Revisiting the Guidance Related to VIEs

In January 2003, the FASB issued FASB Interpretation (FIN) 46, Consolidation of Variable Interest Entities. Less than a year later, the FASB significantly revised the guidance and issued FASB Interpretation 46 (Revised 2003), Consolidation of Variable Interest Entities (FIN 46R). The original and revised guidance was an interpretation of Accounting Research Bulletin (ARB) 51, Consolidated Financial Statements. Under US GAAP, consolidation is required whenever one entity has a controlling financial interest in another entity. The traditional ARB 51 approach assumed that equity—usually common stock—would receive the residual economic interest generated by a business, which is why ARB 51 focused on equity-based majority voting interests. The traditional criterion for a controlling financial interest under ARB 51 was a majority voting interest. However, in the 1980s and 1990s it became common for many companies to control certain businesses without maintaining a majority voting interest in those businesses. Before the issuance of FIN 46, this enabled companies to avoid consolidation, which permitted them to keep the liabilities and losses of their controlled special purpose entities off of their financial statements. In such cases, consolidation based on equity did not serve the purpose of effective reporting because it did not reflect the true nature of relationships among entities. FIN 46R closed this loophole by defining tests to identify a controlling financial interest beyond just equity ownership and voting rights. The guidance emphasized the substance of relationships among entities, rather than emphasizing the form of relationships among entities (such as a majority voting interest), which could be more easily manipulated. Under FIN 46R, the first step was to determine if a company had a variable interest in another entity. In general terms, a variable interest is an interest in an entity that increases and decreases in value (i.e., is variable) according to increases and decreases in the expected cash flows from the entity’s assets and liabilities. Once a variable interest was established, the second step was to determine who is the primary beneficiary of the variable interest entity (or “VIE”). Once a primary beneficiary was identified, it was deemed to have a controlling financial interest in the VIE and had to consolidate the VIE, whether or not it held a majority voting interest. Recent Changes In June 2009, the FASB issued Statement of Financial Accounting Standards (SFAS) 167, Amendments to FASB Interpretation No. 46(R). SFAS 167 was issued to address the effects of eliminating the qualifying special-purpose entity (QSPE) concept from SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and to respond to concerns about the application of certain key provisions of FIN 46R, including concerns over the transparency of reporting entities’ involvement with variable interest entities. The amendments resulting from the issuance of SFAS 167 were effective for annual reporting periods that began after November 15, 2009, and for interim periods within that first annual reporting period. Importantly, for entities with a calendar year-end, the amendments were effective January 1, 2010. Earlier application was prohibited. Check out our whitepaper in this topic at www.gaapquest.com. Or, just shoot us an e-mail (russ@madray.com) for a free copy!