Question

What is the importance of the business-related scope exception in the FASB ASC 810 consolidation model?

If the exception applies, consolidation does not need to be completed
	If the exception applies, a separate set of consolidation rules outside of FASB ASC 810 needs to be evaluated to determine whether or not to consolidate
	If the exception applies, the determination of whether the legal entity is a Variable Interest Entity may be bypassed
	if the exception applies, consolidation must always be completed

Answer 1

The importance of the business-related scope exception relates to certain parameters. They are

a) Identify and segregate any particular assets of the entity

The expected losses associated with the so-called specified assets of the legal entity should be excluded from the expected losses of the overall legal entity. However, if the expected losses of the specified assets are in any way limited (for example by a limited guarantee), then any excess expected losses should be associated with the legal entity as a whole and therefore added back to the overall legal entity’s expected losses.

b) Identify and segregate any discrete form of transparency of the business entity

The equity investment at risk and expected losses of a silo that is separately consolidatable as an element should be excluded from the equity at risk and expected losses of the legal entity as a whole. In this situation, none of the expected losses or benefits of the silo inure to any other variable interest holders of the legal entity, and none of the specified liabilities are payable from the residual assets attributable to the other variable interests of the entity.

c) Determining whether the equity investment at risk is sufficient can be a qualitative analysis, a quantitative analysis, or both. There is a rebuttable presumption in the guidance that equity investment at risk of less than 10% of total assets, both measured at fair value, constitutes insufficient equity investment at risk to finance expected losses. Sufficiency of equity investment at risk should be, if possible, demonstrated qualitatively. This can be very difficult to do for a legal entity with a complex capital structure. A simple capital structure may appear easier to handle from a qualitative perspective, but this may not always be true. The most convincing qualitative evidence is to compare the legal entity’s equity at risk to that of another entity with similar assets and comparable investment equity at risk. If that entity operates with no additional subordinated support, that is strong evidence that the legal entity can do so also. If the answer to this question is “NO”, the entity is a VIE

d) Was the investment equity at risk of the entity established without substantive voting rights?

The holders of equity investment at risk are deemed to not have the power to direct the entity’s activities if their voting rights are determined to be non-substantive. Under the ASC 810 guidance, equity investors at risk do not have substantive voting rights if: 1) The voting rights of some investors are not proportional to their economic interests (based on obligations to absorb expected losses and rights to receive expected residual returns), and 2) substantially all if the legal entity’s activities are conducted for or involve the investors with disproportionately few voting rights. If the answer to this question is “YES”, the entity is a VIE.