Download Advanced Accounting by Hoyle et al, 6th Edition

Chapter Six
Variable Interest
Entities, IntraEntity Debt,
Consolidated
Cash Flows, and
Other Issues
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Variable Interest Entities (VIE’s)
 Known as Special Purpose Entities (SPE)
 Established as a separate business structure
–
–
–
–
Trust
Joint Venture
Partnership
Corporation
 Frequently has neither independent management nor employees
 Typical purposes
– help finance their operations at favorable rates
– Transfers of financial assets
– Leasing
– Hedging financial instruments
– Research and development
 Off-balance sheet financing
6-2
Variable Interest Entities (VIE’s)
Examples of Variable Interests
6-3
Variable Interest Entities
Characteristics of VIEs:
Most established for legitimate business purposes
Some created to avoid consolidated disclosure
Generally have assets, liabilities, and investors with equity
interests
Role of equity investors can be minor if VIE’s activities are
strictly limited
Equity investors may serve simply to allow the VIE to
function as a legal entity
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Variable Interest Entities
Characteristics continued. . .
VIEs bear relatively low economic risk, therefore equity
investors are provided a small rate of return.
Another party (often the sponsoring firm that benefits from
the VIE’s activities) contributes substantial resources –
loans and/or guarantees – to enable a VIE to secure
financing needed to accomplish its purpose.
The sponsoring firm may guarantee the VIE’s debt,
assuming the risk of default.
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Variable Interest Entities
Characteristics continued. . .
Contractual arrangements limit returns to equity holders
yet participation rights provide increased profit potential
and risks to sponsor.
Risks and rewards are not distributed according to stock
ownership but by other variable interests.
Sponsor’s economic interest vary depending on the VIE’s
success – Hence the term variable interest entity.
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Variable Interest Entities
FASB standard FIN 46R3 requires the primary
beneficiary (regardless of their ownership) to consolidate
the VIE.
Who is the “primary beneficiary”?
The firm that has the:
–Power to direct the activities of the VIE that significantly
impact the entity’s economic performance.
–Obligation to absorb significant losses of the entity.
–Right to receive significant benefits of the entity.
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Benefit of VIE’s
A business sponsors a VIE to purchase and finance asset
acquisition.
– The VIE leases the asset to the sponsor.
– VIE is often eligible for lower interest rate.
The VIE has limited assets. This “asset isolation” and
limited activity separates the VIE’s creditor(s) from the
overall risk of the sponsor.
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Disclosure Requirements –
In Footnotes of ALL VIE Interests
Nature, purpose, size, & activities of the VIE
Significant judgments made
in determining the need to
consolidate a VIE or disclose
any involvement
Nature of restrictions on
assets and settlement of
liabilities, and the related
carrying value
Nature of risks, and how a VIE affects the financial position,
performance and cash flows of a Primary Beneficiary
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