Consolidation Rules Issued to Curb Enron-Style Abuses to Get Simpler


Companies paying more to comply with complex accounting rules that were put in place following the Enron scandal may see some relief on the horizon.

The Financial Accounting Standards Board May 16 voted to finalize changes related to a complicated financial vehicle known as variable interest entities. The changes will be effective for periods beginning after Dec. 15, 2019, but can be applied earlier.

The narrow accounting changes will unwind some unintended consequences of consolidation accounting rules that may have resulted in companies having to report more of these variable interest entities on their consolidated financial reports.

VIEs are a financing technique that reduces risk by creating separate partnerships with varying levels of investment by the participants.

The instruments became widely known as a result of the 2001 Enron scandal - the investigation centered around the company’s questionable reporting techniques utilizing VIEs.

“Enron followed all the consolidation GAAP guidance at the time of its scandal,” Margaret Gallagher at Withum in Whippany, N.J., said.  “What it did wrong however, was to hide financial activity in affiliated companies, that under generally accepted accounting principles at that time were not required to be consolidated,” she said. 

Keeping It Simple

VIEs usually hold financial assets such as real estate, loans, or receivables. Under certain circumstances, companies would be required to include them as part of their consolidated financial report as if they were a subsidiary.

VIE consolidation accounting rules haven’t been easy to navigate and therefore any simplification, big or small, is good news, accountants have said.

Under the new rules, companies will be able to evaluate—on a proportional basis—indirect interests they hold in VIEs when the parties are related through common ownership arrangements.

The evaluation relates to fees paid to decision-makers like asset managers of private equity funds that are under common ownership.

“Under the previous guidance the asset manager could be deemed to have a variable interest and potentially would have to consolidate,” Alex Fredericks, partner at Ernst & Young LLP in New York, told Bloomberg Tax.

“But now under this new guidance where the indirect interests only comes into play on a proportional basis, that’s going to lead to less issues with service providers having a variable interest and therefore potentially not having to consolidate an entity that it provides service to,” he said.

Private Companies Get an Option

FASB also voted to allow private companies to have an option to avoid applying VIE accounting rules when they have a variable interest in a sibling entity that's under common ownership.  

The change is a win-win for private companies, many of which have limited internal resources, accountants said.

"Company accountants, as well as many of the external accountants that assist them are spending too much time, which ultimately could be spent in other areas. Today's rules expend much needed resources—whether it’s time or money," Jeremy Dillard, partner in the assurance and advisory practice at SingerLewak, in Los Angeles, told Bloomberg Tax.

"And if you think about a scenario where a private company has to have an audit, the consolidation analysis can be complex," Dillard said.