Accounting Standards are established for the consolidation of majority-owned subsidiaries, or for a majority voting interest in an investment. However, new types of relationships have been established that are difficult to characterize in terms of voting, controlling, or ownership interests. Such entities often are structured to provide financing and/or control through forms other than those used by traditional operating companies. These special types of entities have generally been referred to as Special-Purpose Entities (SPEs) or Variable Interest Entities (VIEs). In general, VIEs are corporations, trusts, or partnerships created for a specified purpose. They usually do not have substantive operations and are used only for financing purposes. SPEs have been used for decades for asset securitization and risk sharing. They can also be used to take advantage of tax statutes.
Prior to 2003, no comprehensive reporting framework had been established for SPEs/VIEs. Since the collapse of Enron (who irresponsibly used VIEs), the FASB has issued guidance several times. A corporation having an interest in a SPE/VIE cannot simply rely on its percentage stock ownership, if any, to determine whether to consolidate the entity; instead, each party having a variable interest in the VIE must determine the extent to which it shares in the VIE’s expected profits and losses AND has influence over the VIEs operations. The nature of each party’s variable interest determines whether consolidation by that party is appropriate. An enterprise that will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or that can control operations, is called the primary beneficiary of the variable interest entity. The primary beneficiary must consolidate the VIE. If the entity’s profits and losses are divided differently, the enterprise absorbing a majority of the losses will consolidate the VIE, unless another investor can influence operations. In that case, the company that influences the operations is the primary, even if they do not absorb any losses.
If consolidation of a VIE is appropriate, the amounts to be consolidated with those of the primary beneficiary are based on fair values at the date the enterprise first becomes the primary beneficiary. However, assets and liabilities transferred to a VIE by its primary beneficiary are valued at their book values, with no gain or loss recognized on the transfer.
Discussion Topic
Before you begin your discussion post:
Research the FASB website (Links to an external site.) for the actual ASC code that addresses VIEs, and specifically those rules that address who the Primary is. ASC 810-10-25-38A through 38J.
Consider the following Off-Balance Sheet Financing scenario (click the button to expand).
Off-Balance Sheet Financing Scenario
In your original post, answer the following:
Which company is the primary beneficiary: PEC or Sunshine Financial? Who has the Controlling Financial Interest? Explain why.
Which company should consolidate the VIE? Please explain why you believe this.
Do you believe that this violates the intent behind the current guidelines as they relate to the consolidation of VIEs? Be sure to fully explain your position.
Do you believe that off-balance-sheet financing should be permitted? Why or why not? If not, how could the standariquds be amended to prevent it?
