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June 2006 Multiple-entity owners and financial statement consolidation In 2003, the Financial Accounting Standards Board (FASB) issued “FASB Interpretation No. 46, Consolidation of Variable Interest Entities” to help determine when a company should include in its GAAP-basis financial statements the assets, liabilities and activities of another entity. Later in 2003, FIN 46 was replaced by FIN 46(R), which made several changes to the original FASB Interpretation. What is known in the accounting profession as “FIN 46” (and, in less appreciative quarters, by names not appropriate for mention in a family-oriented newsletter) is of particular interest to owners of multiple entities. One common and relatively simple multiple-entity arrangement is where a business owner sets up an entity to hold a building (and any related debt) and lease it to an operating entity owned by the same individual. FIN 46 requires a determination of whether any of the multiple entities is a “variable interest entity” (VIE) and, if so, who is required to consolidate the VIE’s financial statements. In general, a VIE is a corporation, partnership, trust or other legal structure that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. In plain terms, an entity that needs financial support from another entity is probably a VIE and should be consolidated with the entity that provides the most financial support. Such financial support commonly includes equity interest, loans, and debt guarantees. A VIE often holds financial assets, including loans or receivables, real estate or other property. A VIE may be essentially passive or it may engage in research and development or other activities on behalf of another company. Prior to FIN 46, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 clarified that voting interests are not the only factor in determining consolidation requirements. A VIE should be consolidated by the “primary beneficiary,” i.e., the company subject to the majority of the risk of loss from the VIE’s activities, or entitled to receive a majority of the VIE’s residual returns, or both. One of the consequences of FIN 46 has been that many joint ventures, general and limited partnerships, and LLCs that were never intended to be consolidated may fall within the criteria for financial statement consolidation. For real estate developers and others, FIN 46 has caused confusion and has raised legal and tax liability issues affecting both completed and future joint ownership transactions. Three years after its issuance, FIN 46 continues to torment business owners involved in multiple-entity arrangements. Since the complexities of its application defy in-depth discussion here, you should consult your Schmidt Westergard & Company professional to measure the potential impact of FIN 46 on your GAAP-basis financial statements and on future plans involving multiple entities. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |
