financed by the registrant, (2) the other party had an equity interest in the VIE since it was founded and before the registrant had an equity interest, (3) the other party did not need a loan in order to continue participating in the business, and (4) the purpose of the buyout agreement was to facilitate dissolution of the VIE. In summary, the registrant concluded that no de facto agency relationship existed and therefore, that the related party tiebreaker was not applicable. Due to power being shared, the registrant concluded it was not the primary beneficiary and should not consolidate the VIE.[5]

OCA staff did not object to the registrant’s conclusion that there was shared power in the arrangement. OCA staff also did not object to the registrant’s view that the other party was not a related party, including that there was no de facto agency relationship in this set of facts and circumstances. As such, the staff did not object to the registrant’s conclusion that it was not the primary beneficiary of the VIE and thus it was not required to consolidate the VIE.

Customer’s Accounting for Consideration Received from a Vendor

The second topic I would like to discuss today relates to a customer’s accounting for consideration received from a vendor or supplier. GAAP requires an entity to account for consideration received from a vendor as a reduction of the purchase price of the goods or services acquired from the vendor unless the consideration received from the vendor is (1) in exchange for a distinct good or service that the entity transfers to the vendor, (2) a reimbursement of costs incurred by the entity to sell the vendor’s products, or (3) consideration for sales incentives offered to customers by manufacturers.[6]

Consider a fact pattern where a registrant had previously purchased fixed assets from a vendor, and also had non-cancellable purchase commitments of fixed assets from the same vendor. After identifying a significant issue with the fixed assets, the registrant and vendor developed a plan to repair the fixed assets. In addition to making the repairs, the vendor also provided cash compensation to the registrant. Neither the prior purchase agreements nor the agreements for the non-cancellable purchase commitments directly addressed the remedy in this situation. However, the registrant asserted that it believed the vendor made the payments for a variety of reasons, including because it was motivated to retain the registrant as a customer.

The registrant determined that ASC 705-20, Accounting for Consideration Received from a Vendor, was applicable in this situation.[7] Although the registrant acknowledged its assertion that the vendor made the payments for a variety of reasons, including because it was motivated to retain them as a customer, the consideration was not in exchange for a distinct good or service that the entity transfers to the vendor. The registrant also asserted that the other exceptions in ASC 705-20, as previously highlighted, were not applicable in this fact pattern.

As a result, the registrant concluded that it would be appropriate to reflect the payment from the vendor as a reduction of the purchase price of the fixed assets previously acquired from the vendor and the fixed assets that the registrant was firmly committed to purchase from the vendor.

OCA staff did not object to the registrant’s conclusion.

Conclusion

This concludes my remarks. Thank you for your time and attention.