As companies diversify and restructure to achieve tax and operational goals, the complexities of consolidation remain at the forefront of financial reporting. Determining if your company meets the requirements for consolidation on a regular basis can lead to a smoother financial reporting process.
Complex business and ownership structures require the need for continual evaluation of the consolidation requirements for financial reporting. Under the accounting principles generally accepted in the United States (“U.S. GAAP”), there are two main relationships between entities that require consolidation: a controlling financial interest and the existence of a variable interest entity.
A controlling financial interest exists when an acquiring company, shareholder, or group of shareholders directly or indirectly obtains greater than 50% of the voting stock of another company. Under this scenario, the acquiring company would effectively be in control of the operating activities of the acquired company, which would require the entities to be reported as a single economic unit.
The second scenario requiring consolidation is when an acquiring company is the primary beneficiary of an acquiree that is considered to be a variable interest entity. An entity is considered a variable interest entity if any of the below conditions are met:
- The entity needs additional financial support other than the amount of invested equity.
- The equity investors lack the power to exert controlling interest.
- The equity investors cannot absorb losses or receive residual returns from the entity.
It should be noted that the acquirer does not necessarily have to be an equity investor to hold a controlling interest or be the primary beneficiary of a variable interest entity. Other types of capital providers such as debt providers and guarantors can also meet this requirement.
Lastly, it is typical for business structures with common ownership to be engaged in lease arrangements. Accounting Standard Update 2014-07 allows for consolidation to be avoided if three conditions are met in a private company lease arrangement with common control:
- The lessor and lessee are under common control.
- A lease arrangement exists between the lessor and lessee.
- Substantially all activities between the two entities relate to the lease arrangement.
Evaluating the need for consolidation can be comprehensive and difficult. For assistance in determining if your entity meets the consolidation requirements, please feel free to contact your L&B professional at (858) 558-9200.