Expected Losses and Expected Residual Returns

FIN 46 creates two important quantitative measures, expected losses and expected residual returns, to determine whether an entity is a VIE and whether an enterprise is the primary beneficiary. Expected losses and residual returns of a VIE refer to amounts derived from probability-weighted expected cash flows as described in FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements. Under FIN 46, the cash flows are divided into two groups, negative cash flows and positive cash flows. The present value of the probability-weighted negative cash flows are the entity’s expected losses and the present value of the probability-weighted positive cash flows are the entity’s expected residual returns.

Expected losses and residual returns include:

• The expected variability in the entity’s net income;
• The expected variability in the fair value of the entity’s assets if it is not included in net income or loss;
• Gross fees to the decision maker; and
• Gross fees to guarantors of the values of all or substantially all of the entity’s assets (including writers of put options and other instruments with similar results) and providers of guarantees that all or substantially all of the entity’s liabilities will be paid.

Example 2 illustrates the computation of expected losses and residual returns. The analysis is complex and requires estimates and judgment.

Click to View Example 2

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