Back to basics: Consolidation–Presentation and disclosure

0:00Thought Leadership from PwC's National Office.

0:07Hello, and welcome to PwC's accounting podcast. I'm Heather Horn. Today, we're wrapping up the Back to Basic series on consolidation accounting. Over the last three episodes, we've revisited the consolidation framework with Matt Sabatini, a deputy chief accountant in PwC's national office, and Alexander Martin, a partner in PwC's deals practice, from understanding the two consolidation models, to identifying a variable interest entity or VIE, and finally determining who, if anyone, actually consolidates it. For today, the final episode, we're turning our attention to presentation and disclosures under the consolidation frameworks, including both VIEs and voting interest entities or VOEs.

0:56Matt and Alexander walk through what companies need to think about once they've reached their consolidation conclusion, including how consolidated entities are presented in the financial statements, the disclosure requirements that apply to VIEs, and what may need to be disclosed even when a company has an interest in a VIE but does not consolidate it. This episode builds nicely on the first three, but it's also a standalone if presentation and disclosure is the area you're focused on. Joining Matt and Alexander to lead this conversation is our guest host, Diana Stoltzfus, who's a partner in PwC's national office and a frequent guest on the podcast.

1:34With that, let's go to Diana's conversation with Matt and Alexander. Thanks so much for joining me for this conversation today. Thanks for having us, Diana. Really excited to be here. Yeah, likewise. Mostly because we're talking about disclosures. I know sometimes people think disclosures and they think snooze fest. And most of the time, I can't speak for Matt, But for myself, a lot of the times when we talk about consolidation, most of the time people are thinking about should I or should I not consolidate this entity? But they don't spend enough time thinking about what those disclosures will actually look like once they get the answer.

2:06And I think that's just as important. It's your chance to explain to the financial statement users what's going on. It's also an area that tends to get some comments from the SEC staff, especially around VIEs and structure transactions. Not that I'm necessarily trying to scare anybody into paying attention, but I'm also not not trying to scare people Well, great. That's some good reminders and a little motivation for our listeners So let's get started matt Can you kick us off with a high-level overview of what consolidated financial statements are and why they matter? Yeah, i'm happy to get started So at a high level consolidated financial statements They present the financial position and operations of a parent company combined with its subsidiaries as if it's a single reporting entity.

2:49So really the guidance around 810 and Rule SX, they have a fundamental principle that drives what good financial reporting is, right? And there's an underlying concept that consolidated financial statements are presumed to be more meaningful for entities in which you have a controlling financial interest, right? And why is that? Well, the idea behind that is it's clearer and it's a more complete picture of the overall financial performance of the group. So like I mentioned, the key framework that describes the disclosure requirements and the presentation requirements are in ASCA 10 and also Rule SX.

3:23Yeah, and I really like your picture analogy. Like to me, the way I keep it straight in my head is it's almost like a jigsaw puzzle where you're assembling all of your different pieces, in this case, that being the separate legal entities into one cohesive picture, which is your consolidated financial statements. So there's some specific requirements about how you end up pulling that together and ultimately what that looks like. Those are your presentation requirements, which we'll hit today. Additionally, and I think most importantly, is the story behind that picture. That's where the disclosures come into play.

3:52There's also some very specific requirements about what those need to include, too. Broadly speaking, though, the presentation and disclosure rules can fall into three separate buckets. So you have the presentation and disclosures that apply to all consolidated entities, regardless of whether it's a VIE or VOE. Then you have incremental disclosure items specifically for VIEs. And then you have the overarching SEC-specific considerations that our public registrant listeners need to think about. That's a very helpful overview. Matt, maybe you can start with some high-level presentation and disclosure requirements when a company consolidates a subsidiary.

4:26Sure. I'm going to start with presentation, right? And the goal behind presentation, similar to disclosure, is transparency. And you're going to hear us say that word a lot, like for our listeners who are playing the drinking game at home. it's going to be a rough one for you. So investors and regulators really want to understand how consolidation impacts financial statements. So some key points to keep in mind on presentation, right? For all consolidated subsidiaries, that is all entities in which you have a controlling financial interest, the financial statements will be presented as if it's one reporting entity.

4:59So I know we said that earlier. The technical term for that is we smush them all together. so right and when you do that right like when you smush entities together there are some things you have to keep in mind right because it's not as simple as just combining all of the line items you also have to understand when they're inter-entity or inter-company transactions or balances because putting things together like that can result in some double counting so you're going to have to eliminate all of that so you kind of get rid of all that noise in the financial statements the other thing to think about is when you're doing the combination of these financial statements in a consolidated set, it's for all wholly owned and partially owned subsidiaries.

5:37So partially owned subsidiaries come with their own nuances, right? You have to think about how am I going to show to the reader that I'm consolidating the financial statements, but I don't own all of it. So I have to allocate a piece of the balance sheet that represents the non-controlling interest holder's claim on the net assets. I have to think about the income statement where I attribute a bit of the net income to the non-controlling interest holder as well. And then a reconciliation of stockholders' equity that shows changes in the ownership status. Yeah. So then layering on top the public company lens that I mentioned, there's also some specific SEC rules that mandate additional disclosures when you either have a majority-owned subsidiary that you're not consolidating or when you have a less-a-majority-owned subsidiary that you are consolidating.

6:17And that's something that the staff tends to keep their eye on. Okay, great. And I'm glad you mentioned disclosures here. Are there any general disclosure principles we want to cover before we dive into the specifics? Yeah, maybe starting just as a general rule. Entities should be disclosing their consolidation policy and their basis of consolidation. Really, that just means essentially how are they determining whether they have a controlling financial interest or not. Like I mentioned before, you should be disclosing your exceptions to consolidation when you have majority ownership, but you're not consolidating and vice versa.

6:47You also want to be disclosing any changes to your consolidation approach or any significant deconsolidation events that have happened and why. And lastly, to the extent you have any significant non-controlling interests that Matt mentioned, you also may want to also be describing how income allocations are made between the controlling and non-controlling interests. So, for example, if you're using an HLBV method, also known as a wonky accounting method, you should be disclosing that as well to make it clear. And these apply to all consolidated entities, regardless of whether it's a VIE or a voting interest entity.

7:19Okay, got it. Now that you've mentioned both VIEs and VIEs, let's break it down. How do their disclosure requirements differ? Maybe we'll start with VIEs. What makes an entity a VIE in the first place? Right. Diana, I wish it were that easy. My best advice for you is to go back and listen to the three-part podcast that we did the summer, really to find out what makes an entity a VIE. But in all seriousness, right, if you can simplify it, it would be a VIE is an entity where the voting rights, and those are generally resident within the common stock of an entity, those aren't the most relevant means for determining if anyone has a controlling financial interest.

7:56So generally in those situations, control or power is obtained by a reporting entity through another means, either contractual or financial dependency. That's as best as I can do in a one minute description of a VIE. Yeah. And I'll pile onto the shameless plug for the podcast series. I recently listened to it and I thought the guests were really engaging and very hilarious too. What I did learn from the podcast was that even if a company doesn't hold a majority voting stake, it still could be required to consolidate the entity if it's determined to be the primary beneficiary or the one that consolidates.

8:29Okay. So if a company determines it is the primary beneficiary of a VIE, what do the financial statements need to reflect? Right. So if a company is the primary beneficiary, it must consolidate the VIE's financials as if it were any other subsidiary, right? So that means the financial statements of the VIE are smushed together with the financial statements of the parent or the primary beneficiary. Just like we talked about earlier, all of the other considerations also apply. So the policies and procedures around under company accounts and controlling and non-controlling interests all apply. Okay.

8:58Are there any differences in the presentation of a consolidated VIE? Yes. Great question. There are some important differences. So first, you're required to separately present the VIE's assets that can only be used to settle its obligations. And the VIE's obligations where creditors have no recourse to the company or the parent company's general credit. Idea here being is that because many VIEs are highly structured, we want to clearly show the users any assets or liabilities that are restricted to the VIE itself and can't be used by the parent. Also, these assets and liabilities have to be presented on a gross basis.

9:31You can't just net the two. The SEC staff is pretty strict about that one. Okay, that's interesting. So do companies have to present these segregated assets and liabilities in their own light items for every consolidated VIE? I can't imagine how confusing that balance sheet might look. Thankfully, no. Companies have several approaches that they can take to comply with these presentation requirements. So the most common ones that I see are a parenthetical disclosure about the amounts that's held in the VIE for each relevant FSLI or financial statement line item on the face of the balance sheet.

10:03Also, the guidance does allow for the aggregation of the same or similar assets or liabilities of all consolidated VIEs into one line item. So that does kind of help with the decluttering of the balance sheet. Matt likes to joke that the FASB was embracing their intermarie condo when they came up with that one. Well, great. Well, very feng shui. So Matt, what about disclosures for VIEs? Right. So one of the important things about VIE disclosure rules, and this is one that people forget a lot, is it's not just for your consolidated VIEs that you have disclosure requirements. It's also for VIEs in which you have an interest, but you don't consolidate.

10:36So I think people miss that. But talking about VIE disclosures, It was one of those standards where the FASB has laid out objectives and principles behind the disclosures. So it's not just a list of requirements and here are all the checks that you have to hit to meet the requirements. It's making sure that you've met the spirit of what those requirements are. So some of the objectives, I'll just list them off, right? So any significant judgments and assumptions that you've made to determine whether or not the entity is a VIE. That's one. The nature of any restrictions on VIE assets and the settlement of its liabilities.

11:10I know Alexander mentioned that earlier. Changes in any risk exposure that you have due to your involvement with the VIE. And lastly, any effect on the financial position, financial performance, or cash flows due to your involvement with the VIE. Yeah, and I'd say the huge thing to emphasize there, again, as Matt mentioned, is that the disclosures are as much of an art as they are of a science, right? So we have these very specific ones that Matt referenced, but the guidance does really clarify that they're more principles-based than anything. So ultimately what we're aiming for here is clarity and transparency when you have an involvement with the VIE.

11:44Okay, I think that's a great point to clarify. So the takeaway is that companies should really aim for clarity. Are there any specific examples where the SEC has asked for more transparency? Yeah, a common one really is when a company determines that it isn't the primary beneficiary of a VIE, even though it holds a significant financial interest. So the staff tend to ask for more details about how the company reached that conclusion. Right. And another area of focus is whether the entity's assets can be used outside of the structure of a VIE. So if a company asserts that the VIE's assets are restricted, they need to disclose what those restrictions are and why they exist.

12:21Okay. I think those examples are really helpful. So now that we've covered the purpose of the disclosures, Matt, can you start us off with the disclosure requirements? Sure. We're going to break it down to three main categories as it relates to disclosures. So the first one is going to be all companies that have a variable interest in a VA. So anybody with an interest in a VIE. The second is going to be just for primary beneficiaries, so just for those parties that consolidate the VIE. And the third is going to be companies who have a variable interest but don't consolidate. So those are the three buckets we're going to cover.

12:51Okay. So let's start with the basic. Companies with a variable interest in a VIE have to provide disclosures whether or not they're the primary beneficiary. Alexander, can you walk us through exactly what needs to be disclosed? Yeah, sure. So at a high level, entities need to outline how they determine if they are or aren't the primary beneficiary of the VIE. This includes key factors, assumptions, significant judgments that are made in that assessment. Again, it's about transparency. Investors and regulators need to understand the decision-making process behind the consolidation or non-consolidation answer.

13:23Okay, that makes sense. And what about cases where there's a change in the company's determination of the primary beneficiary. Say a company previously consolidated a VIE because it was the primary beneficiary, but something's changed and it no longer consolidates VIE. What does it do then? Right. I think you can guess what I'm going to say, but it definitely requires some disclosure, right? So if there's a change in reporting, whether you start consolidating a VIE or you deconsolidate something that you previously were consolidating, you have to disclose the reasons for the change and what the impacts of that change were to the financial statements.

13:59Transparency? Correct. Got it. So, Alexander, what else needs to be disclosed regardless of the PB determination? Yeah, so even if a company isn't the primary beneficiary, it still has to provide qualitative and quantitative details around its involvement with the VIE. This means disclosing the nature, size, purpose, and activities of the VIE, as well as how the VIE is financed. This helps users assess potential risks and exposure to the entity. Okay. So that seems like it ties into another point. the financial or other support that companies may provide to a VIE, even if they weren't contractually required to.

14:34Alexander, what should companies be disclosing in those situations? Yeah, so if a company or reporting entity provides financial or other support that it wasn't previously obligated to provide, it needs to disclose the type and the amount of that support, as well as the primary reasons behind that decision to give it. Thank you for walking us through all that. What exactly needs to be disclosed when a company is the primary beneficiary of a VIE. Right. So this is bucket two in the three buckets I mentioned before. If a company is the primary beneficiary or consolidates a VIE, the company has to disclose the carrying amount and the classification of the VIE's assets and liabilities in its consolidated financial statements.

15:10So it's not just about numbers. You also, if you're the reporting entity, you should provide qualitative information about how those assets and liabilities relate to the broader reporting entity. Okay. So more than just a tick-the-box compliance exercise. What about recourse? How does that factor into the disclosures? Right. So if the creditors of a VIE don't have recourse to the reporting entity's general credit, companies should make that very clear in their disclosures. Investors and stakeholders really need to understand whether the VIE's liabilities could impact the parent company's financial position.

15:42Okay, that makes sense. Now let's talk about something that can trip companies up, support obligations. Alexander, what do companies need to disclose when it comes to arrangements that could require them to provide support to the VIE? Yeah, so if there's any terms or arrangements that could require a company to provide financial support, whether those are contractual or implied, they have to be disclosed. So this includes things like liquidity arrangements or asset purchase obligations. Basically, if there's a chance that the company could be on the hook financially, the disclosures need to reflect that.

16:13Right, so I think there's one last bit in this bucket for primary beneficiary disclosures, and that really is on initial consolidation of a VIE. And this one depends on whether or not the VIE is also a business. And when we say, is it a business? We mean the definition AAC 805. So if it meets the definition of a business under 805, upon initial consolidation, the primary beneficiary has to comply with all of those disclosure requirements as well. So you're bringing in a whole nother standard and a company who consolidates for the first time, a VIE that's a business has to comply with all of those disclosure requirements as well.

16:43Okay. I think that seems like a really important point to keep in mind. So I think the last part we want to discuss regarding VIEs is when a company has a variable interest in a VIE, but it is not the primary beneficiary. Matt, can you start us off here? Sure. Right. We're getting into bucket number three, right? The important thing to keep in mind here is that companies don't have a get out of jail free card related to disclosures when you're not the primary beneficiary of a VIE. So I know I mentioned it earlier, but it's worth repeating, right? The company still has disclosure obligations under GAAP if you only have a variable interest in a VIE and you're not consolidating.

17:18So the recurring theme here, again, is transparency about the company's involvement with the VIE and what kind of risks that the involvement poses. Yeah, and that means the company has to disclose things like the carrying amount and the classification of assets and liabilities that relate to their interest in the VIE. So in other words, what are you putting on your balance sheet that's tied to your relationship with the VIE? So things like loans to the entity or guarantee obligations. Okay, got it. But it's not just about the numbers on the balance sheet, right? there's also an element of explaining the exposure to loss.

17:49Can you elaborate on that, Alexander? Yeah, and this is actually a really important one. So companies are required to disclose their, quote, maximum exposure to loss due to their involvement with the VIE. Basically, where we're getting at is even though I don't consolidate the VIE, I still may have financial risk tied to it. So this disclosure requirement ensures that the users understand the worst case scenario. How much could I lose if things go wrong? The big point here, though, is this analysis needs to be done irrespective of probability. And in addition to the quantitative requirement, you also have to qualitatively disclose how the exposure was determined and the significant source of that exposure to loss.

18:24Right. And relating to the quantitative requirement, if companies can't nail down an exact dollar amount for the quantitative exposure, companies need to disclose that as well. Okay, got it. Now, one thing I saw in the guidance while I was preparing for this discussion was the requirement for a tabular comparison. What's the purpose of that? Yes. Alexander loves tables almost as much as he loves roll forwards, right? So the idea here is to show a side-by-side comparison of the carrying amounts of assets on liabilities versus their maximum exposure to loss. But it doesn't stop, again, at quantitative or just numbers.

18:57You know, a repetitive theme here, right? Companies also have to provide qualitative and quantitative explanations for any differences between the two amounts. Okay, so it's not just like here's the data, but also saying here's why it looks this way. Yeah, I think that's a great way to summarize it. And it does help the users understand where the real risks lie. It's not enough to just throw out the numbers. You need context. But I do actually like tables. Now, one of the optional but encouraged disclosures is about liquidity arrangements, guarantees, and other third-party commitments. How should companies think about including that?

19:28Right. So even though it's not strictly required, I think companies have to keep in mind the overall objectives to these disclosure requirements. And ensuring that they're giving users of the financial statements the right insight into the potential risks that they have associated with VIEs. So if a company has a guarantee or another commitment that exposes it to risk of the VIE, that's useful information for investors or users of the financial statements. Maybe to wrap up our VIE discussion, are there any other useful tidbits on VIE disclosures before we move on to voting interest entities? Yes.

19:59So just two more quick things. So first, for companies that concluded that they don't have to consolidate because power over the VIE significant activities are shared, they actually do need to disclose the significant factors and judgments behind that conclusion. Lastly, I do have a practical expedient for everyone. We love those. So this one is interesting. So if you have a VIE that meets the definition of a business and you hold a majority of the voting equity interests and you're the primary beneficiary and the assets aren't restricted solely to the VIE, then you might not have to provide all those VIE disclosures we just talked about.

20:33So why do we have this exception? Well, really, it's meant for instances where the VIE operates more like a real business. So it's not a structured entity like a securitization vehicle. So if you have this, right, then it probably doesn't have all of those extra crazy risks that we otherwise need to disclose for those highly structured BIEs. So we get to simplify things a little bit. Again, there are some disclosures that are still required. So I think it's a good idea for folks to refer to our consolidation guide or our financial statement presentation guide in these instances to figure out which ones apply and which ones don't.

21:03Okay, great. Thanks for that. So maybe now shifting gears, how did the disclosure requirements for voting interest entities or VOEs compared to those of VIEs. Great. I'm going to start off with a quick reminder of what a voting interest entity or VOE is, right? So this contrasts with a VIE, but a VOE is the type of entity where control is generally determined based on ownership of voting shares or common stock. So unlike VIEs, which require a slightly more nuanced assessment of control, VOEs generally follow a pretty straightforward rule of thumb, which is if a company owns more than 50 % of the voting interests, it typically consolidates that entity into its financial statements.

21:42Okay, got it. So majority rules. But Alexander, are there cases where a company might own more than 50 % but not consolidate? Yes, even under the voting model. And that's where things get a little interesting. So if your minority shareholders have substantive participating rights, which means they have real influence over significant decisions, then consolidation might not actually be allowed here. So for example, if you have minority investors that had the ability to block major decisions, then the majority owner doesn't have full control over the entity, so they're not permitted to consolidate.

22:14So in those cases, what kind of disclosure should companies be thinking about? Right. So if a company is not consolidating due to these substantive participating rights that Alexander just discussed, they should be transparent about why. And that means considering disclosing things like specific rights that minority investors hold, how often they can exercise these rights, why they're substantive, and what happens if there's a dispute between the majority owner and the minority investors. Yeah, and this doesn't just apply to corporations. It also applies to partnerships, too. So if a general partner isn't consolidating a partnership because the limited partners have substantive kickout or liquidation rights, they should consider explaining that in the disclosures, too.

22:53Okay. So investors and stakeholders get a clear picture of who really has control. So speaking of partnerships, what are some of the key disclosure considerations there? Right. So similar themes to what we were discussing earlier, when a general partner doesn't consolidate an entity, they should consider disclosing things like how limited partners can vote to either kick out the general partner or liquidate the partnership, whether there are any operational barriers to exercising those rights, and whether the general partner is excluded from those votes or gets to participate. Okay, those are some great insights.

23:25Well, that wraps up the discussion on VOEs. Does it make sense to move to a lightning round for any other disclosure presentation items that you want to highlight before we wrap up? Sure. Yeah, I've got a few that come to mind. I know we've been talking about consolidated financial statements, but a lot of questions coming around combined financial statements and what's the difference and what are the disclosure requirements. So just at a real high level, we talked about consolidated financial statements as being required when you have a controlling financial interest. That differs from the presentation of combined financial statements, which is really more of a presentation option for situations where entities are under common control or common management.

23:59There's an individual or an entity on top that may wish to present a combined set of financial statements that put those together. Like I said earlier, smush them together. In that situation, it's optional, right? And you should clearly label them as combined financial statements. And you should follow generally all of the same presentation and disclosure requirements you do for consolidated financial statements. So that one comes up a lot. I'd say aligning fiscal period is another one. So there is a general requirement that the parent and the sub should align the fiscal period, so like year ends and quarter ends, with a practical expedient that allows for lag reporting.

24:33If the difference in the subsidiary's year end and the parent's year end is three months or less, you're allowed to keep them the same and report them on a lag. The last one I'll bring up is what we call specialized industry accounting principles. So in that situation, a parent may have a controlling financial interest in a subsidiary and consolidate that subsidiary, but that sub uses some kind of specific industry accounting. So think investment company accounting at a subsidiary level. When the parent consolidates the subsidiary's financial statements, it's actually required to maintain that subsidiary-specified industry accounting principle.

25:07Again, that just assumes that they were doing it the right way. But yeah, you keep that in the consolidated financial statements. Alexander, anything from you? Yeah, maybe two quick, not so quick ones. So you may have heard on our last podcast that certain money market funds are actually exempt from the consolidation rules under ASC 810. So in these instances, you have investors, sponsors and asset managers that don't actually have to assess these funds for consolidation under ASC 810. But you are still required to disclose any financial support that you've provided these funds. So things like capital contributions, letters of credit, guarantees, things like that.

25:43There's also some special disclosure requirements for consolidated collateralized financing entities or CFEs. These mainly relate to the valuation approach that's used. And lastly, if you listen to our last pod, you'd remember that we said there's also an optional VIE scope exception for private companies that are common control if you meet certain requirements. So if you use this exemption, then there's incremental disclosures that are required so users can better understand the legal entity's risks and its exposure to loss here. Well, great. Well, it was so great to have you both on today. Thanks so much, Matt and Alexander.

26:15And to our listeners, thanks for tuning in. And we'll see you next time for more Accounting Insights. Thank you. Thank you. That's our show for today. Tune in next week for more fresh episodes. So that you never miss any of our audio content, follow the PwC Accounting Podcast wherever you listen to your podcasts. And to stay up to date on all our latest accounting and reporting news, sign up for our newsletter at viewpoint.pwc.com. From Thought Leadership at PwC, I'm Heather Horn. Thanks for tuning in.

27:10Please see www.pwc.com slash structure for further details. This podcast is for general information purposes only and should not be used as a substitute for consultation with professional advisors, including accountants and lawyers.