If you work in the investment management industry, you know the amendments to ASC Topic 810 Consolidation impact the accounting for these entities. But did you know that the changes to ASC 810 detailed in Accounting Standards Update (ASU) 2015-02 affect other industries too? Of the many changes, we are only going to focus on one in this post – changes to the long-standing consolidation guidance for limited partnerships.

Background

Under ASC Topic 810, Consolidation, an entity is required to consolidate another entity when it has control over that entity. However, ASC 810 prescribes two very different consolidation models:

Voting Interest Entities (VOEs)

The more traditional VOE consolidation model looks at control from the perspective of voting interests, with the theory that control is achieved by having a majority of the voting rights. In other words, if you hold over 50% of the voting shares of an entity, you should consolidate that entity within your financial statements.

Variable Interest Entities (VIEs)

The VIE model applies when voting interests are not indicative of control. Under this model control is defined based on having power over the decision-making activities and economic exposure, through variable interests. Variable interests in a VIE are contractual, ownership, or other pecuniary interests in a VIE that change with changes in the fair value of the VIE's net assets exclusive of variable interests.

Consolidation of Limited Partnerships – Existing Guidance

When considering whether or not to consolidate limited partnerships, an entity must first consider whether or not the partnership is a VIE using the guidance within ASC Topic 810. If it is, then the VIE consolidation model applies. If it is not, then the VOE consolidation model applies with the presumption that the general partner controls the partnership and therefore must consolidate. This presumption is based on the decision-making powers of the general partner and the passive nature of the limited partners. How the partnership profits are split is irrelevant! The only way this presumption can be overcome is if the limited partners have either substantive kick-out or substantive participation rights.

Most limited partnerships are not VIEs under current guidance. Plus, it is fairly uncommon for limited partners to have substantive rights precluding consolidation by the general partner. As a result, under current guidance, the general partner consolidates most limited partnerships. Even if a limited partnership were a VIE, the general partner most likely would be considered the primary beneficiary and be required to consolidate the limited partnership. This is because the general partner most likely would have the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and, although small, probably also has a variable interest.

Many general partners are not happy about consolidating limited partnerships. Why? Many believe they are merely acting on behalf of the limited partners. Furthermore, they argue that generally they have a limited economic interest in the partnership. These two points they feel preclude them from consolidation.

Consolidation of Limited Partnerships – New Guidance

So, what has changed? Under the revised consolidation guidance, limited partnerships are now considered VIEs, regardless of whether they would otherwise qualify as a VOE, unless the limited partners (a simple majority, or even an individual partner) have either substantive kick-out or substantive participating rights. Consolidating VIEs is tricky business. This sounds awful! However, this is actually good news for general partners. If the limited partnership is analyzed under the VIE guidance; it will be less likely that the general partner will have to consolidate it.

Why? Because the VIE consolidation model considers both economic interest (risk/reward exposure) and power over decision-making activities. Since ASU 2015-02 significantly limits the effect that fees paid to a decision maker have on the VIE consolidation analysis, and considering general partners usually have limited non-fee related economic interest, it will be less likely that they will have to consolidate under the VIE model.

Furthermore, ASU 2015-02 removed the general presumption that the general partner controls a limited partnership that is not considered a VIE. Since general partners usually do not have majority control, they would not consolidate under the VOE model either.

Although all of this is generally good news for general partners, there is a bit of bad news too. Extensive disclosures are required if an entity holds variable interests in VIEs, irrespective of whether the entity has to consolidate the VIE. Since general partners generally hold variable interests in limited partners, these additional disclosure requirements would apply if the limited partnerships are considered VIEs.

Effective Date

The changes to ASC 810 as a result of ASU 2015-02 are effective for public entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2015, so beginning January 1, 2016 for calendar-year entities. For all other entities, the guidance is effective for annual periods beginning after December 15, 2016, and interim periods beginning after December 15, 2017.

Summary

In summary, general partners most likely will no longer need to consolidate limited partnerships. This makes sense because the general partner usually is simply acting as a service provider for the other partners and does not truly have control. However, since most limited partnerships are considered VIEs under the new guidance, general partners will have to make more extensive disclosures in their financial statements.

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