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
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 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”
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”
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”
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
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
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
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.
From Deloitte & Touche Presentation
Filling the Buckets
+ Fees
Probability
Weighted
Scenarios
Expected
Losses
Expected
Residual Returns
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?
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
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 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
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 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.)
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
(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.
Para. 7 & 15
Reconsideration Triggers
Reconsider
Event
Change in governing documents
or contracts
Increase in activities or assets
Decrease in activities or assets
VIE issues new equity
VIE issues new other variable
interests
VIE redeems equity
VIE status
Yes
Am I still the
Did I become the
Primary Beneficiary? Primary Beneficiary?
Yes
Yes
If VIE status changes
No
No
No
No
Only if I buy some
No
No
Only if I buy some
Only if others become
exposed to expected
loss
No, unless I have no
more association with
the entity
No, unless I have no
more association with
the entity
Only if expected losses
increase
No
No
VIE redeems other variable
interests
I dispose of my equity/other
variable interest to other holders
I acquire equity/other variable
interest from other holders
From Deloitte & Touche Presentation
No
No
No
No
Yes
No
No
No
Only if it is from the
primary beneficiary
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 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
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.