Financial Reporting Financial Reporting
  March 2003   

 Issues Covered


Consolidation Based on Variable Interests

If an entity meets the definition of a VIE, the FASB concluded that the normal condition for consolidation – ownership of a majority voting equity interest – is not meaningful, either because the equity interest is very small or because the equity owners’ vote is not meaningful. Instead, each holder of an interest in the VIE, including both equity and other interests that will either absorb losses or participate in profits, evaluates its economic position to determine whether its holdings will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both. A holder that will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both, is deemed to be the VIE’s primary beneficiary and consolidates the VIE. If one holder absorbs a majority of the expected losses and another holder receives a majority of the expected residual returns, the holder absorbing a majority of losses is the primary beneficiary and should consolidate the VIE. The ability to make significant decisions regarding the activities of the VIE is a strong indication that the decision maker has one or both of the characteristics of a primary beneficiary.

For purposes of analyzing its economic position, a holder should combine its holdings with the holdings of its related parties as defined in FASB Statement No. 57, Related Party Disclosures, and its de facto agents. Under FIN 46, de facto agents of an enterprise include:

  • Its officers, employees, and directors;
  • A party that cannot finance its operations without subordinated financial support (e.g., another VIE of which the enterprise is the primary beneficiary);
  • A party that received its interests in the VIE as a contribution or loan from the enterprise;
  • A party that has an agreement that it cannot sell, transfer, or encumber its interests in the VIE without the prior approval of the enterprise; or
  • A party that has a close business relationship with the investor (e.g., the investor’s attorney or investment banker).

If the group taken together qualifies as the primary beneficiary, then one entity within the group is deemed the primary beneficiary and must consolidate the VIE. FIN 46 provides the following guidance: If two or more parties with variable interests have a principal/agency relationship, the principal (and not the agent) is the primary beneficiary. If there is no principal/agency relationship, the primary beneficiary is the party most closely associated with the VIE’s activities. For example, if the VIE leases assets, the lessee would be most closely associated with the VIE’s activities.

A holder of a variable interest should determine whether it is the primary beneficiary of a VIE at the time the holder becomes involved with the entity (i.e., when ownership, contractual or other financial relationships begin). The primary beneficiary should reconsider its initial decision to consolidate if the VIE’s governing documents or the contractual arrangements change or the primary beneficiary sells all or part of its interest to unrelated parties. A holder of a variable interest that is not the primary beneficiary also should reconsider the need to consolidate if it acquires newly issued interests in the VIE or a portion of the primary beneficiary’s interest in the VIE.

A VIE can have only one primary beneficiary, but some VIEs have no primary beneficiary. If no holder absorbs a majority of the expected losses or the expected residual returns, the VIE is not consolidated. Note that potential primary beneficiaries need to know the nature and terms of the involvement by other parties. This means that an enterprise significantly involved with a VIE should monitor its position relative to other involved enterprises and consider whether new transactions make it the primary beneficiary.

Continue Reading - Variable Interests in Specified Assets of a VIE


Copyright © 2003, BDO USA,LLP. Material discussed in this Financial Reporting newsletter is meant to provide general information and should not be acted upon without first obtaining professional advice appropriately tailored to your individual facts and circumstances.