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Variable Interest Entities. FIN 46 (Revised Dec. 2003). Complexity of issues is confirmed by the issuance of several FSPs including FASB Staff Position No. FIN 46(R)-6, “Determining the Variability to Be Considered In Applying FASB

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variable interest entities

Variable Interest Entities

FIN 46 (Revised Dec. 2003)

Complexity of issues is confirmed by the issuance of several FSPs including FASB Staff Position No. FIN 46(R)-6, “Determining the Variability to Be Considered In Applying FASB

Interpretation No. 46(R),” April 2006 (most recent thru 3/20/07)

variable interest entities vies defined
Variable Interest Entities (VIEs): Defined
  • VIE: A less than majority-owned entity that is subject to consolidation under the provisions of FASB Interpretation 46R.
    • If certain conditions exist, the entity must be consolidated.
  • An entity that has a variable interest in a VIE—an interest that changes with changes in the VIE’s net assets—must determine if it must consolidate the VIE.
variable interest entities vies variable interest relationships
Variable Interest Entities (VIEs):“Variable Interest Relationships”
  • Variable Interest Relationships:
    • Situations in which an entity:Receives benefits and/or is exposed to risks similar to those received from having a majority ownership interest.
    • Result from contractual arrangements.
    • Appendix B has illustrations of various types of variable interests
variable interest entities vies contractual arrangements
Variable Interest Entities (VIEs): “Contractual Arrangements”
  • Contractual Arrangement Types:
    • Options (e.g., written put options)
    • Leases (with guarantee of value, etc)
    • Guarantees of asset recovery values
    • Guarantees of debt repayment
  • Contractual arrangements may exist simultaneously with a less than majority ownership in a VIE.
  • May exclude a “business” (Appendix C for definition somewhat different from that in EITF 98-3)
variable interest entities vies most are spes
Variable Interest Entities (VIEs):Most are “SPEs”
  • Special Purpose Entities:
    • Legally structured entities to serve a specific, predetermined, limited purpose.
    • May be a corporation, partnership, trust, or some other legal entity.
    • Creator is called the “sponsor.”
    • Usually thinly capitalized.
    • Most commonly used for securitizations (of receivables).
variable interest entities vies spes
Variable Interest Entities (VIEs):“SPEs”
  • Special Purpose Entities:
    • Not subject to consolidation provisions of FIN 46 if sales recognition criteria of FAS 140 is met for transfer of assets to SPE.
      • If met, SPE is called a “Qualifying SPE.” (If not met, the proceeds from the transfer are treated as a loan.)
    • FAS 140 prohibits transferors from consolidating QSPEs (because risk exposure is considered insignificant).
qspe a trust of another legal vehicle that
QSPE = a trust of another legal vehicle that
  • Is demonstrably distinct from transferor
  • Has restrictions on its permitted activities
  • Has restrictions on assets and derivatives it may hold
  • Has restrictions on the way it can sell or dispose of non-cash financial assets
  • Has restrictions on agreements entered into between it and the transferor
  • Has restrictions on the ability to reissue beneficial interests
variable interest entities vies potential variable interests
Variable Interest Entities (VIEs):Potential Variable Interests
  • Potential Variable Interests:
    • Subordinated loans to a VIE.
    • Equity interests in a VIE (50% or less).
    • Guarantees to a VIE’s lenders or equity holders (that reduce the true risk of these parties).
    • Written put options on a VIE’s assets held by a VIE or its lenders or equity holders.
    • Forward contracts on purchases and sales.
variable interest entities vies the primary beneficiary
Variable Interest Entities (VIEs):The Primary Beneficiary
  • PRIMARY BENEFICIARY of a VIE must consolidate the VIE.
    • PRIMARY BENEFICIARY is the entity that:
      • Will absorb a majority (more than 50%) of the VIE’s expected losses and/or
      • Will receive a majority (more than 50%) of the VIE’s expected residual returns.
      • Expected losses are given more weight than expected residual returns in certain situations.
filling the buckets

From Deloitte & Touche Presentation

Filling the Buckets

Above Average

Outcomes

Below Average

Outcomes

+ Fees

Probability Weighted Scenarios

ExpectedResidual Returns

ExpectedLosses

how to tell if i am not a vie

From Deloitte & Touche Presentation

How to Tell if I am NOT a VIE
  • Total equity investment greater than Expected Losses
  • Some equity holder has voting or other rights like a shareholder or General Partner, and as a group, equity holders can directly or indirectly make decisions on entity’s activities
  • Equity holders as a group will absorb expected losses and benefit from expected residual returns without guarantee or cap
  • “Subordinated Financial Support” is something that will absorb some of the expected losses, if they occur
what kind of equity
What Kind of Equity?
  • Needs to be shown as equity on the books of the entity
    • (Watch out for FAS 150)
  • Can include non-voting, but needs to have significant profit/loss participation
    • Watch out for significant non-voting equity held by someone associated with substantially all of the entity’s activities

From Deloitte & Touche Presentation

primary beneficiary cascade
Primary Beneficiary Cascade
  • If anyone holds Variable Interests that expose them to a majority of the expected losses, they are the Primary Beneficiary, otherwise
  • If anyone holds Variable Interests that would enjoy a majority of the expected residual returns, they are the Primary Beneficiary, otherwise
  • There is no Primary Beneficiary
  • “Variable Interests” are financial interests that change in value with changes in the entity’s net asset value

From Deloitte & Touche Presentation

variable interest entities vies the primary beneficiary14
Variable Interest Entities (VIEs):The Primary Beneficiary
  • Only one PRIMARY BENEFICIARY can exist for a VIE (by definition).
  • Potential for Erroneously Determined Multiple Primary Beneficiaries Does Exist:
    • When one or more variable interest holders (VIH) has incomplete information about the VIE’s other VIH.
    • Different VIH make different judgments about their variable interests.
variable interest entities vies determining if an entity is a vie
Variable Interest Entities (VIEs):Determining if an Entity is a VIE
  • IN GENERAL, an entity is subject to consolidation if, by design, any of three conditions exists. These conditions focus on: 1. Sufficiency of equity investment at risk. 2. Characteristics of the holders of equity investment at risk. 3. Whether certain disproportionalities exist among the equity investors.
variable interest entities vies determining if an entity is a vie16
Variable Interest Entities (VIEs):Determining if an Entity is a VIE
  • Condition #1: Equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support (SFS).
      • SFS is defined as variable interests that will absorb some or all of an entity’s expected losses (example: a debt guarantee or an equity guarantee).
      • In general, the equity at risk is deemed sufficient if it is at least 10% of total assets. (May need more than 10%.)
determining if an entity is a vie cont
Determining if an Entity is a VIE (cont.)
  • Condition #2: The holders of the equity investment at risk (as a group) lack any of the following characteristics:
      • The ability to make decisions about an entity’s activities.
      • The obligation to absorb the entity’s expected losses.
      • The right to receive the entities expected residual returns.
determining if an entity is a vie cont18
Determining if an Entity is a VIE (cont.)
  • Condition #3: Certain disproportionalities exist among the equity investors.
      • Example: Certain equity holders possess voting rights that are not proportional to their obligation to share the VIE’s losses.
reconsideration triggers
Reconsideration Triggers

Para. 7 & 15

From Deloitte & Touche Presentation

variable interest entities vies consolidation procedures
Variable Interest Entities (VIEs):Consolidation Procedures
  • Major Points in Consolidating:
    • #1 Eliminate primary beneficiary’s interest in the VIE.
    • #2 Report VIE’s assets & liabilities at fair values—not their book values.
    • #3 Report goodwill if it exists.
    • #4 Extinguish “negative goodwill” (BPE) if it exists.
    • #5 Report noncontrolling interest at FV.
    • #6 Eliminate intercompany transactions.
disclosures required when involved with vies
Disclosures Required When Involved with VIEs
  • Disclosures for Primary Beneficiaries:
    • #1 VIE’s nature, purpose, size, activities.
    • #2 Carrying value and classification of consolidated assets that are collateral for the VIE’s obligations.
    • #3 Lack of recourse if creditors (or beneficial interest holders) of a consolidated VIE have no recourse to the general credit of the primary beneficiary.
variable interest entities vies disclosures required when involved
Variable Interest Entities (VIEs):Disclosures Required When Involved
  • Disclosures for anyone that holds a significant variable interest in a VIE
    • #1 Nature of involvement with VIE and when involvement began.
    • #2 VIE’s nature, purpose, size, activities.
    • #3 The entity’s maximum exposure to loss as a result of its involvement with the VIE.