E - Y VIE Manual June 2011

Financial reporting developments
A comprehensive guide
Consolidation of variable interest entities

Revised June 2011
To our clients and other friends

In June 2009, the Financial Accounting Standards Board (FASB) issued Statement 167,1 thereby amending the consolidation guidance for variable interest entities (VIEs). While initially the amendments were focused on eliminating the scope exception for qualifying special purpose entities (QSPEs) and responding to concerns over the transparency of enterprises involvement with VIEs, the final amendments were pervasive and have had a significant effect on the application of the Variable Interest Model for many enterprises. It is important to note that the amendments to the Variable Interest Model are applicable to all enterprises and to all entities with which those enterprises are involved, regardless of when that involvement arose (except for those entities subject to the deferral described below). Therefore, upon adoption of Statement 167, all enterprises were required to reconsider their consolidation conclusions for all entities with which they are involved. These amendments to the Variable Interest Model were effective as of the beginning of an enterprises first annual reporting period that began after 15 November 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. That is, Statement 167 was effective for calendar year-end enterprises beginning on 1 January 2010. Statement 167s final amendments to the Variable Interest Model were extensive and among other things: Required a qualitative rather than a quantitative analysis to determine the primary beneficiary of a VIE Amended the Variable Interest Models consideration of related party relationships in the determination of the primary beneficiary of a VIE by providing, among other things, an exception with respect to de facto agency relationships in certain circumstances Amended certain guidance in the Variable Interest Model for determining whether an entity is a VIE, which may have changed an enterprises assessment of whether an entity with which it is involved is a VIE Amended the criteria for determining whether fees paid to a decision maker and other service contracts are variable interests Required continuous assessments of whether an enterprise is the primary beneficiary of a VIE Required enhanced disclosures about an enterprises involvement with a VIE
It is important to note that Statement 167 established a more principles-based approach to the determination of the primary beneficiary. In doing so, there are several elements of the standard for which there is not detailed implementation guidance, and the application of professional judgment will be required. Given the lack of detailed implementation guidance, we anticipate that practice will continue to evolve subsequent to the effective date.
FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R) (primarily incorporated into FASB ASC Topic 810-10, ConsolidationOverall, by ASU 2009-17)
Financial reporting developments Consolidation of variable interest entities
To our clients and other friends
One of the industries that might have been most significantly affected by Statement 167 is the asset management industry. As currently written, Statement 167 would have resulted in asset managers consolidating many hedge funds, private equity funds and other investment funds that they manage. However, in February 2010, the FASB issued an Accounting Standards Update (ASU) primarily to address concerns with the application of Statement 167 by reporting enterprises in the asset management industry by deferring the effective date of Statement 167 for certain investment funds. The FASB currently has a project on its agenda that would eliminate the deferral discussed above. In addition, the FASBs tentative decisions would modify the Variable Interest Models provisions for evaluating an enterprise as a principal or an agent and the provisions for evaluating the substance of kick-out rights and participating rights, among other things. Readers should monitor developments in this area closely. In May 2011, the IASB issued new consolidation accounting guidance that establishes a single consolidation model for all entities. The FASB and IASB jointly deliberated much of the IASBs new consolidation guidance. However, after hearing from constituents, the FASB decided in early-2011 not to issue consolidation guidance similar to the IASBs guidance. The FASB disagreed with aspects of the IASBs new consolidation model, but said it plans to amend US GAAP to better align it with the IASBs new guidance related to the principal-agent determination. The new IASB guidance is more similar to the guidance for the consolidation of VIEs than the current guidance, but it creates new differences between US GAAP and IFRS in some areas. Some longstanding differences also remain. We have updated this version of our publication to provide insights from the SEC, updates on recent standard-setting activities and further clarifications and enhancements to our interpretative guidance. Refer to Appendix A for further detail on the updates provided. We will continue to provide updates in the future as consolidation accounting evolves. We hope this publication will help you understand and apply the complex accounting provisions of the Variable Interest Model. We are available to assist you in understanding and complying with these provisions and are prepared to answer your particular concerns and questions.
June 2011
Contents
1 Introduction ................................................................................................................ 13 1.1 Interpretative guidance ........................................................................................................ 15 1.2 IFRS convergence ................................................................................................................ 18 2 Definitions of terms ..................................................................................................... 19 2.1 Interpretative guidance ........................................................................................................ 20
Questions and interpretative responses 2.1 Expected losses and expected residual returns are not GAAP or economic income or loss ....................................................... 20 2.2 Subordinated financial support............................................................ 21
3 Consideration of substantive terms, transactions and arrangements ........................... 22 3.1 Interpretative guidance ........................................................................................................ 22
Questions and interpretative responses 3.1 Evaluation of changes in terms, transactions and arrangements prior to the adoption of Statement 167 .......................... 23 3.2 Consideration of the substance of existing terms, transactions and arrangements upon the adoption of Statement 167 ........................ 24
4 Scope .......................................................................................................................... 25 4.1 Interpretative guidance Legal entities ................................................................................ 26

Questions and interpretative responses 4.1 Common arrangements/entities subject to the Variable Interest Models provisions.............................................................................. 27 4.2 Portions of entities............................................................................. 28 4.3 Collaborative arrangements not conducted through a separate entity .................................................................................. 29 4.4 Majority-owned entities ...................................................................... 30 4.5 Application of Variable Interest Model to tiered structures..................... 30 4.6 Fiduciary accounts, assets held in trust ................................................ 31 Scope exceptions ................................................................................................................. 32 Interpretative guidance Scope exceptions general............................................................ 33 Questions and interpretative responses 4.7 Analogies to the scope exceptions ....................................................... 34 4.8 Eligibility for scope exceptions in applying the Variable Interest Model upon adoption of Statement 167s amendments to ASC 810-10 ...................................................................................... 34 Interpretative guidance Employee benefit plans .................................................................. 34 Questions and interpretative responses 4.9 Applicability of the Variable Interest Model to employee benefit plans .... 35 4.10 Employee benefit plans not subject to ASC 712 or 715 ......................... 35 4.11 Employee stock ownership plans ......................................................... 35 4.12 Deferred compensation trusts ............................................................. 36 4.13 Service providers to employee benefit plans ......................................... 37
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4.2 4.3
4.4
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4.5
Interpretative guidance Qualifying special-purpose entities ................................................. 37 Questions and interpretative responses 4.14 Impact of the elimination of the QSPE scope exception .......................... 37 4.6 Interpretative guidance Investment companies ................................................................... 38 Questions and interpretative responses 4.15 Variable interests in investment companies .......................................... 38 4.16 Investment company scope exclusion .................................................. 39 4.7 Interpretative guidance Governmental entities ................................................................... 41 Questions and interpretative responses 4.17 Could an enterprise be required to consolidate a governmental entity?... 41 4.18 Could governmental entities consolidate VIEs? ..................................... 41 4.19 Governmental financing vehicles ......................................................... 41 4.8 Interpretative guidance Not-for-profit organizations ........................................................... 42 Questions and interpretative responses 4.20 Not-for-profit organizations used to circumvent consolidation ............... 43 4.21 Not-for-profit organizations as related parties ...................................... 43 4.9 Interpretative guidance Separate accounts of life insurance enterprises............................... 44 4.10 Interpretative guidance Information availability .................................................................. 44 Questions and interpretative responses 4.22 Lack of information necessary to apply the Variable Interest Models provisions ................................................................. 44 4.11 Interpretative guidance Certain businesses......................................................................... 47 Questions and interpretative responses 4.23 Business scope exception ................................................................... 47 4.24 Determining whether a variable interest holder participated significantly in the design or redesign of the entity ............................... 48 4.25 Joint venture scope exception ............................................................ 48 4.26 Franchisee scope exception ................................................................ 49 4.27 Determining whether substantially all of the activities of an entity involve, or are conducted on behalf of, a variable interest holder ........... 51 4.28 Determining the amount of subordinated financial support provided by an enterprise ................................................................... 52 4.29 Applicability of business scope exception for each party to an entity ...... 52 4.30 Business scope exception must be evaluated at each reporting period .... 53
5 Evaluation of variability and the variable interest determination .................................. 54 5.1 Interpretative guidance ........................................................................................................ 56
Questions and interpretative responses 5.1 Trust preferred securities ................................................................... 61 Terms of interests issued ..................................................................................................... 64 Subordination ...................................................................................................................... 64 Questions and interpretative responses 5.2 Determining whether subordination is substantive ................................ 65 Certain interest rate risk....................................................................................................... 66 Interpretative guidance Certain interest rate risk ................................................................ 66 Questions and interpretative responses 5.3 Excluding variability from periodic interest receipts/payments ............... 66 5.4 Evaluating prepayment risk................................................................. 68
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5.2 5.3
5.4 5.5
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5.6 5.7
5.8
Certain derivative instruments.............................................................................................. 68 Interpretative guidance Certain derivative instruments ....................................................... 70 Questions and interpretative responses 5.5 Application of the Variable Interest Models strongly indicated derivatives guidance ........................................................... 70 5.6 Total return swaps ............................................................................. 73 5.7 Embedded derivatives ........................................................................ 75 5.8 Notional amounts are not specified assets ............................................ 77 5.9 Variable rate liabilities owed to a VIE ................................................... 77 Other arrangements and examples ....................................................................................... 78 Questions and interpretative responses 5.10 Identification of the risks the entity is designed to create is based on underlying economics, not accounting or legal form ................ 78 5.11 Financial guarantees as variable interests ............................................ 79 5.12 Purchase and supply contracts as variable interests .............................. 81 5.13 Operating leases as variable interests .................................................. 82 5.14 Prepaid rent as variable interests ........................................................ 82 5.15 Local marketing agreements and joint service agreements in the broadcasting industry as variable interests ................................. 83 5.16 Purchase and sale contracts for real estate as variable interests ............ 84 5.17 Netting or offsetting contracts ............................................................ 85 5.18 Implicit variable interests.................................................................... 87 5.19 Impact on acquisition date provisions in ASC 805 ................................. 90 5.20 Illustrative example Identification of variable interests commercial real estate ....................................................................... 91
6 Variable interests fees paid to decision makers or service providers ......................... 92 6.1 Interpretative guidance ........................................................................................................ 93
Questions and interpretative responses 6.1 Evaluation of same level of seniority as other operating liabilities of the entity ....................................................................... 95 6.2 Estimating an entitys anticipated economic performance................... 96 6.3 Determination of what level of other interests meets the definition of more than an insignificant amount (ASC 810-10-55-37(c)) ............. 97 6.4 Determination of what meets the definition of more than an insignificant amount (ASC 810-10-55-37(c)) vs. the determination of whether an equity investment is substantive in the VIE assessment......................................................................... 98 6.5 Determination of whether the magnitude of fees meets the definition of insignificant (ASC 810-10-55-37(e) and (f)) .................... 98 6.6 Concept of insignificant in the evaluation of fees paid to a decision maker or service provider vs. could be potentially significant in the determination of the primary beneficiary ................... 99 6.7 Consideration of a decision maker that does not hold a variable interest............................................................................... 100 6.8 Reconsideration of a decision makers or service providers fees as variable interests .................................................................. 101
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6.9 6.10 6.11
Related parties in evaluating fees paid to a decision maker(s) or service provider(s) ......................................................... 102 Employee benefit plans..................................................................... 102 Consideration of quantitative analysis in evaluating fees paid to decision maker(s) or service provider(s) as variable interests ............... 103
7 Silos .......................................................................................................................... 104 7.1 Interpretative guidance ...................................................................................................... 104

Questions and interpretative responses 7.1 When does a silo exist? ..................................................................... 105 7.2 Effect of silos on the host entitys expected losses and expected residual returns ................................................................. 109 7.3 Stand-alone financial statements and silos ......................................... 110 7.4 Effect of silos on determining variable interests in specified assets....... 110 7.5 Can silo assets be greater than 50% of the fair value of a VIEs total assets? .................................................................................... 111 7.6 Silo not required to have a primary beneficiary to be excluded from host entity ............................................................................... 113 7.7 Determining the primary beneficiary of a silo...................................... 113
8 Variable interests interests in specified assets ....................................................... 114 8.1 Interpretative guidance ...................................................................................................... 114
Questions and interpretative responses 8.1 Interests in specified assets .............................................................. 115 8.2 Illustrative example .......................................................................... 117
9 Determining whether an entity is a variable interest entity ........................................ 119 9.1 Interpretative guidance Equity investment at risk (ASC 810-10-15-14(a)).......................... 121
Questions and interpretative responses 9(a).1 Forms of investments that qualify as an equity investment at risk ........ 125 9(a).2 Sufficiency of equity investment at risk based on fair value ................. 125 9(a).3 Commitments to fund losses, stock subscriptions ............................... 126 9(a).4 Significant participation in profits and losses ...................................... 126 9(a).5 Other investments made by equity owners ......................................... 127 9(a).6 Source of the equity investment ........................................................ 127 9(a).7 Effect of items reported in other comprehensive income ..................... 129 9(a).8 Do profitable entities have expected losses? ...................................... 129 9(a).9 Sweat equity ................................................................................... 129 9(a).10 Effect of variable interests in specified assets and silos ....................... 130 9(a).11 Equity investment financed with nonrecourse debt ............................. 131 9(a).12 Fees received by an equity investor ................................................... 132 9(a).13 At-risk equity group for equity sufficiency test is used to determine if the at-risk equity group has power .................................. 133 9(a).14 Call option premiums received by an equity investor ........................... 134 9(a).15 Entities used to invest in synthetic fuel tax credits .............................. 134 9(a).16 Transactions outside the entity ......................................................... 135 9(a).17 Determining sufficiency of equity through comparison with other entities ................................................................................... 137 9(a).18 Regulatory capital requirements ....................................................... 138
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9.2
9.3
9.4
Illustrative examples Qualitative and quantitative analyses of sufficiency of equity at risk .............................................. 139 9(a).20 Is an equity investment of 10% of the entitys total assets sufficient? ... 141 9(a).21 Illustrative examples Sufficiency of equity at risk ............................. 142 Interpretative guidance Power (ASC 810-10-15-14(b)(1))................................................. 146 Questions and interpretative responses 9(b)(1).1 Holders of the equity investment at risk must make substantive decisions ....................................................................... 147 9(b)(1).2 Must all equity holders participate in decision making? ........................ 148 9(b)(1).3 Participation in decision making by holders of interests that are not equity investments at risk...................................................... 149 9(b)(1).4 Effect of decision makers or service providers when evaluating power under ASC 810-10-15-14(b)(1) ............................... 150 9(b)(1).5 Can interests other than equity investment at risk be considered for purposes of evaluating power under ASC 810-10-15-14(b)(1)? ................................................................ 150 9(b)(1).6 Determining whether a general partners at-risk equity investment is substantive ................................................................. 151 9(b)(1).7 Consideration of kick-out rights and participating rights ...................... 154 9(b)(1).8 Franchise arrangements ................................................................... 155 9(b)(1).9 Illustrative examples ........................................................................ 156 9(b)(1).10 Affordable housing projects .............................................................. 159 Interpretative guidance Obligation to absorb expected losses (ASC 810-10-15-14(b)(2)) ................................................................................................. 161 Questions and interpretative responses 9(b)(2).1 Do customary business arrangements violate ASC 810-10-15-14(b)(2)? ................................................................ 163 9(b)(2).2 Common arrangements that may violate ASC 810-10-15-14(b)(2) ....... 163 9(b)(2).3 Disproportionate sharing of losses ..................................................... 164 9(b)(2).4 Absorption of expected losses by an equity holder through other than an equity investment ........................................................ 164 9(b)(2).5 May other variable interest holders be shielded from risk of loss? ........ 165 9(b)(2).6 Sharing first dollar risk of loss ........................................................... 166 9(b)(2).7 Variable interests in specified assets ................................................. 166 9(b)(2).8 Illustrative examples ........................................................................ 167 Interpretative guidance Right to receive expected residual returns (ASC 810-10-15-14(b)(3)) ................................................................................................. 169 Questions and interpretative responses 9(b)(3).1 Examples of situations that violate the conditions of ASC 810-10-15-14(b)(3) .................................................................. 169 9(b)(3).2 Equity holder receives expected residual returns through other than an equity interest............................................................. 171 9(b)(3).3 Participation of other variable interest holders in expected residual returns ............................................................................... 171 9(b)(3).4 Disproportionate sharing of profits .................................................... 172 9(b)(3).5 Variable interests in specified assets ................................................. 172 9(b)(3).6 Impact of call options on an entitys assets or its equity ....................... 173
9(a).19
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9.5
Interpretative guidance Anti-abuse clause (when the economics do not follow the votes) (ASC 810-10-15-14(c)) ...................................................................................... 175 Questions and interpretative responses 9(c).1 Evaluating the substantially all requirement ....................................... 176 9(c).2 Variable interests to be considered when applying the antiabuse clause .................................................................................... 177 9(c).3 Limited partnerships ........................................................................ 178 9(c).4 Related parties ................................................................................ 179 9(c).5 Do related parties include de facto agents? ........................................ 180 9(c).6 Determining whether voting rights are proportionate to economic rights ............................................................................... 181 9(c).7 Illustrative examples ........................................................................ 182
10 Expected losses and expected residual returns .......................................................... 184 10.1 Interpretative guidance ...................................................................................................... 184
Questions and interpretative responses 10.1 Profitable entities have expected losses ............................................. 187 10.2 Expected losses and expected residual returns are based on design of entity ................................................................................ 188 10.3 Calculation of expected losses and expected residual returns............... 188 10.4 Approaches to calculating expected losses and expected residual returns ............................................................................... 191 10.5 Use of the risk-free rate for discounting ............................................. 191 10.6 Allocation of a VIEs expected losses and expected residual returns...... 192 10.7 Sum of expected losses and expected residual returns of variable interest holders exceed those of the VIE ................................ 195 10.8 Reasonableness checks for an expected loss calculation ...................... 197 10.9 Number of possible outcomes needed ................................................ 199 10.10 Possible outcome projections for an entity with an indeterminate life............................................................................. 200 10.11 Inability to obtain information necessary to calculate expected losses and expected residual returns ................................... 200 10.12 Effect of variable interests in specified assets on an entitys expected losses ............................................................................... 200 10.13 Inclusion of credit risk in an expected loss calculation ......................... 201 10.14 Inclusion of investors tax benefits in an expected loss calculation ........ 202 10.15 Inclusion of interest rate risk in an expected loss calculation ................ 203 10.16 Concepts underlying the application of Fair Value, Cash Flow and Cash Flow Prime Methods ................................................... 203 10.17 Effect of the application of the fair value accounting provisions in ASC 820 ......................................................................................... 205
11 Initial determination of VIE status ............................................................................. 207 11.1 Interpretative guidance ...................................................................................................... 207
Questions and interpretative responses 11.1 Is there a significance threshold in applying the Variable Interest Model? ................................................................... 207 11.2 Consideration of anticipated changes in an entitys design or activities ..................................................................................... 208
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12 Reconsideration events ............................................................................................. 210 12.1 Interpretative guidance ...................................................................................................... 210

Questions and interpretative responses 12.1 Common VIE status reconsideration events ........................................ 213 12.2 Design of an entity should be reconsidered......................................... 214 12.3 Conversions of accounts receivables into notes .................................. 214 12.4 Transfer of an entitys debt between lenders ...................................... 214 12.5 Evaluation of the sufficiency of equity upon occurrence of a reconsideration event ...................................................................... 214 12.6 Only substantive changes are reconsideration events.......................... 215 12.7 Asset acquisitions and dispositions .................................................... 216 12.8 Distributions to equity holders .......................................................... 217 12.9 Replacement of temporary financing with permanent financing ........... 218 12.10 Adoption of accounting standards ..................................................... 219 12.11 Incurrence of losses that reduce the equity investment at risk ............. 219 12.12 Acquisition of a business that has a variable interest ........................... 219 12.13 Bankruptcy ...................................................................................... 220 12.14 Loss of power or similar rights .......................................................... 220 12.15 SEC reporting considerations following consolidation or deconsolidation after reconsideration event ....................................... 220
13 Development stage enterprises ................................................................................. 221 13.1 Interpretative guidance ...................................................................................................... 221
Questions and interpretative responses 13.1 Development stage enterprises are not exempt from all VIE provisions .................................................................................. 222 13.2 Assessment of a development stage enterprise as a potential VIE.................................................................................... 222 13.3 Reconsideration of the sufficiency of a development stage enterprises equity investment at risk ................................................ 223 13.4 Analogies to the provisions of the Variable Interest Model for development stage enterprises .................................................... 223
14 Primary beneficiary determination ............................................................................ 224 14.1 Interpretative guidance Power and benefits ...................................................................... 226
Questions and interpretative responses 14.1 Consideration of both the power and benefits criterion........................ 230 14.2 Multiple primary beneficiaries ........................................................... 230 14.3 Effect of the variable interest determination on the primary beneficiary analysis .......................................................................... 231 14.4 Entities with no substantive decision-making ...................................... 231 14.5 Consideration of related parties in the primary beneficiary determination ................................................................. 232 14.6 Relationship of the assessment of power in the VIE determination vs. the primary beneficiary determination ..................... 232 14.7 Reconsideration of which party has the power .................................... 232 14.8 Examples where no party has the power ............................................ 233 14.9 Power under the Variable Interest Model vs. control for voting interest entities ............................................................................... 233
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14.2
14.3
14.4 14.5
Power to significantly impact the entitys economic performance ......... 234 Evaluating rights held by the board of directors and an operations manager in an operating venture ...................................... 234 14.12 Concept of could potentially be significant in the determination of the primary beneficiary ........................................... 236 14.13 Quantitative analysis of benefits........................................................ 236 14.14 Power when circumstances arise or events happen ............................. 236 14.15 Power when circumstances arise or events happen vs. protective rights .............................................................................. 237 14.16 A VIE can be the primary beneficiary of another VIE ........................... 238 14.17 Performing the primary beneficiary assessment prior to the VIE determination ............................................................................ 238 14.18 Consideration of potential voting rights (e.g., call options, convertible instruments) when assessing power.................................. 238 Interpretative guidance Kick-out rights, participating rights and protective rights ............... 239 Questions and interpretative responses 14.19 Consideration of the board of directors when assessing power ............. 240 14.20 Evaluating the substance of kick-out rights in the Variable Interest Model .................................................................... 240 14.21 Consolidation through participating rights .......................................... 241 14.22 Liquidation rights as kick-out rights ................................................... 242 14.23 Call options as kick-out rights ............................................................ 242 14.24 Kick-out right holder as party with the power ..................................... 242 Interpretative guidance Shared power.............................................................................. 243 Questions and interpretative responses 14.25 Different parties with power over the entitys life cycle........................ 244 Interpretative guidance Involvement with the design of the VIE ......................................... 245 Interpretative guidance Disproportionate power and benefits ............................................ 245 Questions and interpretative responses 14.26 Evaluating disproportionate power and benefits ................................. 246 14.27 Effect of VIE determination anti-abuse clause (ASC 810-10-15-14(c)) on the identification of the primary beneficiary .......................................................................... 246
14.10 14.11
15 Related parties and de facto agents........................................................................... 247 15.1 Interpretative guidance ...................................................................................................... 247
Questions and interpretative responses 15.1 Application of the phrase without the prior approval of the reporting entity to common contractual provisions ............................ 249 15.2 Conditions in ASC 810-10-25-43(d) on an agreement that it cannot sell, transfer or encumber its interests in the VIE without the prior approval of the reporting entity are inclusive ................ 250 15.3 Close business relationship condition ................................................. 251 15.4 Substantive sale, transfer or encumbrance restriction that is one-sided ..................................................................................... 251 15.5 Separate accounts of life insurance enterprises as related parties ........ 251
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16 Determining the primary beneficiary from a related party group ................................ 253 16.1 Interpretative guidance ...................................................................................................... 253
Questions and interpretative responses 16.1 Principal-agency relationship ............................................................ 254 16.2 Determining the relationship and significance of a VIEs activities to members of a related party group .................................... 255 16.3 One member of a related party group not clearly identified as primary beneficiary ...................................................................... 256 16.4 Equity interests held by related parties of the primary beneficiary are noncontrolling interests ............................................. 257 16.5 Determining which party within the related party group is primary beneficiary .......................................................................... 257 16.6 Quantitative analysis in determining the primary beneficiary from a related party group ............................................... 258
17 Initial measurement and consolidation ....................................................................... 259 17.1 Interpretative guidance ...................................................................................................... 260
Questions and interpretative responses 17.1 Form 8-K and pro forma reporting requirements................................. 261 17.2 Form 8-K and SEC Regulation S-X Rules 3-05 and 3-14 reporting requirements .................................................................... 261 17.3 Pre-existing hedge relationships under ASC 815 ................................. 261 17.4 Continuation of leveraged lease accounting by an equity investor in a deconsolidated lessor trust ............................................ 266
18 Accounting after initial measurement ........................................................................ 267 18.1 Interpretative guidance ...................................................................................................... 267
Questions and interpretative responses 18.1 Attribution of intercompany eliminations in consolidation .................... 268 18.2 Losses in excess of noncontrolling interests ....................................... 272 18.3 Consolidated versus combined financial statements ............................ 272 18.4 Primary beneficiarys acquisition of noncontrolling interest ................. 272 18.5 Accounting for liabilities after initial consolidation .............................. 273 18.6 Possible embedded derivative contained in certain limited recourse obligations ......................................................................... 273 18.7 Reduction of preferred stock noncontrolling interest after consolidation ........................................................................... 274 18.8 Date to reflect deconsolidation of a VIE.............................................. 275 18.9 Attribution of income/loss in an asset-backed financing entity ............. 275
19 Presentation ............................................................................................................. 277 19.1 Interpretative guidance ...................................................................................................... 277

Questions and interpretative responses 19.1 Availability of aggregation principle for separate presentation ............. 277 19.2 Separate presentation on a net or a single line item basis .................... 278
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20 Disclosures................................................................................................................ 280 20.1 Interpretative guidance ...................................................................................................... 283

Questions and interpretative responses 20.1 Public company MD&A disclosure requirements .................................. 284 20.2 Meaning of maximum exposure to loss ............................................... 285 20.3 Aggregation .................................................................................... 285
21 Effective date and transition ..................................................................................... 286 21.1 Interpretative guidance ...................................................................................................... 289
Questions and interpretative responses 21.1 Effect of prior period VIE reconsideration events on initial measurement ......................................................................... 293 21.2 Transition for an enterprise that is not the primary beneficiary on the adoption date but would have been in prior periods presented if Statement 167 had applied ......................... 294 21.3 Practicability exception for measurement available on an entity-by-entity basis........................................................................ 294 21.4 Practicability exception for measurement when the activities of the entity are primarily related to securitizations or other forms of asset-backed financings .................... 294 21.5 Practicability exception general ...................................................... 295 21.6 Determining fair value in arriving at carrying amounts upon transition.. 295 21.7 Determining initial carrying amounts when involvement precedes the effective date of current accounting standards ............... 296 21.8 Application of accounting standards that require an assessment of managements intent or application of judgment retrospectively .................................................................. 296 21.9 Practicability exception not available for deconsolidation .................... 297 21.10 Retrospective application when an enterprise no longer consolidates a VIE at the date of adoption .......................................... 297 21.11 SEC registration requirements following the adoption of Statement 167 ................................................................................ 298 21.12 Derivatives hedge designation for newly consolidated VIEs upon adoption of Statement 167 ....................................................... 298 21.13 Accumulated other comprehensive income and carrying amounts ........ 298 21.14 Table of selected financial data in Form 10-K ..................................... 299 21.15 Internal control over financial reporting requirements for an entity newly consolidated pursuant to the adoption Statement 167 ............... 299 21.2 Interpretative guidance Statement 167 deferral ............................................................... 300 Questions and interpretative responses 21.16 Consolidation analysis for entities that qualify for the deferral ............. 302 21.17 Disclosures ...................................................................................... 303 21.18 Foreign investment funds ................................................................. 303 21.19 Foreign money market funds............................................................. 303 21.20 Subsequent loss of status to qualify for the deferral Recognition and measurement principle ............................................. 304 21.21 Partnership obligation to fund losses .............................................. 304 21.22 Significance obligation to fund losses .............................................. 305
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Appendix A: Summary of important changes ................................................................... 306 Appendix B: Abbreviations used in this publication .......................................................... 308 Appendix C: Index of ASC references in this publication .................................................. 310 Appendix D: Step-by-step guide to applying the Variable Interest Model .......................... 314 Appendix E: Variable Interest Entity identifier tool ............................................................. 315 Appendix F: Example VIE analysis ................................................................................... 322 Appendix G: Other publications ....................................................................................... 334
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Notice to readers: This publication includes excerpts from and references to the FASB Accounting Standards Codification (the Codification or ASC). The Codification uses a hierarchy that includes Topics, Subtopics, Sections and Paragraphs. Each Topic includes an Overall Subtopic that generally includes pervasive guidance for the topic and additional Subtopics, as needed, with incremental or unique guidance. Each Subtopic includes Sections that in turn include numbered Paragraphs. Thus, a Codification reference includes the Topic (XXX), Subtopic (YY), Section (ZZ) and Paragraph (PP). Throughout this publication references to guidance in the Codification are shown using these reference numbers. References are also made to certain pre-Codification standards (and specific sections or paragraphs of pre-Codification standards) in situations in which the content being discussed is excluded from the Codification. This publication has been carefully prepared but it necessarily contains information in summary form and is therefore intended for general guidance only; it is not intended to be a substitute for detailed research or the exercise of professional judgment. The information presented in this publication should not be construed as legal, tax, accounting, or any other professional advice or service. Ernst & Young LLP can accept no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. You should consult with Ernst & Young LLP or other professional advisors familiar with your particular factual situation for advice concerning specific audit, tax or other matters before making any decisions.
Portions of FASB publications reprinted with permission. Copyright Financial Accounting Standards Board, 401 Merritt 7, P.O. Box 5116, Norwalk, CT 06856-5116, U.S.A. Copies of complete documents are available from the FASB.
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Excerpt from Accounting Standards Codification
Consolidation Overall Overview and Background Consolidation of VIEs 810-10-05-8 The Variable Interest Entities Subsections clarify the application of the General Subsections to certain legal entities in which equity investors do not have sufficient equity at risk for the legal entity to finance its activities without additional subordinated financial support or, as a group, the holders of the equity investment at risk lack any one of the following three characteristics: a. b. c. The power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impact the entitys economic performance The obligation to absorb the expected losses of the legal entity The right to receive the expected residual returns of the legal entity.
Paragraph 810-10-10-1 states that consolidated financial statements are usually necessary for a fair presentation if one of the entities in the consolidated group directly or indirectly has a controlling financial interest in the other entities. Paragraph 810-10-15-8 states that the usual condition for a controlling financial interest is ownership of a majority voting interest. However, application of the majority voting interest requirement in the General Subsections of this Subtopic to certain types of entities may not identify the party with a controlling financial interest because the controlling financial interest may be achieved through arrangements that do not involve voting interests. 810-10-05-8A The reporting entity with a variable interest or interests that provide the reporting entity with a controlling financial interest in a variable interest entity (VIE) will have both of the following characteristics: a. b. The power to direct the activities of a VIE that most significantly impact the VIEs economic performance The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.
810-10-05-9 The Variable Interest Entities Subsections explain how to identify VIEs and how to determine when a reporting entity should include the assets, liabilities, noncontrolling interests, and results of activities of a VIE in its consolidated financial statements. Transactions involving VIEs are common. Some reporting entities have entered into arrangements using VIEs that appear to be designed to avoid reporting assets and liabilities for which they are responsible, to delay reporting losses that have already been incurred, or to report gains that are illusory. At the same time, many reporting entities have used VIEs for valid business purposes and have properly accounted for those VIEs based on guidance and accepted practice.
Financial reporting developments Consolidation of variable interest entities 13
1 Introduction
810-10-05-10 Some relationships between reporting entities and VIEs are similar to relationships established by majority voting interests, but VIEs often are arranged without a governing board or with a governing board that has limited ability to make decisions that affect the VIEs activities. A VIEs activities may be limited or predetermined by the articles of incorporation, bylaws, partnership agreements, trust agreements, other establishing documents, or contractual agreements between the parties involved with the VIE. A reporting entity implicitly chooses at the time of its investment to accept the activities in which the VIE is permitted to engage. That reporting entity may not need the ability to make decisions if the activities are predetermined or limited in ways the reporting entity chooses to accept. Alternatively, the reporting entity may obtain an ability to make decisions that affect a VIEs activities through contracts or the VIEs governing documents. There may be other techniques for protecting a reporting entitys interests. In any case, the reporting entity may receive benefits similar to those received from a controlling financial interest and be exposed to risks similar to those received from a controlling financial interest without holding a majority voting interest (or without holding any voting interest). The power to direct the activities of a VIE that most significantly impact the entitys economic performance and the reporting entitys exposure to the entitys losses or benefits are determinants of consolidation in the Variable Interest Entities Subsections. The Variable Interest Entities Subsections also provide guidance on determining whether fees paid to a decision maker or service provider should be considered a variable interest in a VIE. 810-10-05-11 VIEs often are created for a single specified purpose, for example, to facilitate securitization, leasing, hedging, research and development, reinsurance, or other transactions or arrangements. The activities may be predetermined by the documents that establish the VIEs or by contracts or other arrangements between the parties involved. However, those characteristics do not define the scope of the Variable Interest Entities Subsections because other entities may have those same characteristics. The distinction between VIEs and other entities is based on the nature and amount of the equity investment and the rights and obligations of the equity investors. 810-10-05-12 Because the equity investors in an entity other than a VIE generally absorb losses first, they can be expected to resist arrangements that give other parties the ability to significantly increase their risk or reduce their benefits. Other parties can be expected to align their interests with those of the equity investors, protect their interests contractually, or avoid any involvement with the entity. 810-10-05-13 In contrast, either a VIE does not issue voting interests (or other interests with similar rights) or the total equity investment at risk is not sufficient to permit the legal entity to finance its activities without additional subordinated financial support. If a legal entity does not issue voting or similar interests or if the equity investment is insufficient, that legal entitys activities may be predetermined or decisionmaking ability is determined contractually. If the total equity investment at risk is not sufficient to permit the legal entity to finance its activities, the parties providing the necessary additional subordinated financial support most likely will not permit an equity investor to make decisions that may be counter to their interests. That means that the usual condition for establishing a controlling financial interest as a majority voting interest does not apply to VIEs. Consequently, a standard for consolidation that requires ownership of voting stock or some other form of decision-making ability is not appropriate for such entities.
14
1 Introduction
1.1
Interpretative guidance
Note: In February 2010, the FASB issued an Accounting Standards Update (ASU) primarily to address concerns with the application of Statement 167 for reporting enterprises in the asset management industry by deferring the effective date of Statement 167 for certain investment funds. See additional discussion in Chapter 21. The FASB currently has a project on its agenda that would eliminate the deferral discussed above. In addition, the FASBs tentative decisions would modify the Variable Interest Models provisions for evaluating an enterprise as a principal or an agent (see Chapter 6) and the provisions for evaluating the substance of kick-out rights and participating rights (see Chapters 9 and 14), among other things. Readers should monitor developments in this area closely. In many instances, an enterprise will consolidate an entity because the entity is controlled through voting interests. In situations in which the equity investors lack the characteristics of a controlling financial interest, the voting interest approach is not effective in identifying whether an enterprise should consolidate an entity. For example, these situations arise when the equity investors do not bear the residual economic risks or have the rights to the residual economic returns. ASC 810-10 explains how to identify variable interests and variable interest entities (VIEs), and how an enterprise should assess its interest in a VIE to decide whether to consolidate that entity. Only if an entity is determined not to be a VIE (i.e., a voting interest entity), would the traditional voting interest model in ASC 810 be considered. Enterprises1 should apply ASC 810-10s variable interest consolidation model2 (the Variable Interest Model) to transactions with other entities to determine if they have a variable interest in the entity and, if so, whether the entity is a VIE. If the enterprise has a variable interest in a VIE, the enterprise must determine whether consolidation of that VIE is required. In effect, in determining whether to apply the Variable Interest Model, one must consider the following three threshold questions: Does the enterprise have a variable interest in an entity? If so, is the entity a VIE? If the entity is a VIE, should the enterprise consolidate the VIE?
When we use the term enterprise in this publication, we refer to the enterprise that is evaluating its potential variable interest in a potential VIE for purposes of determining whether it must consolidate that entity or to the enterprise that consolidates a VIE. When we use the term entity, we refer to the potential VIE or to the VIE. That is, the purpose of the Variable Interest Model is to determine whether the enterprise is the party that must consolidate an entity that is a VIE. Generally, ASC 810-10 includes guidance with respect to the consolidation considerations for voting interest entities and variable interest entities for each of ASC 810-10s sections. In each of ASC 810-10s sections there is a General subsection with respect to the consolidation model. This guidance applies to voting interest entities and also may apply to variable interest entities in certain circumstances. The Variable Interest Entities subsection within each of ASC 810-10s sections contains considerations with respect to variable interest entities. In referring to the Variable Interest Model in ASC 810-10, we are referring to the guidance applicable to variable interest entities in each of ASC 810-10s sections. 15
1 Introduction
If the enterprise is subject to a scope exception to the Variable Interest Model, does not have a variable interest or the entity is not a VIE, other GAAP should be applied to the transaction (i.e., other GAAP should be applied to account for the interest in or involvement with the entity). If the entity is a VIE, the Variable Interest Model should be followed, and the VIE should be evaluated for consolidation based on whether the enterprise has both: The power to direct the activities of a VIE that most significantly impact the entitys economic performance (power) The obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE (benefits)
Variable interests in an entity are contractual, ownership or other pecuniary interests in an entity that change with changes in the fair value of the entitys net assets exclusive of variable interests (e.g., equity interests, certain management or service contracts). ASC 810-10 describes various types of variable interests and provides considerations for evaluating what meets the definition of a variable interest. In order to determine whether an entity is a VIE, ASC 810-10-15-14 provides criteria for determining whether (a) the entity lacks sufficient equity or (b) the entitys equity holders lack power or the obligation and right as equity holders to absorb the entitys expected losses or to receive its expected residual returns. These entities VIEs are subject to the Variable Interest Model and are to be evaluated for consolidation based on the power and benefits criteria and not based on the ownership of outstanding voting shares. To determine a VIEs primary beneficiary, an enterprise must perform a qualitative assessment to determine which party, if any, has the power and benefits. Therefore, an enterprise must identify which activities most significantly impact the VIEs economic performance and determine whether it, or another party, has the power to direct those activities. Prior to Statement 167s amendments, ASC 810-10 generally required an enterprise to determine the primary beneficiary through the quantification and allocation of potential variability in an entitys returns to its variable interest holders. Estimates of a number of possible future outcomes of the entity, as well as the probability of each outcome occurring, were prepared. The results of each possible outcome were allocated to the parties holding variable interests in the VIE. Based on the allocation of these possible outcomes, the party, if any, that absorbed a majority of the entitys variability was the VIEs primary beneficiary and was required to consolidate the VIE. Statement 167 eliminated the quantitative analysis for purposes of determining the primary beneficiary. However, it should be noted that Statement 167 did not necessarily eliminate the need to perform a quantitative analysis in applying its other provisions, as described elsewhere in this publication (e.g., sufficiency of equity at risk in the VIE determination).
16
1 Introduction
ASC 810s overall consolidation model is illustrated by the diagram below.
Scope exception to variable interest model?
Yes
No
Variable interest in an entity?
No
Yes
VIE?
Yes
Yes
Primary beneficiary of the VIE?
No
Follow other GAAP*
Yes
Consolidate the VIE
* Apply other GAAP, which may include other GAAP within ASC 810. If a VIE and the enterprise has a variable interest in the VIE, the Variable Interest Models disclosure requirements may still be applicable.
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1 Introduction
1.2
IFRS convergence
Under both US GAAP and IFRS, the underlying determination of whether entities are consolidated by a reporting enterprise is based on a controlling financial interest. However, differences do exist. Unlike IFRS, US GAAP distinguishes between VIEs and voting interest entities. Under US GAAP, the determination of whether an entity is a VIE or a voting interest entity is often a critical consideration. If an entity is a VIE, the consolidation analysis is based on the variable interests held the entity. In May 2011, the IASB issued new consolidation accounting guidance3 that establishes a single control model for all entities. The new guidance replaces or amends portions of the existing consolidation guidance under IFRS and is effective for fiscal years beginning on or after 1 January 2013. The FASB and IASB jointly deliberated much of the IASBs new consolidation guidance. However, after hearing from constituents, the FASB decided in early-2011 not to issue consolidation guidance similar to the IASBs guidance. The FASB disagreed with aspects of the IASBs new consolidation model, but said it plans to amend US GAAP to better align it with the IASBs new guidance related to the principalagent determination. The new IASB guidance is more similar to the guidance for the consolidation of VIEs than the current guidance, but it creates new differences between US GAAP and IFRS in some areas. Some longstanding differences also remain. Our To the Point publication, Key differences between IASBs new consolidation guidance and US GAAP, highlights some of the significant differences that exist between current US GAAP and the IASBs new guidance.
IFRS 10, Consolidated Financial Statements 18
Definitions of terms
Consolidation Overall Glossary 810-10-20 Expected Losses and Expected Residual Returns Expected losses and expected residual returns refer to amounts derived from expected cash flows as described in FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements. However, expected losses and expected residual returns refer to amounts discounted and otherwise adjusted for market factors and assumptions rather than to undiscounted cash flow estimates. The definitions of expected losses and expected residual returns specify which amounts are to be considered in determining expected losses and expected residual returns of a variable interest entity (VIE). Expected Variability Expected variability is the sum of the absolute values of the expected residual return and the expected loss. Expected variability in the fair value of net assets includes expected variability resulting from the operating results of the legal entity. Primary Beneficiary An entity that consolidates a variable interest entity (VIE). See paragraphs 810-10-25-38 through 25-38G for guidance on determining the primary beneficiary. Subordinated Financial Support Variable interests that will absorb some or all of a variable interest entitys (VIEs) expected losses. Variable Interest Entity A legal entity subject to consolidation according to the provisions of the Variable Interest Entities Subsections of Subtopic 810-10. Variable Interests The investments or other interests that will absorb portions of a variable interest entitys (VIEs) expected losses or receive portions of the entitys expected residual returns are called variable interests. Variable interests in a VIE are contractual, ownership, or other pecuniary interests in a VIE that change with changes in the fair value of the VIEs net assets exclusive of variable interests. Equity interests with or without voting rights are considered variable interests if the legal entity is a VIE and to the extent that the investment is at risk as described in paragraph 810-10-15-14. Paragraph 810-10-25-55 explains how to determine whether a variable interest in specified assets of a legal entity is a variable interest in the entity. Paragraphs 810-10-55-16 through 55-41 describe various types of variable interests and explain in general how they may affect the determination of the primary beneficiary of a VIE.
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2 Definitions of terms
2.1
Following are some important terms relevant to the application of the Variable Interest Model and our observations about them: Expected losses and expected residual returns/expected variability Negative variability in outcomes to be absorbed (expected losses) or positive variability in outcomes to be received (expected residual returns) by holders of variable interests in a variable interest entity. Expected losses and expected residual returns are derived using the techniques described in CON 7. The determination of an entitys expected losses and expected residual returns is discussed in the Interpretative guidance and Questions in Chapter 10 of this publication. Primary beneficiary An enterprise that has (1) the power to direct activities of a VIE that most significantly impact the entitys economic performance and (2) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE. A VIE should have only one primary beneficiary. A VIE may not have a primary beneficiary if no party meets the criteria described above. Subordinated financial support Variable interests that absorb some or all of an entitys expected losses. Variable interest entity A VIE is an entity that does not qualify for a scope exception from the Variable Interest Model (see Interpretative guidance and Questions to Chapter 4 for scope exceptions) and is subject to consolidation based on the Variable Interest Model. The Variable Interest Models criteria identify a VIE as an entity (1) which has an insufficient amount of at-risk equity to permit the entity to finance its activities without additional subordinated financial support provided by any parties, (2) whose at-risk equity owners, as a group, do not have power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entitys economic performance or (3) whose atrisk equity owners do not absorb the entitys losses or receive the entitys residual returns. Variable interests Refer to Chapter 5 for a detailed discussion of variable interests. Equity investment Interests reported as equity in the financial statements of the entity being evaluated for consolidation. An equity investment is a variable interest in a VIE only to the extent the investment is considered to be at risk.
Questions and interpretative responses
Expected losses and expected residual returns are not GAAP or economic income or loss
Question 2.1 Do expected losses and expected residual returns represent the amounts expected to be reported under generally accepted accounting principles (GAAP) or economic losses and income that are expected to be earned by the entity? The concepts of expected losses and expected residual returns are difficult aspects of the Variable Interest Model to understand and to apply. This difficulty arises primarily because expected losses and expected residual returns are neither GAAP nor economic losses expected to be incurred by the entity nor GAAP or economic income expected to be earned by the entity. Instead, expected losses and expected residual returns are defined as amounts derived from techniques described in CON 7. CON 7 requires expected cash flows to be derived by projecting possible outcomes and assigning each possible outcome a probability weight. Under the Variable Interest Model, expected losses and expected residual
2 Definitions of terms
returns represent the potential for variability in each outcome from the expected (or mean) outcome. Outcomes that exceed the expected outcome give rise to expected residual returns (overperformance or positive variability), while outcomes that are less than the expected outcome give rise to expected losses (underperformance or negative variability). The Variable Interest Model also provides that expected losses and expected residual returns represent amounts discounted and otherwise adjusted for market factors and assumptions, rather than undiscounted cash flow estimates. The concept of expected losses and expected residual returns is further discussed in the Interpretative guidance and Questions in Chapter 10 of this publication.
Subordinated financial support

Question 2.2 What constitutes subordinated financial support provided to an entity? Subordinated financial support refers to a variable interest that absorbs some or all of an entitys expected losses. It does not refer solely to equity interests, subordinated debt or other forms of financing that are subordinate to other senior interests in the entity. Subordinated financial support could be provided to an entity in many ways, including: Equity interests both common and preferred Debt subordinated and senior Contracts with terms that are not market-based Guarantees Derivatives Commitments to fund losses
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Consideration of substantive terms, transactions and arrangements

Consolidation Overall Scope and Scope Exceptions 810-10-15-13A For purposes of applying the Variable Interest Entities Subsections, only substantive terms, transactions, and arrangements, whether contractual or noncontractual, shall be considered. Any term, transaction, or arrangement shall be disregarded when applying the provisions of the Variable Interest Entities Subsections if the term, transaction, or arrangement does not have a substantive effect on any of the following: a. b. c. A legal entitys status as a VIE A reporting entitys power over a VIE A reporting entitys obligation to absorb losses or its right to receive benefits of the legal entity.
810-10-15-13B Judgment, based on consideration of all the facts and circumstances, is needed to distinguish substantive terms, transactions, and arrangements from nonsubstantive terms, transactions, and arrangements.
3.1
Statement 167 added language to ASC 810-10 stating that only substantive terms, transactions and arrangements, whether contractual or noncontractual, should be considered in applying the Variable Interest Model. The FASB concluded that this guidance is necessary to avoid situations in which the form of an entity may indicate that an entity is not a VIE or an enterprise is not a primary beneficiary when the substance of the arrangement may indicate otherwise. However, the inclusion of this provision is not meant to imply that nonsubstantive terms should be considered in other areas of accounting. The FASB included this provision in response to concerns regarding the potential for certain enterprises to engage in restructuring in and around their involvement with a VIE in an effort to maintain their consolidation conclusions that otherwise would have changed upon adoption of Statement 167. ASC 810-10 does not provide detailed implementation guidance or examples of the considerations that enterprises should evaluate when determining whether terms, transactions and arrangements are substantive. We believe that, in certain circumstances, significant professional judgment will be required to determine whether terms, transactions and arrangements are substantive and would therefore be considered in applying the Variable Interest Model. In some instances, enterprises previously may not have evaluated whether terms, transactions or arrangements are substantive as there was no explicit requirement to do so. In considering whether terms, transactions and arrangements are substantive, we believe that it is appropriate to consider among other things, the purpose and design of the entity and the business purposes for the particular arrangements or transactions when alternative arrangements or transactions are typically used with respect to involvement in an entity.
3 Consideration of substantive terms, transactions and arrangements
Given the nature of the considerations in ASC 810-10-15-13A and 15-13B, we believe that it is likely that these provisions will be broadly applied by the SEC staff. As such, we believe that it will be important for an enterprise to contemporaneously document the substance of the terms, transactions and arrangements that it enters into, with particular emphasis on changes to the terms, transactions and arrangements that occur for existing involvement in entities prior to the effective date of Statement 167.
Evaluation of changes in terms, transactions and arrangements prior to the adoption of Statement 167
Question 3.1 How should an enterprise evaluate changes in terms, transactions and arrangements for entities for which they are already involved that occur subsequent to the issuance, but prior to the effective date, of Statement 167? For purposes of evaluating the provisions of ASC 810-10-15-13A and 15-13B, only changes in terms, transactions and arrangements that have a substantive effect on the consolidation analysis (e.g., an entitys status as a VIE, the determination of the primary beneficiary of a VIE) are required to be considered. In evaluating whether changes in terms, transactions and arrangements are substantive, and therefore should have an effect on the Variable Interest Model analysis, careful consideration should be given to changes that occur to existing arrangements prior to Statement 167s effective date. The Variable Interest Model does not provide detailed implementation guidance or examples of the considerations that enterprises should evaluate when determining whether terms, transactions and arrangements are substantive. Thus, we believe that, in certain circumstances, significant professional judgment will be required to determine whether changes to terms, transactions and arrangements are substantive and, therefore, are necessarily considered in applying the provisions of the Variable Interest Model. In evaluating the substance of the changes, we believe that it is appropriate to consider, among other things, the entitys original purpose and design and the business rationale for the changes. In particular, the business purpose of the change to a transaction or arrangement should be analyzed when alternative arrangements or transactions typically are used with respect to involvement in an entity. For example, changes made to the structure of an arrangement to conform the arrangement to other similar arrangements that the enterprise is involved in may be relevant in concluding that a change is substantive. Alternatively, changes made to a particular arrangement that deviate from an enterprises traditional involvement may call into question the substance of the particular change. In many circumstances, the underlying economics that accompany a change will be an important consideration. We generally believe that substantive changes to terms, transactions and arrangements will have an economic consequence to the parties involved. For example, assume that party A has a variable interest and would have the power to direct the activities of a VIE that most significantly impact the entitys economic performance over a VIE under the Variable Interest Model. Assume that leading up to the adoption of Statement 167, the arrangements between the parties involved with the VIE are altered such that party B is provided with the unilateral ability to remove party A as the party with the power. Thus, under the Variable Interest Model, party A would no longer have power. Also, assume that party A received no substantive compensation as part of party B obtaining the kick-out rights. Under this scenario, the arrangements should be carefully analyzed to ensure that the change is substantive. The fact that party A received no compensation for giving up its rights to control the VIE may raise questions as to whether the changes to arrangements were substantive.
3 Consideration of substantive terms, transactions and arrangements
Consideration of the substance of existing terms, transactions and arrangements upon the adoption of Statement 167
Question 3.2 Is an enterprise required to evaluate the provisions of ASC 810-10-15-13A and 15-13B for an entity that the enterprise previously has been involved with and for which there has not been any changes in the terms, transactions or arrangements? Yes. Under the transition provisions of Statement 167, an enterprise is required to evaluate the effects of Statement 167 on historical consolidation conclusions as if Statement 167s requirements have always been effective. Thus, an enterprise should consider the provisions of ASC 810-10-15-13A and 15-13B on historical terms, transactions and arrangements in making this assessment. The Variable Interest Model does not provide detailed implementation guidance or examples of the evaluation that enterprises should make when determining whether terms, transactions or arrangements are substantive. We believe that enterprises should consider, among other things, the entitys original purpose and design and the business rationale for existing structures. Under the provisions of the Variable Interest Model, we note that the form of a transaction is often an important consideration in arriving at an accounting conclusion. While form is important in the accounting analysis, the form of a transaction and its related attributes often drive the economics attributable to an entitys variable interest holders. One such example is the importance of form in establishing the tax status and related attributes of an interest in an entity. As such, when evaluating the provisions of ASC 810-10-15-13A and 15-13B, we believe that a comparison of the terms, transactions and arrangements to the enterprises involvement in similar entities and a comparison to the typical involvement that other enterprises may have in similar entities may provide an indication as to the substance of an existing arrangement. For example, if a particular arrangement is consistent with an enterprises typical involvement in and structure of an entity (or the traditional form of the arrangement for similar entities), it may provide an indication that the terms, transactions or arrangements are substantive. Significant professional judgment will be required when evaluating whether terms, transactions and arrangements are substantive and would therefore be considered in applying the provisions of Statement 167. Notwithstanding the requirements of ASC 810-10-15-13A and 15-13B, we believe that the primary intent of the FASB in including those provisions in the amendments to the Variable Interest Model was its concern with respect to potential structuring opportunities that certain enterprises may have contemplated to avoid an anticipated accounting consequence upon adoption of Statement 167 (e.g., consolidation of a previously nonconsolidated entity). While the amendments to the Variable Interest Model introduce an explicit requirement to consider the substance of terms, transactions and arrangements in evaluating consolidation conclusions, we believe that a consideration of substance was implicitly required in evaluating the business purpose of an enterprises involvement with a particular entity and, ultimately, the accounting conclusions prior to the amendments to the Variable Interest Model. As a result, we generally would not expect that the provisions of ASC 810-10-15-13A and 15-13B would necessitate a change to a prior consolidation conclusion under the amendments to the Variable Interest Model, as non-substantive terms, transactions or arrangements likely were not determinative in an enterprises previous consolidation conclusion with respect to involvement in an entity.
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Scope
Consolidation Overall Scope and Scope Exceptions General 810-10-15-1 The Scope Section of the Overall Subtopic establishes the pervasive scope for all Subtopics of the Consolidation Topic. Unless explicitly addressed within specific Subtopics, the following scope guidance applies to all Subtopics of the Consolidation Topic. 810-10-15-2 The General Subsection of this Section establishes the pervasive scope for this Subtopic, with specific exceptions noted in the other Subsections of this Section. 810-10-15-3 All reporting entities shall apply the guidance in the Consolidation Topic to determine whether and how to consolidate another entity and apply the applicable Subsection as follows: a. b. If the reporting entity is within the scope of the Variable Interest Entities Subsections, it should first apply the guidance in those Subsections. If the reporting entity has an investment in another entity that is not determined to be a VIE, the reporting entity should use the guidance in the General Subsections to determine whether that interest constitutes a controlling financial interest. Paragraph 810-10-15-8 states that the usual condition for a controlling financial interest is ownership of a majority voting interest, directly or indirectly, of more than 50 percent of the outstanding voting shares. Noncontrolling rights may prevent the owner of more than 50 percent of the voting shares from having a controlling financial interest. If the reporting entity has a contractual management relationship with another entity that is not determined to be a VIE, the reporting entity should use the guidance in the Consolidation of Entities Controlled by Contract Subsections to determine whether the arrangement constitutes a controlling financial interest.
c.
810-10-15-4 All legal entities are subject to this Topics evaluation guidance for consolidation by a reporting entity, with specific qualifications and exceptions noted below. 810-10-20 Legal Entity Any legal structure used to conduct activities or to hold assets. Some examples of such structures are corporations, partnerships, limited liability companies, grantor trusts, and other trusts.
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4 Scope
Scope and Scope Exceptions General 810-10-15-6 The guidance in this Topic applies to all reporting entities, with specific qualifications and exceptions noted below. 810-10-15-8 The usual condition for a controlling financial interest is ownership of a majority voting interest, and, therefore, as a general rule ownership by one reporting entity, directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity is a condition pointing toward consolidation. The power to control may also exist with a lesser percentage of ownership, for example, by contract, lease, agreement with other stockholders, or by court decree. 810-10-15-9 A majority-owned subsidiary is an entity separate from its parent and may be a variable interest entity (VIE) that is subject to consolidation in accordance with the Variable Interest Entities Subsections of this Subtopic. Therefore, a reporting entity with an explicit or implicit interest in a legal entity within the scope of the Variable Interest Entities Subsections shall follow the guidance in the Variable Interest Entities Subsections. 810-10-15-11 A difference in fiscal periods of a parent and a subsidiary does not justify the exclusion of the subsidiary from consolidation. Scope and Scope Exceptions Variable Interest Entities 810-10-15-15 Portions of legal entities or aggregations of assets within a legal entity shall not be treated as separate entities for purposes of applying the Variable Interest Entities Subsections unless the entire entity is a VIE. Some examples are divisions, departments, branches, and pools of assets subject to liabilities that give the creditor no recourse to other assets of the entity. Majority-owned subsidiaries are legal entities separate from their parents that are subject to the Variable Interest Entities Subsections and may be VIEs.
4.1
Interpretative guidance Legal entities

The provisions of the Variable Interest Model are applicable to all legal entities, with limited exceptions. The Variable Interest Model defines legal entity as any legal structure used to conduct activities or to hold assets. Thus, almost any legal structure used to hold assets or conduct activities may be subject to the Variable Interest Models provisions. Corporations, partnerships, limited-liability companies, other unincorporated legal entities and trusts are examples of structures that meet this definition. There are no exceptions for structures used by specific industries, and the nature of the structures activities or assets held is not considered in determining whether the structure is an entity subject to the Variable Interest Model. Portions of entities, such as divisions, departments and branches of an entity are not considered separate entities under the Variable Interest Model, unless the entire entity is a VIE.5
If the entire entity is a VIE, the enterprise must consider whether silos are present. Refer to Chapter 7 of this publication for further details. 26
4 Scope
Determining whether a structure meets the definition of a legal entity requires the consideration of the individual facts and circumstances and may require the assistance of legal counsel. In situations in which this evaluation proves challenging, answering yes to some or all of the following questions may suggest the structure is a legal entity. Can the structure under its own name (i.e., apart from other parties): Enter into contracts? Enter into or become part of court or regulatory proceedings? File a tax return? Open a bank account or obtain financing?
The Variable Interest Models scope is so broad that even a majority-owned (or wholly-owned) subsidiary that is legally separate from its parent is subject to the Variable Interest Model and may be a VIE, notwithstanding the parents apparent control of the entity through its ownership of a majority of the subsidiarys outstanding voting stock. The parent must determine whether the subsidiary is a VIE. If the subsidiary is not a VIE (or qualifies for one of the Variable Interest Models scope exceptions) other GAAP should be followed and presumably the parent should continue to consolidate the subsidiary based on its ownership of a majority of the subsidiarys outstanding voting stock. If, however, the subsidiary is a VIE, the Variable Interest Model must be applied, and the parent should consolidate the subsidiary only if the enterprise has (1) the power to direct activities of a VIE that most significantly impact the entitys economic performance and (2) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE.
Common arrangements/entities subject to the Variable Interest Models provisions

Question 4.1 What are examples of common arrangements/entities that are subject to the Variable Interest Models provisions? Entities subject to the Variable Interest Models provisions include corporations, partnerships, limitedliability companies, other unincorporated legal entities, majority-owned subsidiaries and grantor trusts. Examples of entities/arrangements that may involve VIEs and, accordingly, be subject to the Variable Interest Models provisions, include:6 Common examples Equity-method investees Franchises Single purpose insurance and reinsurance entities Investment companies Hedge funds Private equity funds Venture capital funds Mutual funds Entities used to facilitate product and inventory financing arrangements Vendor financing arrangements Research and development ventures Entities used to facilitate collaborative arrangements Entities receiving assets owned by related parties (including members of management and employees) through a sale or transfer
This list is not all-inclusive. 27
4 Scope
Entities used to facilitate leasing arrangements Build-to-suit arrangements Leases including lessee guarantees of asset values Leases including lessee purchase options Sale/Leasebacks Enhanced Equipment Trust Certificates Sale of property subject to operating leases Lot option deposits of homebuilders Land banks used by homebuilders Real estate partnerships Investment partnerships
Securitization vehicles Commercial paper conduits Collateralized Debt Obligations, Collateralized Bond Obligations and Collateralized Loan Obligations
Structures formerly known as qualified special-purpose entities (QSPEs) Entities used for tax-motivated structures Affordable housing partnerships Synthetic fuel partnerships Wind farms Trust preferred securities Grantor trusts Credit card master trusts
Limited-liability companies
Partnerships
Trusts
Entities used to facilitate residential and commercial mortgage-backed securities arrangements
Joint ventures
There are no exceptions for entities used by specific industries.
Portions of entities
Question 4.2 What does the Variable Interest Model mean when it refers to portions of entities or aggregations of assets within an entity, and what is the conceptual basis for excluding them from the scope of the Variable Interest Model? Prior to the FASBs introduction of the Variable Interest Model, a multi-purpose special-purpose entity (SPE) (e.g., a single SPE with a residual equity investment that owns multiple properties leased to a number of different lessees, each financed with the proceeds from nonrecourse financings that do not contain crosscollateral provisions) was determined to create multiple virtual SPEs because the nonrecourse debt with no cross-collateral provisions effectively segregated the cash flows and assets of the various leases. Each virtual SPE was evaluated for potential consolidation by the individual lessees. Application of this approach could have resulted in the recognition of the same asset and nonrecourse debt by both the lessor (because it has legal title to the asset and is the primary obligor of the debt) and the lessee (because a substantive capital investment was not at risk in the virtual SPE during the lease term). In its deliberations regarding consolidation of VIEs, the FASB decided that the same asset and same debt should not be recognized by multiple parties. Accordingly, the Variable Interest Model provides that a portion of an entity, such as a division, department or branch, is excluded from the Variable Interest Models scope unless the entire entity is a VIE. However, for VIEs in which an enterprise holds a variable interest in specified assets of an entity, an enterprise must treat its portion of the entity as a separate VIE if the specified assets are essentially the only source of payment for specified liabilities or specified other interests. (See the Interpretative guidance and Questions in Chapter 7 for a discussion of the silo provisions.)
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4 Scope
Illustration 4-1: Example 1
Portions of entities
Manufacturer X leases a building under an operating lease from Company Y, which is not a VIE. The lease contains a fixed price purchase option and a first dollar risk of loss residual value guarantee. Company Y finances 100% of its purchase of the asset with nonrecourse debt. Example 2 Company Y creates a separate legal entity that is a VIE to acquire an asset to be leased to Manufacturer X under the same terms as Example 1. The asset is financed entirely by nonrecourse debt. In Example 1, the nonrecourse debt effectively segregates the cash flows and the asset associated with the lease and, therefore, in substance creates a silo, or virtual SPE (as it was previously referred to) in Company Ys financial statements. This transaction is economically similar to Example 2, in which the leased asset and the debt are in a separate legal structure. In Example 1, because Company Y is not a VIE, and the Variable Interest Model prohibits a portion of a non-VIE from being treated as a separate entity, Manufacturer X is prohibited from evaluating the assets and liabilities under the lease for potential consolidation under the Variable Interest Models provisions. In contrast, in Example 2, the existence of a separate entity invokes the provisions of the Variable Interest Model. Because that entity is a VIE, Manufacturer X is required to determine whether it is the VIEs primary beneficiary. Because of the difference in legal form between the two transactions above, different accounting may result when the substance of the transaction is very similar.
Collaborative arrangements not conducted through a separate entity

Question 4.3 Do the Variable Interest Models provisions apply to collaborative arrangements between companies that, while established by contract, are not conducted through a separate legal entity (a so-called virtual joint venture)? No. The Variable Interest Models provisions apply only to legal structures used to conduct activities and to hold assets. If companies have established a contractual collaborative relationship, but have not formed a separate entity that is used to conduct the joint operations, the Variable Interest Models provisions do not apply. Illustration 4-2: Facts Two companies enter into a joint marketing arrangement. Each company agrees to collaboratively produce marketing materials and use their existing sales channels to market the products and services of the other. Each company contractually agrees to share a specified percentage of the revenues received from the sale of products and services made under the joint marketing arrangement to customers of the other company. However, no separate entity is established to conduct the joint marketing activities, and each company retains its own assets and continues to conduct its activities separately from the other. Analysis Although the companies have contractually agreed to the joint arrangement, because no separate entity has been established to conduct the joint marketing activities, the provisions of the Variable Interest Model should not be applied to the arrangement. Refer to ASC 808 for guidance on accounting for these arrangements. Collaborative arrangements
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4 Scope
Majority-owned entities
Question 4.4 Should an enterprise evaluate a majority-owned or wholly-owned entity as a potential VIE? All entities (as defined) are subject to the Variable Interests Model, including majority-owned and whollyowned entities. Accordingly, an enterprise should evaluate a majority-owned or wholly-owned entity to determine whether (1) the entity qualifies for one of the Variable Interest Models scope exceptions (see the Interpretative guidance and Questions below), (2) the entity is a VIE and (3) if the entity is a VIE, whether the enterprise is the primary beneficiary.7 Application of the Variable Interest Models provisions could result in an enterprise not consolidating a wholly owned subsidiary. For example, if an enterprise has formed an entity that has an equity investment that is insufficient to absorb its expected losses, the entity could be a VIE. If another variable interest holder in the entity (e.g., a service provider) has (1) the power to direct activities of a VIE that most significantly impact the entitys economic performance and (2) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE, then the enterprise would not be the primary beneficiary. In many cases, however, it will be clear that an enterprise is a majority-owned entitys primary beneficiary (if, in fact, the entity is a VIE), given its capital structure and corresponding rights with respect to decision-making (i.e., power). As a result, an enterprise would likely consolidate the majorityowned entity regardless of whether it is an entity evaluated for consolidation based on the ownership of voting interests or variable interests. While it still may be necessary to determine whether the entity is a voting interest entity or a VIE because of the differing disclosure requirements for each type of entity, the Variable Interest Model provides for relief from certain of its disclosures if (1) an enterprise holds a majority voting interest in an entity, (2) the entity meets the definition of a business in ASC 805 and (3) the entitys assets can be used for purposes other than the settlement of the entitys obligations. For further discussion, see the Interpretative guidance and Questions in Chapter 20 on disclosures.
Application of Variable Interest Model to tiered structures

Question 4.5 How should the Variable Interest Models provisions be applied to tiered structures? We believe the Variable Interest Model should be applied in a bottoms up manner in that the lowest tiered entity should be evaluated as a potential VIE for possible consolidation. Regardless of whether that entity is a VIE or is required to be consolidated by another entity (under either a voting or variable interest model), we believe the lowest tiered entitys variable interest holders have variable interests in only that entity; they do not have variable interests in a parent. We believe the parent should, in turn, be evaluated separately as a potential VIE by its own variable interest holders.
An enterprise with greater than 50% ownership in an entity will have a variable interest in that entity through its equity interest. 30
4 Scope
Illustration 4-3: Facts
Tiered structures
CompanyA 70% CompanyB

The balance sheets of Company A and Company B are as follows:
Company A Investment in Co. B $ 35 Other Assets 132 $ 167 Equity $ 167 $ 167 Securities Loans Company B $ 300 150 $ 450 Debt Equity $ 400 $ 50 $ 450
Assume Company B is determined to be a VIE and Company A is its primary beneficiary. Analysis We believe Company B first should be evaluated as a potential VIE. This example assumes that Company A is Company Bs primary beneficiary. Accordingly, Company A should consolidate Company B. In evaluating whether Company A is a VIE, we believe Company As standalone balance sheet without consolidation of Company B should be used. That is, Company A should be evaluated based on its own contractual arrangements without consideration of Company Bs financial position. In this case, Company As variable interest holders are its equity holders. Company Bs variable interest holders remain variable interest holders only in Company B and are not variable interest holders in Company A, even though Company A is required to consolidate Company B.
Fiduciary accounts, assets held in trust

Question 4.6 Are legal structures such as fiduciary accounts or assets held in trust (i.e., not in a separate legal entity) subject to the provisions of the Variable Interest Model? The provisions of the Variable Interest Model are applicable only to legal entities (as defined). If assets are held on behalf of others (by a trustee, for example), but not in a separate entity, the provisions of the Variable Interest Model would not apply.
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4 Scope
4.2
Scope exceptions
Consolidation Overall Scope and Scope Exceptions General 810-10-15-12 The guidance in this Topic does not apply in any of the following circumstances: a. b. c. d. e. An employer shall not consolidate an employee benefit plan subject to the provisions of Topic 712 or 715. [Subparagraph superseded by Accounting Standards Update No. 2009-16] [Subparagraph superseded by Accounting Standards Update No. 2009-16] Investments accounted for at fair value in accordance with the specialized accounting guidance in Topic 946 are not subject to consolidation according to the requirements of this Topic. A reporting entity shall not consolidate a governmental organization and shall not consolidate a financing entity established by a governmental organization unless the financing entity meets both of the following conditions: 1. 2. Is not a governmental organization. Is used by the business entity in a manner similar to a (VIE) in an effort to circumvent the provisions of the Variable Interest Entities Subsections.
Scope and Scope Exceptions Variable Interest Entities 810-10-15-13 The Variable Interest Entities Subsections follow the same Scope and Scope Exceptions as outlined in the General Subsection of this Subtopic, see paragraph 810-10-15-1, with specific transaction qualifications and exceptions noted below. 810-10-15-17 The following exceptions to the Variable Interest Entities Subsections apply to all legal entities in addition to the exceptions listed in paragraph 810-10-15-12: a. Not-for-profit entities (NFPs) are not subject to the Variable Interest Entities Subsections, except that they may be related parties for purposes of applying paragraphs 810-10-25-42 through 2544. In addition, if an NFP is used by business reporting entities in a manner similar to a VIE in an effort to circumvent the provisions of the Variable Interest Entities Subsections, that NFP shall be subject to the guidance in the Variable Interest Entities Subsections. Separate accounts of life insurance entities as described in Topic 944 are not subject to consolidation according to the requirements of the Variable Interest Entities Subsections. A reporting entity with an interest in a VIE or potential VIE created before December 31, 2003, is not required to apply the guidance in the Variable Interest Entities Subsections to that VIE or legal entity if the reporting entity, after making an exhaustive effort, is unable to obtain the information necessary to do any one of the following: 1. 2. 3. Determine whether the legal entity is a VIE Determine whether the reporting entity is the VIEs primary beneficiary Perform the accounting required to consolidate the VIE for which it is determined to be the primary beneficiary.
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b. c.
4 Scope
This inability to obtain the necessary information is expected to be infrequent, especially if the reporting entity participated significantly in the design or redesign of the legal entity. The scope exception in this provision applies only as long as the reporting entity continues to be unable to obtain the necessary information. Paragraph 810-10-50-6 requires certain disclosures to be made about interests in VIEs subject to this provision. Paragraphs 810-10-30-7 through 30-9 provide transition guidance for a reporting entity that subsequently obtains the information necessary to apply the Variable Interest Entities Subsections to a VIE subject to this exception. d. A legal entity that is deemed to be a business need not be evaluated by a reporting entity to determine if the legal entity is a VIE under the requirements of the Variable Interest Entities Subsections unless any of the following conditions exist (however, for legal entities that are excluded by this provision, other generally accepted accounting principles [GAAP] should be applied): 1. The reporting entity, its related parties (all parties identified in paragraph 810-10-25-43, except for de facto agents under paragraph 810-10-25-43(d)), or both participated significantly in the design or redesign of the legal entity. However, this condition does not apply if the legal entity is an operating joint venture under joint control of the reporting entity and one or more independent parties or a franchisee. The legal entity is designed so that substantially all of its activities either involve or are conducted on behalf of the reporting entity and its related parties. The reporting entity and its related parties provide more than half of the total of the equity, subordinated debt, and other forms of subordinated financial support to the legal entity based on an analysis of the fair values of the interests in the legal entity. The activities of the legal entity are primarily related to securitizations or other forms of asset-backed financings or single-lessee leasing arrangements.
2. 3.
4.
A legal entity that previously was not evaluated to determine if it was a VIE because of this provision need not be evaluated in future periods as long as the legal entity continues to meet the conditions in (d).
4.3
Interpretative guidance Scope exceptions general

Note: In February 2010, the FASB issued an Accounting Standards Update (ASU) primarily to address concerns with the application of Statement 167 for reporting enterprises in the asset management industry by deferring the effective date of Statement 167 for certain investment funds. As currently written, Statement 167 would have resulted in asset managers consolidating many hedge funds, private equity funds and other investment funds that they manage. Additionally, the ASU deferred the effective date of Statement 167 for money market funds (MMFs) that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940. For further discussion of this ASU, refer to Chapter 21. The FASB currently has a project on its agenda that would eliminate the deferral discussed above. In addition, the FASBs tentative decisions would modify the Variable Interest Models provisions for evaluating an enterprise as a principal or an agent (see Chapter 6) and the provisions for evaluating the substance of kick-out rights and participating rights (see Chapters 9 and 14), among other things. Readers should monitor developments in this area closely. The FASB decided to provide certain limited scope exceptions to enterprises applying the Variable Interest Model.
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4 Scope
Analogies to the scope exceptions

Question 4.7 May analogies be made to Variable Interest Models scope exceptions? We believe that it is inappropriate to analogize to the scope exceptions. That is, unless a specific scope exception exists, a legal entity (as defined by ASC 810-10) is subject to all of the provisions of the Variable Interest Model.
Eligibility for scope exceptions in applying the Variable Interest Model upon adoption of Statement 167s amendments to ASC 810-10
Question 4.8 Should an enterprise evaluate its eligibility to apply a scope exception for entities with which it is involved upon the adoption of Statement 167s amendments to the Variable Interest Model (which are effective 1 January 2010 for calendar year-end companies)? Yes. In adopting the amendments to the Variable Interest Model in ASC 810-10, an enterprise should assume that those amendments have always been effective. The determination of whether an entity is a VIE and which enterprise, if any, is the VIEs primary beneficiary should be made as of the date the enterprise first became involved with the entity. That conclusion should then be reevaluated when events requiring reconsideration of the entitys status as a VIE or when a change in the primary beneficiary would have occurred under the Variable Interest Model. Therefore, we believe that making the determination of whether an entity with which the enterprise is involved is a VIE requires the enterprise to evaluate whether any of the Variable Interest Models scope exceptions are applicable. Generally with respect to the scope exceptions, we believe that the historical conclusions reached will be consistent with the conclusions reached upon the adoption of Statement 167s amendments to the Variable Interest Model. That is, aside from the QSPE scope exception, an entity that previously qualified for a scope exception to the Variable Interest Model likely will qualify for a scope exception upon adoption of the amendments. This is because the amendments did not modify the scope exceptions, except with respect to QSPEs. See Question 4.14 for a discussion of QSPEs.
4.4
Interpretative guidance Employee benefit plans

An employer should not consolidate its sponsored employee benefit plans that are subject to the provisions of ASC 712 or 715 as a result of applying the Variable Interest Model. Other parties with variable interests in employee benefit plans (e.g., trustees, administrators, etc.) should evaluate these entities as potential VIEs.
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4 Scope
Applicability of the Variable Interest Model to employee benefit plans

Question 4.9 Should an employee benefit plan apply the provisions of the Variable Interest Model? The financial statements of defined benefit plans generally are prepared pursuant to ASC 960. The financial statements of defined contribution plans and other employee health and welfare benefit plans generally are prepared pursuant to the AICPA Audit and Accounting Guide, Audits of Employee Benefit Plans. Historically, employee benefit plans generally have not applied consolidation guidance. Historical guidance has specified that it was directed primarily to business enterprises organized for profit. We understand from discussions with the FASB staff that it was not the FASBs intent to broaden the applicability of the consolidation guidance in ASC 810 through the establishment of the Variable Interest Model such that it would apply to the financial statements of employee benefit plans. Accordingly, we do not believe that an employee benefit plan should apply the Variable Interest Model.
Employee benefit plans not subject to ASC 712 or 715

Question 4.10 Are all employee benefit plans not subject to ASC 712 or 715 subject to the scope of the Variable Interest Model? While employee benefit arrangements not subject to ASC 712 or 715 must consider the Variable Interest Model, we believe a trust that holds assets to cover benefits under a health and welfare benefit plan (e.g., a voluntary employees benefit association or a 501(c)(9) trust) is not to be consolidated by an employer. While the employers accounting for health and welfare benefit plans is not in the scope of ASC 712 or 715, the AICPA Accounting and Auditing Guide, Audits of Employee Benefit Plans, uses certain of those standards measurement concepts. While we generally believe that analogies to the Variable Interest Models scope exceptions are not appropriate, we do not believe the FASB intended to include a trust holding assets under a health and welfare benefit plan in the scope of the Variable Interest Model. We understand the FASB staff shares our view.
Employee stock ownership plans

Question 4.11 Is an ESOP subject to consolidation by its sponsor as a VIE? An employee stock ownership plan (ESOP) is a compensation/benefit vehicle used to transfer a companys (the Sponsors) shares to its employees on a tax-deferred basis. An ESOP is a special type of a tax-qualified defined contribution retirement plan. ESOPs can be established to compensate employees, provide the means for a Sponsor to match contributions to a 401(k) plan, or even as an exit vehicle for a retiring founder. ESOP structures also vary in the type of stock held (i.e., either the Sponsors common shares or its convertible preferred stock). ESOPs can be leveraged or nonleveraged. In a nonleveraged ESOP, the ESOP receives shares from the Sponsor, usually annually, which are immediately allocated to specific employee accounts. Those shares remain in the ESOP until they are distributed to the employees, generally at termination or retirement. Vesting requirements often exist, which provide that if the employee terminates his employment with the company prior to a specified date, his shares are redistributed to the other participants or applied to reduce the Sponsors next contribution. The shares may not be returned to the Sponsor.
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4 Scope
A leveraged ESOP issues debt and uses the proceeds to buy shares either from the Sponsor or the market. All the shares are initially unallocated (or are in suspense) but then become released to specific employee accounts as the ESOP makes its debt service payments. Vesting provisions often also are applied. As such, a leveraged ESOP typically has three types of shares at any point in time: unallocated shares in the suspense account, allocated but unvested shares and vested shares. A leveraged ESOP can either borrow externally (e.g., from a bank or other lender) or internally from the Sponsor. In either case, however, the ESOP has no source of funds for debt service other than dividends (if any) on the shares held. It must rely, therefore, on the Sponsors subsequent contributions to provide the necessary funding. The Variable Interest Model provides a scope exception to an employer for its employee benefit plans subject to the provisions of ASC 712 or 715. Nonleveraged ESOPs are defined contribution pension plans covered by ASC 715. ASC 718 includes guidance on nonleveraged ESOPs that is generally consistent with the guidance for defined contribution plans in ASC 715. Accordingly, we believe that nonleveraged ESOPs are excluded from the scope of the Variable Interest Model for their sponsors. The guidance for accounting for leveraged ESOPs in ASC 718 is not consistent with the guidance for defined contribution plans in ASC 715 (because vesting is not a factor in recognizing compensation costs for defined contribution plans under ASC 715, and ASC 718 provides accounting models for when shares are to be credited to unearned ESOP shares and the measurement of compensation). However, because leveraged ESOPs are a form of defined contribution plan and ASC 718 provides detailed clarifying guidance for leveraged ESOPs, we believe an employer should not evaluate a leveraged ESOP for potential consolidation pursuant to the Variable Interest Model.
Deferred compensation trusts

Question 4.12 Does a rabbi trust have to apply the Variable Interest Model? We generally believe a rabbi trust will be a VIE. A rabbi trust that is not a VIE should be consolidated pursuant to ASC 710-10-45. If it is determined that a rabbi trust should not be consolidated, an enterprise should evaluate whether financial assets that are transferred to a rabbi trust should be derecognized in accordance with the provisions of ASC 860. Certain deferred compensation arrangements allow amounts earned by employees to be invested in the stock of the employer or other assets and placed in a rabbi trust. A rabbi trust is a funding vehicle sometimes used to protect promised deferred executive compensation benefits from events other than bankruptcy. A rabbi trust protects the funded benefits against hostile takeover ramifications and disagreements with management, but not against the claims of general creditors if bankruptcy occurs. This important, although not all-inclusive, protection is provided while deferring income taxes for the employees. We generally believe a rabbi trust will be a VIE because the rabbi trust has no equity (it has a liability to the employees). In those situations in which a rabbi trust is determined to have equity, that rabbi trust also will be a VIE because the equity investment is not at risk pursuant to ASC 810-10-15-14(a)(3), and the employer provided the equity investment to the employee. As discussed in Question 9(a).9, equity interests provided in exchange for services generally are not considered to be at risk. Because a rabbi trust generally will be a VIE, an enterprise (the employer) must consider whether it has (1) the power to direct activities of a rabbi trust that most significantly impact its economic performance and (2) the obligation to absorb losses or the right to receive benefits from a rabbi trust that could potentially be significant to the rabbi trust.
4 Scope
In most circumstances, we believe that the employer will be the primary beneficiary. The decisions that most significantly impact the economic performance of a rabbi trust will be those involving the funding of the trust and the investment strategy. While the employee may indicate a desired strategy, we generally believe that the investment decisions of a rabbi trust rest with the employer. In addition, decisions involving funding of the trust rest with the employer. As a result, the employer has the power to make decisions that most significantly impact the economic performance of the rabbi trust. In addition, the employer has benefits that could be potentially significant to the economic performance of the trust by virtue of its contingent call option on the rabbi trusts assets in the event of the employers bankruptcy. Because plans and trust agreements vary, careful consideration of the specific terms and conditions is required before applying the Variable Interest Model.
Service providers to employee benefit plans

Question 4.13 Should service providers evaluate employee benefit plans as potential VIEs subject to consolidation pursuant to the Variable Interest Model? Yes. Only sponsoring employers are not required to apply the Variable Interest Model to their employee benefit plans that are subject to the provisions of ASC 712 or 715. Others parties with variable interests in employee benefit plans, such as investment advisors and plan administrators, should evaluate their interests as the scope exception does not apply to other variable interest holders in the plan.
4.5
Interpretative guidance Qualifying special-purpose entities

Statement 166 (primarily contained within ASC 860) eliminated the concept of a qualifying special purpose entity (QSPE) from ASC 860. As a result of these amendments, the Variable Interest Model was amended to eliminate the original scope exception for QSPEs. Thus, all QSPEs will be evaluated for consolidation regardless of when the transactions were entered into. As most QSPEs meet the definition of a VIE, many QSPEs will be subject to the Variable Interest Model on Statement 167s effective date.
Impact of the elimination of the QSPE scope exception

Question 4.14 How is an enterprise that has historically availed itself of the Variable Interest Models QSPE scope exception affected by the adoption of the amendments to ASC 810-10? Statements 166 and 167 eliminated the concept of a QSPE from ASC 860 and the Variable Interest Model, respectively. As a result of these amendments, the scope exception is no longer available. Thus, all QSPEs should be evaluated for consolidation regardless of when the entity was formed and related transactions were entered into. As most QSPEs meet the definition of a VIE, many QSPEs will be subject to the consolidation provisions under the Variable Interest Model. Under Statement 167, the consolidation assessment should be made as of an enterprises initial involvement with an entity.
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4 Scope
4.6
Interpretative guidance Investment companies

Entities subject to SEC Regulation S-X Rule 6-03(c)(1) are not to consolidate any entity that is not also subject to that same rule. The following entities generally are subject to SEC Regulation S-X Rule 603(c)(1), and thus should not consolidate any entity that is not an investment company. This list is not all-inclusive, and each entity should be carefully evaluated to determine whether it is subject to that SEC Regulation. Regulated Investment Companies Unit Investment Trusts Small Business Investment Companies Business Development Companies
Additionally, investments accounted for at fair value in accordance with the specialized accounting guidance in ASC 946 are not subject to consolidation according to the requirements of the Variable Interest Model. The FASB currently has a project on its agenda to amend ASC 946 to modify the definition of an investment company (i.e., the scope of ASC 946), which could change which enterprises are eligible to apply investment company accounting. Readers should monitor developments in this area closely.
Variable interests in investment companies

Question 4.15 Does the investment company scope exception apply only to investments made by investment companies or do they also apply to investors in, and service providers to, investment companies? The scope exception is applicable only to investments accounted for at fair value in accordance with the specialized accounting guidance in ASC 946. Investment companies, themselves, may be subject to consolidation as VIEs. An enterprise investing in, or providing services to, an investment company must determine if the investment company is a VIE, and, if so, whether it should consolidate the investment company as its primary beneficiary (refer to Chapter 21 for discussion of the deferral of the amendments to the Variable Interest Model for certain investment funds). The FASB currently has a project on its agenda to amend ASC 946 to modify the definition of an investment company (i.e., the scope of ASC 946), which could change which enterprises are eligible to apply investment company accounting. Readers should monitor developments in this area closely.
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4 Scope
Investment company scope exception
Assume that ABC, Inc., which is not an investment company, has an investment in RIC, a registered investment company subject to SEC Regulation S-X Rule 6-03(c)(1) that accounts for its investments in accordance with ASC 946. RIC is a VIE, and ABC, Inc. is the primary beneficiary. RIC has only three investments, in Company A, Company B and Company C. Although not required, if ABC, Inc. were to evaluate each investee of RIC to determine if it is a VIE, assume ABC, Inc. concludes the following:
VIE? Company A Company B Company C No Yes Yes Is RIC primary beneficiary? Not applicable Yes No
Analysis Although RIC is the primary beneficiary of a VIE (Company B), it would not consolidate Company B. Because RIC applies the guidance in ASC 946, it is exempt from applying the Variable Interest Model provisions. However, RIC should be consolidated by ABC, Inc. because RIC is a VIE and ABC, Inc. is its primary beneficiary. Pursuant to ASC 810-10-25-15, ABC, Inc. would retain in its consolidated financial statements the specialized accounting followed by RIC. That is, because RIC is provided a scope exception from applying the Variable Interest Model, ABC, Inc. would not be required to evaluate RICs investments in Company A, Company B or Company C as potential variable interests requiring consolidation of those companies. Refer to Question 4.16 for further discussion of the status of ASC 810-10-25-15.
Investment company scope exclusion

Question 4.16 How should the Variable Interest Models investment company exclusion be applied upon the effective date of SOP 07-1 (pending content that links to ASC 946-10-65-1)? At the time of this publication, the FASB has deferred SOP 07-1s provisions indefinitely. Additionally, in The FASB currently has a project on its agenda to amend ASC 946 to modify the definition of an investment company (i.e., the scope of ASC 946), which could change which enterprises are eligible to apply investment company accounting and supersede SOP 07-1s provisions. Readers should closely monitor developments in this area. Accordingly, the guidance in the response to this question would not be applicable other than in the rare cases where SOP 07-1s provisions were adopted before its deferral. Background SOP 07-1 provides guidance for determining whether (1) an entity is within the scope of ASC 946 and (2) the specialized industry accounting principles should be retained by a parent company in consolidation (and equity method investors). As such, SOP 07-1 supersedes for investment companies ASC 810-10-25-15, which generally provides that the specialized industry accounting principles applied at the subsidiary should be retained in consolidation.
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4 Scope
If the specialized accounting in ASC 946 is not to be retained by a non-investment company parent or equity method investor of an investment company, the parent company or equity method investor must apply the Variable Interest Models provisions to investments held by the investment company in the parents or equity-method investors financial statements. Illustration 4-5: Investment company scope exclusion under SOP 07-1
Example 2
Example 1
Non-investment company reporting entity
Investment company reporting entity
Investment company
Investee
Investee
If the reporting entity in Example 1 meets the definition of an investment company pursuant to SOP 07-1 (and is therefore within its scope), it is not required to apply the Variable Interest Models provisions. If the investee was also an investment company, the reporting entity must determine whether to consolidate the investment company investee. However, the Variable Interest Model should not be used in making that determination. In Example 2, the non-investment company reporting entity is required to apply the Variable Interest Models provisions to determine whether it should consolidate the investment company. If consolidation of the investment company were required, a separate evaluation must be made as to whether investment company accounting should be retained by the reporting entity. If investment company accounting is retained by the reporting entity, the reporting entity would not apply the Variable Interest Model to the investment companys investees. However, if investment company accounting is not retained by the reporting entity, the Variable Interest Model must be applied to each of the investees to determine whether they should be consolidated based on their voting or variable interests in the consolidated financial statements of the non-investment company reporting entity. Effective date and transition SOP 07-1s provisions have been deferred indefinitely. However, the above guidance would apply if SOP 07-1 was adopted before its deferral.
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4 Scope
4.7
Interpretative guidance Governmental entities

The Variable Interest Model provides that an enterprise shall not consolidate a governmental organization. Additionally, an enterprise shall not consolidate a financing entity established by a governmental organization, unless the financing entity is not a governmental organization itself and is used by the business enterprise in an effort to circumvent the Variable Interest Models consolidation provisions.
Could an enterprise be required to consolidate a governmental entity?

Question 4.17 An enterprise may have a variable interest in a governmental entity (e.g., an operating lease with a municipality containing a residual value guarantee). Could the governmental entity be a VIE that is subject to potential consolidation by the enterprise? A governmental entity (e.g., a state or local governmental agency, airport authority, etc.) should not be evaluated as a potential VIE that could be consolidated pursuant to Variable Interest Model. However, certain entities formed by governmental entities (e.g., municipal bond trusts formed by economic development authorities) may be potential VIEs that are subject to consolidation (see Question 4.19).
Could governmental entities consolidate VIEs?

Question 4.18 Could a governmental entity consolidate a VIE pursuant to the Variable Interest Model? Governmental entities following accounting standards issued by the Governmental Accounting Standards Board (GASB) are not required to apply the provisions of the Variable Interest Model, unless they have elected to apply standards issued by the FASB under GASB 20. However, a governmental entity may have a variable interest in a VIE. When determining whether an entity is a VIE which may be consolidated by a non-governmental enterprise, variability should be ascribed to that variable interest.
Governmental financing vehicles

Question 4.19 Are financing vehicles formed by governmental entities (e.g., municipal bond trusts) subject to the scope of the Variable Interest Model? The Variable Interest Model provides that a financing entity formed by a governmental organization should not be consolidated by an enterprise, unless the financing entity itself is not a governmental organization and is used by the enterprise in a manner similar to a VIE in an effort to circumvent its provisions. The AICPA Audit and Accounting Guide, Audits of State and Local Governments (GASB 34 Edition), defines a governmental entity as having one or more of the following characteristics: Popular election of officers or appointment (or approval) of a controlling majority of the members of the organizations governing body by officials of one or more state or local governments; The potential for unilateral dissolution by government with the net assets reverting to a government; or The power to enact and enforce a tax levy.
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Furthermore, entities are presumed to be governmental if they have the ability to issue directly (rather than through a state or municipal authority) debt that pays interest exempt from federal taxation. However, entities possessing only that ability (to issue tax-exempt debt) and none of the other governmental characteristics may rebut the presumption that they are governmental entities if their determination is supported by compelling, relevant evidence. A governmental agency may form a separate entity (such as a municipal bond trust) for the specific purpose of allowing an enterprise to obtain lower cost financing (generally due to tax benefits provided to investors) as an incentive to have the enterprise invest in an economically distressed area, or to serve some specific public purpose. Although governmental entities are not subject to consolidation under the Variable Interest Model, we believe that a separate financing vehicle formed by a governmental agency for the purpose of assisting an enterprise in obtaining lower cost financing will not necessarily be a governmental entity, based on the characteristics above. However, in order to be subject to the Variable Interest Model, a financing vehicle formed by a governmental entity must also be used by the enterprise in a manner similar to a VIE in an effort to circumvent the application of the Variable Interest Model. We believe the SEC staff is applying scope exceptions somewhat literally. Accordingly, we believe that it would be difficult to justify how an entity that issues debt that pays interest exempt from federal taxation could be used to circumvent consolidation provisions. That is, we believe that it would be difficult to assert that a financing vehicle that met the requisite criteria to issue tax-exempt debt was used to circumvent consolidation without calling into question whether the financing vehicle should continue to have the ability to issue debt with preferential tax treatment. Accordingly, while the evaluation as to whether this scope exception is applicable should be based on consideration of all the relevant facts and circumstances, we believe an entity that issues debt that pays interest exempt from federal taxation generally will not be subject to the Variable Interest Models provisions.
4.8
Interpretative guidance Not-for-profit organizations

A not-for-profit organization should not evaluate an entity for consolidation under the Variable Interest Model. Rather, not-for-profit organizations should evaluate entities for consolidation using the guidance provided in ASC 958-810. Additionally, a for-profit enterprise should not evaluate a not-for-profit organization for consolidation under the Variable Interest Model, but should consider the other consolidation guidance in ASC 810. When the Variable Interest Model was first introduced, the FASB provided a scope exception for not-forprofit organizations evaluating entities for consolidation because traditional consolidation literature referred only to business enterprises. The FASB did not believe it was appropriate to extend the Variable Interest Model to not-for-profit organizations evaluating entities for consolidation because the consolidation literature did not specifically apply to such organizations. The FASB did acknowledge, however, that some of the requirements in ASC 810-10 (outside of the Variable Interest Model) are applied by certain not-for-profit organizations and did not intend for the Variable Interest Model to result in a change in those practices. Although the FASB provided a scope exception for all not-for-profit organizations being evaluating for consolidation, if it is concluded that, based on the individual facts and circumstances, a not-for-profit organization is being used to circumvent the Variable Interest Model (e.g., a not-for-profit established solely to lease an asset to a commercial enterprise in a structured transaction), that not-for-profit organization should be subject to evaluation for consolidation under the Variable Interest Model.
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4 Scope
Not-for-profit organizations used to circumvent consolidation

Question 4.20 How should the provisions above stating, [i]n addition, if a not-for-profit entity is used by business enterprises in a manner similar to a variable interest entity in an effort to circumvent the provisions of this Interpretation, that not-for-profit entity shall be subject to this Interpretation be applied? If it is concluded that, based on the individual facts and circumstances, a not-for-profit organization is being used to circumvent the Variable Interest Model, the not-for-profit organization that would otherwise be excluded from the scope should be evaluated pursuant to the Variable Interest Model. For example, assume Company A leases a building from a VIE (lessor) and concludes that, by applying the Variable Interest Model, it is the VIEs primary beneficiary. As a result, Company A restructures the lease so Company As charitable foundation becomes the lessee and Company A enters into a sublease with the foundation that is an operating lease pursuant to ASC 840. Because the charitable foundation is being used by Company A to avoid consolidating the VIE (lessor), the charitable foundation is subject to the Variable Interest Model (and Company A would look through the foundation and consolidate the VIE). We understand, generally, that the SEC staff is applying the not-for-profit scope exception somewhat literally. For example, certain enterprises may contract with state or local governmental agencies to provide certain services in a defined geographical area. The governmental agencies may be statutorily prohibited from contracting for such services with other than not-for-profit organizations. In order to conduct its business operations, the enterprise may form a not-for-profit organization to contract directly with the governmental agencies. The not-for-profit organization has no other activities, and employees of the enterprise comprise the majority of the not-for-profit organizations board membership. Concurrently, the enterprise enters into a management agreement with the not-for-profit organization to effectively outsource the provision of the services from the not-for-profit organization to the enterprise. The fees charged to the not-for-profit organization by the enterprise approximate the fees charged to the governmental agency by the not-for-profit organization. The outsourcing contract is structured in such a way that the not-for-profit organization continues to qualify as such under the Internal Revenue Code. We understand the SEC staff would weigh heavily the fact that, because the notfor-profit organization was not formed in an attempt to circumvent the provisions of the Variable Interest Model, the scope exception is applicable and the enterprise should not consolidate the not-for-profit organization, even though the not-for-profit organization exists solely to allow the enterprise to conduct its for-profit business activities.
Not-for-profit organizations as related parties

Question 4.21 May a not-for-profit organization be considered an enterprises related party in determining a VIEs primary beneficiary? Yes. If a not-for-profit organization holding a variable interest in a VIE is a related party to an enterprise that also holds a variable interest in the same VIE, the interests of the not-for-profit organization should be aggregated with that of the enterprise if considering the related party provisions of the Variable Interest Model is necessary (i.e., no party with a variable interest in the VIE individually has power). A notfor-profit organization could be an enterprises related party if, for example, the enterprise contributed the variable interest to the not-for-profit organization. See the Interpretative guidance and Questions in Chapters 15-16 regarding the Variable Interest Models related party provisions for further discussion.
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4 Scope
4.9
Interpretative guidance Separate accounts of life insurance enterprises

Separate accounts of life insurance enterprises, as described in ASC 944, are not subject to the Variable Interest Models consolidation provisions. Certain provisions within ASC 944 specifically require life insurance enterprises to recognize assets and liabilities held in separate accounts. The FASB chose not to change those requirements without a broader reconsideration of accounting by insurance enterprises, which was beyond the scope of the Variable Interest Model project. Refer to Question 15.5 for guidance on how an insurance enterprise should consider investments held by a separate account in the insurance enterprises consolidation analysis of the underlying investee.
4.10
Interpretative guidance Information availability

Some entities that are potential VIEs created before 31 December 2003 may not have included provisions in their organizational and other documents assuring that all parties involved would have access to information required to apply the Variable Interest Model. Therefore, an enterprise with an interest in an older entity may be unable to obtain information to (a) determine whether the entity is a variable interest entity, (b) determine whether the enterprise is the primary beneficiary of the entity or (c) consolidate the variable interest entity for which it is determined to be the primary beneficiary. Consequently, an enterprise is not required to apply the provisions of the Variable Interest Model to entities created before 31 December 2003, if the enterprise is unable to obtain information necessary to (a) determine whether the entity is a variable interest entity, (b) determine whether the enterprise is the entitys primary beneficiary or (c) perform the accounting required to consolidate the entity. To qualify for this scope exception, the enterprise must have made and must continue to make exhaustive efforts to obtain the information. The scope exception applies to individual variable interest entities or potential variable interest entities, not to a class of entities if information is available for some members of the class. The FASB believes situations to which this scope exception will apply will be infrequent, particularly when the company was involved in creating the entity. Additionally, the exception will be applicable only until the necessary information is obtained, at which point the provisions of the Variable Interest Model will apply. Companies utilizing the scope exception have a continuing obligation to attempt to obtain the necessary information. ASC 810-10 does not provide guidance on what constitutes exhaustive efforts. Determining when exhaustive efforts have occurred without successfully obtaining the required information will be based on the applicable facts and circumstances. Companies wishing to avail themselves of this scope exception should be prepared to document the efforts that have been undertaken to obtain the necessary information.
Lack of information necessary to apply the Variable Interest Models provisions

Question 4.22 Some arrangements that are potential VIEs created before the issuance of FIN 46(R) may not have included provisions assuring that parties involved would have access to information required to apply the Variable Interest Model. How should scope exceptions for these arrangements be considered? An enterprise is not required to apply the Variable Interest Model to entities created before 31 December 2003, if the enterprise is unable to obtain information necessary to (a) determine whether the entity is a variable interest entity, (b) determine whether the enterprise is the primary beneficiary or (c) perform the accounting required to consolidate the entity.
4 Scope
To qualify for this scope exception, the enterprise must have made and must continue to make exhaustive efforts to obtain the information. The scope exception applies to individual variable interest entities or potential variable interest entities, not to a class of entities if information is available for some members of the class. Additionally, the exception applies only until the necessary information is obtained, at which point the Variable Interest Models provisions would apply. Companies utilizing the scope exception have a continuing obligation to attempt to obtain the information necessary to perform the evaluation of whether the entity is a VIE and, if so, whether the enterprise is the primary beneficiary. We understand that the SEC staff believes that when making a determination of when an entity was created, consideration should be given as to whether the entity was created and began substantive operations prior to 31 December 2003. The SEC believes that the exception should not be applied to an entity whose legal structure was merely formed prior to that date, but began substantive operations or was reconfigured after 31 December 2003 in such way that the creation date of the entity is not relevant. We also believe that the scope exception should not be applied to entities that were created prior to 31 December 2003 and had substantive operations, if the entity became dormant and was reactivated at a date subsequent to 31 December 2003. We believe that it is inappropriate for an enterprise to apply this scope exception if a significant amount of information about an entity is known by the enterprise, and reasonable assumptions can be made about the unknown information necessary to apply the provisions. If material, disclosures should be made regarding the assumptions used. The FASB expects that the use of this scope exception will be infrequent, particularly if the enterprise was involved in creating or restructuring the VIE or potential VIE. We understand that the SEC staff also believes that the use of this exception should be infrequent and limited to the aforementioned types of situations. An enterprise holding a variable interest in another entity that exposes it to substantial risks would normally obtain information about that entity to monitor its exposure (even if the exposure is limited). If this scope exception has been applied and the information subsequently becomes available, the Variable Interest Model must be applied at that time. If the enterprise determines that the entity is a VIE and it must consolidate the entity as its primary beneficiary, it initially should consolidate the entity through a cumulative catch-up adjustment (see the Interpretative guidance and Questions in Chapter 21). ASC 810-10 does not provide guidance on what constitutes exhaustive efforts. Determining when exhaustive efforts have occurred without successfully obtaining the required information will be based on the applicable facts and circumstances. Companies wishing to avail themselves of this scope exception should be prepared to document the efforts that have been undertaken to obtain the necessary information. In determining whether an entity has inappropriately applied this scope exception, we understand that the SEC staff intends to consider all relevant facts and circumstances, including whether registrants operating in the same industry with similar types of arrangements were able to obtain the required information. The SEC staff will address whether this scope exception has been inappropriately applied on a case-by-case basis, as discussed in a December 2003 speech. Note that the references to FIN 46 in the following speech equate to the Variable Interest Model in the ASC.
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4 Scope
Speech excerpts by Eric Schuppenhauer

2003 AICPA National Conference on Current SEC Developments Scope Exception for Lack of Information In its redeliberations [yesterday], the FASB decided to provide enterprises with an exception from applying the Interpretation if such enterprise has an interest in a variable interest entity or potential variable interest entity created before December 31, 2003, if the enterprise, after making an exhaustive effort, is unable to obtain the information necessary to do what is required to apply FIN 46. Our understanding was that this scope exception was provided in response to concerns raised by constituents that they were unable to obtain the information to apply FIN 46 to entities in existence prior to the effective date of FIN 46 because of legal or other barriers, such as privacy laws in foreign jurisdictions. It was intended for those situations and should be limited to those situations. In this regard, I would like to make a few observations. First, the scope exception only applies to an enterprise with an interest in a variable interest entity or potential variable interest entity created before December 31, 2003. For instance, in making a determination whether to apply the scope exception, registrants should carefully consider whether the entity was really created prior to December 31st or was merely in existence prior to that date and reconfigured in such a way that the creation date of the legal entity is not relevant. For instance, if an entity was inactive for a number of years and then re-activated after December 31st to carry out new activities and issue new variable interests, the staff would consider the use of the information scope exception abusive. Second, the staff has begun to contemplate the meaning of an exhaustive effort in applying this limited scope exception. Consistent with the thoughts of the FASB, as expressed in the modifications to FIN 46, the staff anticipates that the use of the exception will be infrequent. We plan to deal with instances where the information scope exception is being applied on a case-by-case basis, considering all of the relevant facts and circumstances. In assessing those facts and circumstances, the staff can be expected to consider whether registrants operating in the same industry with similar types of arrangements were able to obtain the requisite information. The SEC staff in December 2004 expanded on its views about use of the scope exception for lack of information. Note that the references to FIN 46(R) in the following speech equate to the Variable Interest Model in the ASC.
Speech excerpts by Jane D. Poulin

2004 AICPA Conference on SEC and PCAOB Developments While the staff recognizes that FIN 46R is a challenging area, it is a companys responsibility to prepare financial statements in accordance with GAAP. The staff believes that an investor has the same responsibility for analyzing whether to consolidate a variable interest entity, and for preparing financial statements in which a variable interest entity is consolidated, as they do in the case of a voting interest entity. FIN 46R only includes an information out for enterprises involved in entities created prior to December 31, 2003. We, therefore, expect that all the information necessary to make a FIN 46R assessment and, if required, to consolidate a variable interest entity is available for entities created after December 31, 2003. Additionally, in those cases where a company believes they can avail themselves of the information out for entities created before December 31, 2003, companies should be prepared to support how you have satisfied the exhaustive efforts criterion.
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4 Scope
4.11
Interpretative guidance Certain businesses

The Variable Interest Model provides for a scope exception based on whether the entity is a business and, if so, the relationship of the enterprise to the entity (i.e., the extent to which the entity receives financing from the reporting enterprise and its related parties and the extent to which the entitys activities involve or are conducted on behalf of the reporting enterprise and its related parties). The business scope exception lists conditions that, if met, would obviate the need for further analysis and application of the Variable Interest Model.
Business scope exception

Question 4.23 What constitutes a business that is eligible for the scope exception from having to apply the Variable Interest Model (assuming the other conditions described in ASC 810-10-15-17(d) are met)? ASC 805 provides guidance for determining what constitutes a business for purposes of applying the scope exception. ASC 805 defines a business as an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants. Historically, the definition of a business required all three elements: inputs, processes and outputs. The definition in ASC 805 does not require outputs for an integrated set of activities and assets to qualify as a business. Rather, it is the combination of inputs and processes that together are or will be used to create outputs. Under ASC 805, the determination of whether an integrated set of activities and assets is a business is based on whether the integrated set of activities and acquired assets is capable of being conducted and managed for the purpose of providing a return Thus, an acquired set of assets does not, under ASC 805, need to include all of the inputs or processes that the seller used in operating that set of assets to constitute a business. If a market participant, as defined in ASC 820, is capable of utilizing the acquired set of assets to produce outputs, for example, by integrating the set of assets with its own inputs and processes, then the acquired set of assets might constitute a business. In other words, in evaluating whether a particular set of assets and activities is a business, it would not be relevant whether the seller had historically operated the transferred set as a business or whether the acquirer intends to operate the transferred set as a business. The term capable of is sufficiently broad and will require significant judgment assessing whether an acquired set of activities and assets constitutes a business. As implied above, because outputs are not required to be present at the acquisition date, one consequence of the expanded definition of a business in ASC 805 is that development stage enterprises might qualify as businesses. In these situations, various factors will need to be assessed to determine whether the transferred set of assets and activities is a business, including whether the entity: (1) has commenced the anticipated principal activities, (2) has employees and other inputs and processes that can be applied to those inputs, (3) is pursuing a plan to produce outputs and (4) has the ability to obtain access to customers that will purchase those outputs. However, not all of these factors need to be present in order for an entity to be a business. Refer to our Financial reporting developments publication, Business combinations, for further discussion of the definition of a business.
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4 Scope
Determining whether a variable interest holder participated significantly in the design or redesign of the entity
Question 4.24 A holder of a variable interest in an entity that is a business, as defined by ASC 805, is eligible for a scope exception from applying the Variable Interest Model if the variable interest holder and its related parties did not participate significantly in the design or redesign of the entity (among other conditions). How should a variable interest holder determine whether it significantly participated in designing or redesigning the entity? We believe an enterprise holding a variable interest in an entity generally should be deemed to have significantly participated in the design or redesign of the entity, and the business scope exception should not be applied, if any of the following criteria are met: The entity was initially formed as a wholly- or majority-owned subsidiary of the enterprise or its related parties (excluding de facto agents as that term is defined by the Variable Interest Model see Chapter 15 for further discussion). The enterprise or its related parties (excluding de facto agents) held a significant variable interest in the entity at or shortly after the entitys formation or redesign. The entity was formed or restructured by others on behalf of the enterprise or its related parties (excluding de facto agents). If the enterprise or its related parties acquire a significant variable interest in an entity shortly after formation, this may indicate that the entity was formed on its behalf. Determining if the entity was formed on behalf of the enterprise will be based on the applicable facts and circumstances and will require the use of professional judgment.
We believe that the reference to the design or redesign of the entity refers to the legal structure, including ownership of variable interests in the entity, nature of the variable interests and the nature of the entitys activities. If an entitys operations are significantly revised, this should be considered a redesign of the entity, even if the ownership of variable interests or the legal structure of the entity is not substantially changed. The determination of whether a variable interest holder participated significantly in the design or redesign of an entity should be based on consideration of all relevant facts and circumstances.
Joint venture scope exception

Question 4.25 When evaluating eligibility for the business scope exception, how should an enterprise determine if it holds a variable interest in an operating joint venture that it jointly controls? ASC 323-10-20 defines a corporate joint venture as a corporation owned and operated by a small group of entities (the joint venturers) as a separate and specific business or project for the mutual benefit of the members of the group. A government may also be a member of the group. The purpose of a corporate joint venture frequently is to share risks and rewards in developing a new market, product or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities. A corporate joint venture also usually provides an arrangement under which each joint venturer may participate, directly or indirectly, in the overall management of the joint venture. Joint venturers thus have an interest or relationship other than as passive investors. An entity that is a subsidiary of one of the joint venturers is not a corporate joint venture. The ownership of a corporate joint venture seldom changes, and its stock is usually not traded publicly. A noncontrolling interest held by public ownership, however, does not preclude a corporation from being a corporate joint venture.
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4 Scope
Entities described as joint ventures are organized in a variety of legal forms. In addition to the corporate form, partnerships and individual interests may also be used to organize a joint venture as contemplated by ASC 323-30-15-3. We believe that to conclude an entity is a joint venture under joint control, the following conditions generally should be present: The entity should be under the joint control of the venturers. Joint control of major decisions is one of the most significant characteristics of the class of entities described as joint ventures, which should be assessed without regard to the legal form of ownership or the proportion of voting interest held. Joint control contemplates joint decision making over key decisions such as significant acquisitions and dispositions and issuance or repurchase of equity interests, among others. In ventures with more than two venturers, we believe that joint control exists only if all major decisions are subject to unanimous consent by all venturers. The venturers must be able to exercise control of the venture through their equity investments. If a venturer exercises its decision-making authority through a means other than a voting equity investment (e.g., through a management services contract), the entity should not be evaluated as a joint venture for purposes of applying the business scope exception. In such situations, we believe, by design, the holders of the entitys equity investment at risk do not have the ability to make decisions that have a significant effect on the success of the entity (see the Interpretative guidance and Questions in Chapter 9). Consequently, we believe that it would generally be inappropriate for enterprises holding variable interests in such entities to avail themselves of the joint venture scope exception.
Determining whether an enterprise holds a variable interest in an operating joint venture will be a matter of facts and circumstances and will require the use of professional judgment. For example, the terms of put or call options between or among parties should be carefully evaluated in determining whether the entity is a joint venture that is subject to joint control.
Franchisee scope exception

Question 4.26 A holder of a variable interest in an entity that is a business as defined by ASC 805 is eligible for a scope exception from applying the Variable Interest Model, provided that the variable interest holder did not participate significantly in the design or redesign (among other conditions) of the entity, unless the entity is a franchisee. How should an enterprise determine if it holds a variable interest in an entity that is a franchisee? Can dealers or distributors apply the franchise scope exception by analogy to other arrangements? An entity should be considered a franchisee if it is a business (as defined by ASC 805) operating within a defined geographical area subject to a written agreement (the Franchise Agreement) between an investor in the entity and a party (the Franchisor) who has granted business rights to the investor.
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4 Scope
Excerpt from Accounting Standards Codification Master Glossary

Franchisors Overall Glossary 952-10-20 Franchise Agreement A written business agreement that meets the following principal criteria: a. b. c. The relation between the franchisor and franchisee is contractual, and an agreement, confirming the rights and responsibilities of each party, is in force for a specified period. The continuing relation has as its purpose the distribution of a product or service, or an entire business concept, within a particular market area. Both the franchisor and the franchisee contribute resources for establishing and maintaining the franchise. The franchisors contribution may be a trademark, a company reputation, products, procedures, manpower, equipment, or a process. The franchisee usually contributes operating capital as well the managerial and operational resources required for opening and continuing the franchised outlet. The franchise agreement outlines and describes the specific marketing practices to be followed, specifies the contribution of each party to the operation of the business, and sets forth certain operating procedures that both parties agree to comply with. The establishment of the franchised outlet creates a business entity that will, in most cases, require and support the full-time business activity of the franchisee. (There are numerous other contractual distribution agreements in which a local businessperson becomes the authorized distributor or representative for the sale of a particular good or service, along with many others, but such a sale usually represents only a portion of the persons total business). Both the franchisee and the franchisor have a common public identity. This identity is achieved most often through the use of common trade names or trademarks and is frequently reinforced through advertising programs designed to promote the recognition and acceptance of the common identity within the franchisees market area.
d.
e.
f.
The payment of an initial franchise fee or continuing royalty fee is not a necessary criterion for an agreement to be considered a franchise agreement. We believe that analogies generally should not be made to the scope exceptions to the Variable Interest Model. Therefore, we believe that the franchise scope exception should only be applied to franchisees (or operating joint ventures see Question 4.25).
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4 Scope
Determining whether substantially all of the activities of an entity involve, or are conducted on behalf of, a variable interest holder
Question 4.27 In applying the Variable Interest Models business scope exception, how should a variable interest holder determine if substantially all of the activities of an entity either involve it or are conducted on its behalf? The assessment of whether substantially all of the entitys activities either involve, or are conducted on behalf of, a variable interest holder is a judgmental determination that should be based on an assessment of the applicable facts and circumstances. Although the amount of the entitys economics attributable to the variable interest holder is a factor that should be considered, we believe the determination of whether substantially all of the activities of an entity involve or are conducted on behalf of a variable interest holder should not be based primarily on a quantitative analysis. We believe the activities of the entity under evaluation should be compared to those of the variable interest holder. Factors that should be considered in determining if substantially all of the activities of the entity involve or are conducted on behalf of the variable interest holder8 for determining the applicability of the scope exception include: Are the entitys operations substantially similar in nature to the activities of the variable interest holder? Are the majority of the entitys products or services bought from or sold to the variable interest holder? Were substantially all of the entitys assets acquired from the variable interest holder? Are employees of the variable interest holder actively involved in managing the operations of the entity? Do employees of the entity receive compensation tied to the stock or operating results of the variable interest holder? Is the variable interest holder obligated to fund operating losses of the entity, if they occur? Has the variable interest holder outsourced certain of its activities to the entity? If the entity conducts research and development activities, does the variable interest holder have the right to purchase any products or intangible assets resulting from the entitys activities? Has a significant portion of the entitys assets been leased to or from the variable interest holder? Does the variable interest holder have a call option to purchase the interests of the other investors in the entity? Fixed price and in the money call options likely are stronger indicators than fair value call options. Do the other investors in the entity have an option to put their interests to the variable interest holder? Fixed price and in the money put options likely are stronger indicators than fair value put options.
For purposes of evaluating the factors listed, the term variable interest holder should be read to include the holder and its related parties, except its de facto agents under ASC 810-10-25-43(d). 51
4 Scope
Determining the amount of subordinated financial support provided by an enterprise

Question 4.28 In evaluating the scope exception as to whether the enterprise and its related parties have provided more than half of the entitys subordinated financial support, how should the amount of the subordinated financial support provided to an entity be determined? Subordinated financial support refers to variable interests that will absorb some or all of an entitys expected losses. The determination of the amount of subordinated financial support provided to an entity by an enterprise should be based on a comparison of the fair value of the subordinated financial support provided by the enterprise to the fair value of the entitys total subordinated financial support.
Determining the amount of subordinated financial support provided by an enterprise
Assume an enterprise, Investco, has provided subordinated financial support to a business, Bizco. In determining if it can apply the business scope exception, Investco obtains the following information regarding the capital structure of Bizco:
Fair value basis Subordinated financial support Debt Preferred stock Common stock Book basis $ 500 700 1,000 $ 2,200 Provided by Investco $ 400 500 100 $ 1,000 Provided by others $ $ 200 300 500 $ Total 600 500 400 $ 1,500
Analysis In this example, because Investco has provided more than half of Bizcos subordinated financial support, on a fair value basis (66%, or $1,000 divided by $1,500), it is unable to apply the scope exception to the variable interests it holds in Bizco. In certain circumstances, a variable interest holder may also provide a guarantee on the debt of the entity. In these circumstances, we generally believe that it is appropriate to include the fair value of the underlying debt subject to the guarantee when determining the amount of subordinated financial support provided by the variable interest holder.
Applicability of business scope exception for each party to an entity

Question 4.29 May a reporting enterprise apply the business scope exception because another party was able to use that scope exception? Or, should each party to an entity separately evaluate whether the business scope exclusion criteria have been met? We believe each reporting enterprise with a variable interest in an entity should determine whether it is eligible for the business scope exception. We do not believe it would be appropriate for a reporting enterprise to determine whether it is eligible for the business scope exception based on any other reporting enterprises ability to avail itself of that exception. For example, assume Investor X and Investor Y each have variable interests in Business B and provide 35% and 55%, respectively, of the total subordinated financial support to the entity based on an analysis of the fair values of the entitys interests. Assuming none of the conditions identified in the business scope exception exist, Investor X
4 Scope
need not apply the Variable Interest Models provisions to its variable interests in Business B because it does not provide more than half of the subordinated financial support to the entity. Investor Y, however, must apply the Variable Interest Model to its variable interests in Business B because it provides more than half of the subordinated financial support to the entity.
Business scope exception must be evaluated at each reporting period

Question 4.30 Should the business scope exception be applied only at acquisition of a variable interest or is it required to be evaluated at each subsequent reporting period? ASC 810-10-15-17(d) infers that the evaluation of an entity meeting the requirements of the business scope exception should be performed on an ongoing basis. Accordingly, we believe an entity not previously evaluated to determine if it was a variable interest entity, because it availed itself of the business scope exception, must be evaluated in future periods to determine whether the entity continues to be eligible.
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Evaluation of variability and the variable interest determination

Consolidation Overall Recognition 810-10-25-21 The variability that is considered in applying the Variable Interest Entities Subsections affects the determination of all of the following: a. b. c. Whether the legal entity is a VIE Which interests are variable interests in the legal entity Which party, if any, is the primary beneficiary of the VIE.
That variability will affect any calculation of expected losses and expected residual returns, if such a calculation is necessary. Paragraph 810-10-25-38A provides guidance on the use of a quantitative approach associated with expected losses and expected residual returns in connection with determining which party is the primary beneficiary. 810-10-25-22 The variability to be considered in applying the Variable Interest Entities Subsections shall be based on an analysis of the design of the legal entity as outlined in the following steps: a. b. Step 1: Analyze the nature of the risks in the legal entity (see paragraphs 810-10-25-24 through 25-25). Step 2: Determine the purpose(s) for which the legal entity was created and determine the variability (created by the risks identified in Step 1) the legal entity is designed to create and pass along to its interest holders (see paragraphs 810-10-25-26 through 25-36).
810-10-25-23 For purposes of paragraphs 810-10-25-21 through 25-36, interest holders include all potential variable interest holders (including contractual, ownership, or other pecuniary interests in the legal entity). After determining the variability to consider, the reporting entity can determine which interests are designed to absorb that variability. The cash flow and fair value are methods that can be used to measure the amount of variability (that is, expected losses and expected residual returns) of a legal entity. However, a method that is used to measure the amount of variability does not provide an appropriate basis for determining which variability should be considered in applying the Variable Interest Entities Subsections. 810-10-25-24 The risks to be considered in Step 1 that cause variability include, but are not limited to, the following: a. Credit risk
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5 Evaluation of variability and the variable interest determination
b. c. d. e. f.
Interest rate risk (including prepayment risk) Foreign currency exchange risk Commodity price risk Equity price risk Operations risk.
810-10-25-25 In determining the purpose for which the legal entity was created and the variability the legal entity was designed to create and pass along to its interest holders in Step 2, all relevant facts and circumstances shall be considered, including, but not limited to, the following factors: a. b. c. d. e. The activities of the legal entity The terms of the contracts the legal entity has entered into The nature of the legal entitys interests issued How the legal entitys interests were negotiated with or marketed to potential investors Which parties participated significantly in the design or redesign of the legal entity.
810-10-25-26 Typically, assets and operations of the legal entity create the legal entitys variability (and thus, are not variable interests), and liabilities and equity interests absorb that variability (and thus, are variable interests). Other contracts or arrangements may appear to both create and absorb variability because at times they may represent assets of the legal entity and at other times liabilities (either recorded or unrecorded). The role of a contract or arrangement in the design of the legal entity, regardless of its legal form or accounting classification, shall dictate whether that interest should be treated as creating variability for the entity or absorbing variability. 810-10-25-27 A review of the terms of the contracts that the legal entity has entered into shall include an analysis of the original formation documents, governing documents, marketing materials, and other contractual arrangements entered into by the legal entity and provided to potential investors or other parties associated with the legal entity. 810-10-25-29 A qualitative analysis of the design of the legal entity, as performed in accordance with the guidance in the Variable Interest Entities Subsections, will often be conclusive in determining the variability to consider in applying the guidance in the Variable Interest Entities Subsections, determining which interests are variable interests, and ultimately determining which variable interest holder, if any, is the primary beneficiary.
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5.1
ASC 810-10-25-22 requires an enterprise to evaluate the design of an entity as the basis for determining the entitys variability in applying the Variable Interest Model. The by design approach is a qualitative approach that considers (1) the nature of the risks in the entity and (2) the purpose for which the entity was created in determining the variability the entity is designed to create and pass along to its interest holders. Once the variability the entity is designed to create and pass along to its interest holders is determined, variable interests are identified. Variable interests absorb or receive the variability created by the entitys assets, liabilities or other contracts. Interests that introduce the risk that the entity is designed to create generally are not variable interests in the entity; variable interests absorb the risk the entity is designed to pass along to its interest holders. After the entitys variable interests are determined, the entitys expected losses and expected residual returns can be evaluated. We are aware of three primary methods used to calculate expected losses and expected residual returns: Fair Value, Cash Flow and Cash Flow Prime. The methods differ based on how the underlying cash flows are projected and discounted. Each of these methods used to calculate expected losses and expected residual returns is described in this chapter and more fully in the Interpretative guidance in Chapter 10 of this publication. Expected losses and expected residual returns should not be computed prior to the identification of the interests that absorb the selected variability. We believe that the provisions of the Variable Interest Model should be applied as follows: Step 1: Determine the variability the entity was designed to create and distribute Consideration 1: Consideration 2: What is the nature of the risks in the entity? What is the purpose for which the entity was created? If the subordination in the entity is substantive, the entity is likely designed to create and distribute credit risk. Consider whether the entity is designed to create and distribute interest rate risk from periodic receipts. Separately consider prepayment risk from interest rate risk.
Step 2:
Identify variable interests Consideration 1: Consideration 2: Variable interests absorb the variability designated in Step 1 without regard to the instruments legal form or accounting classification. While a derivative instrument may absorb variability the entity was designed to create, it is likely not a variable interest if (1) its underlying is a market observable variable and (2) it is senior relative to other interest holders. If changes in the fair value or cash flows of the derivative are expected to offset all, or essentially all, of the risk or return (or both) related to a majority of the assets (excluding the derivative instrument) or the entitys operations, further analysis of entitys design is required to determine whether the derivative instrument is a variable interest (discussed further in this Chapter). Determine whether the variable interest is in a specified asset (discussed further in Chapter 8).
Consideration 3:
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Step 3:
Compute expected losses and expected residual returns9 Consideration 1: Consideration 2: Identify silos and exclude them from the calculation of expected losses and expected residual returns (discussed in Chapter 7). Use the Fair Value Method to measure expected losses and expected residual returns if the entity was designed to create and distribute fair value variability (discussed fully in Chapter 10). Use either the Cash Flow Method or Cash Flow Prime Method to measure expected losses and expected residual returns if the entity is designed to create and distribute cash flow variability.10
Consideration 3:
The remaining discussion in this section describes each of these steps in more detail. Step 1: Determining the variability the entity was designed to create and distribute While the Variable Interest Model indicates all entity risks should be considered, the by design approach does not require that all risks be included in measuring and assigning variability. For example, while an entity may have interest rate risk that is created by periodic interest receipts from its assets, that interest rate risk appropriately should be excluded from applying the provisions of the Variable Interest Model if it is concluded that the entity was not designed to create and distribute interest rate risk. Step 1 Consideration 1: Nature of risks in the entity The nature of the risks of the entity (i.e., the risks the entity is exposed to) should be considered in determining the basis for applying the provisions of the Variable Interest Model. These risks may include, but are not limited to: Credit risk Interest rate risk (including prepayment risk) Foreign currency exchange risk Commodity price risk Equity price risk Operations risk
Step 1 Consideration 2: Purpose for which the entity was created ASC 810-10-25-25 requires an analysis of the entitys activities, including which parties participated significantly in the design or redesign of the entity, the terms of the contracts the entity entered into, the nature of entity interests issued and how the entitys interests were marketed to potential investors. The entitys governing documents, formation documents, marketing materials and all other contractual arrangements should be closely reviewed and combined with the analysis of the entitys activities to determine the variability the entity was designed to create.
10
Subsequent to the adoption of Statement 167, the determination of expected losses and expected residual returns is no longer necessary for determining the primary beneficiary of a variable interest entity. However, the Variable Interest Model still utilizes the concepts of expected losses and expected residual returns for certain provisions, such as the determination of whether or not an entity is a variable interest entity. The difference between the methods is primarily due to the method of measuring interest rate variability on variable rate assets and is discussed fully in Chapter 10. 57
Step 2: Identifying variable interests Instruments that absorb the variability the entity was designed to create and distribute without regard to their accounting or legal forms are variable interests. Accordingly, we believe the entitys underlying economics should be used as the basis for determining the risks the entity was designed to create and distribute to its interest holders. Interests that absorb risks the entity was not designed to create are considered part of the entitys net assets. The method to measure variability should be selected to ensure that the variability associated with the entitys designed risks are appropriately measured and allocated to the entitys variable interest holders. The method selected to measure variability does not necessarily dictate which interests are variable interests (as opposed to creators of variability), as the methods seem to indicate by their title. Rather, it is the design of the entity that drives that distinction. The following excerpt from the Accounting Standards Codification provides implementation guidance for identifying variable interests. Refer to Chapter 6 for the consideration of fees paid to a decision maker or service provider as variable interests.

Consolidation Overall Implementation Guidance and Illustrations Identifying variable interests 810-10-55-17 The identification of variable interests requires an economic analysis of the rights and obligations of a legal entitys assets, liabilities, equity, and other contracts. Variable interests are contractual, ownership, or other pecuniary interests in a legal entity that change with changes in the fair value of the legal entitys net assets exclusive of variable interests. The Variable Interest Entities Subsections use the terms expected losses and expected residual returns to describe the expected variability in the fair value of a legal entitys net assets exclusive of variable interests. 810-10-55-18 For a legal entity that is not a VIE (sometimes called a voting interest entity), all of the legal entitys assets, liabilities, and other contracts are deemed to create variability, and the equity investment is deemed to be sufficient to absorb the expected amount of that variability. In contrast, VIEs are designed so that some of the entitys assets, liabilities, and other contracts create variability and some of the entitys assets, liabilities, and other contracts (as well as its equity at risk) absorb or receive that variability. 810-10-55-19 The identification of variable interests involves determining which assets, liabilities, or contracts create the legal entitys variability and which assets, liabilities, equity, and other contracts absorb or receive that variability. The latter are the legal entitys variable interests. The labeling of an item as an asset, liability, equity, or as a contractual arrangement does not determine whether that item is a variable interest. It is the role of the itemto absorb or receive the legal entitys variabilitythat distinguishes a variable interest. That role, in turn, often depends on the design of the legal entity. 810-10-55-20 Paragraphs 810-10-55-16 through 55-41 describe examples of variable interests in VIEs subject to the Variable Interest Entities Subsections. These paragraphs are not intended to provide a complete list of all possible variable interests. In addition, the descriptions are not intended to be exhaustive of the possible roles, and the possible variability, of the assets, liabilities, equity, and other contracts. Actual instruments may play different roles and be more or less variable than the examples discussed.
Finally, these paragraphs do not analyze the relative significance of different variable interests, because the relative significance of a variable interest will be determined by the design of the VIE. The identification and analysis of variable interests must be based on all of the facts and circumstances of each entity. 810-10-55-21 Paragraphs 810-10-55-16 through 55-41 also do not discuss whether the variable interest is a variable interest in a specified asset of a VIE or in the VIE as a whole. Guidance for making that determination is provided in paragraphs 810-10-25-55 through 25-56. Paragraphs 810-10-25-57 through 25-59 provide guidance for when a VIE shall be separated with each part evaluated to determine if it has a primary beneficiary. Equity Investments, Beneficial Interests, and Debt Instruments 810-10-55-22 Equity investments in a VIE are variable interests to the extent they are at risk. (Equity investments at risk are described in paragraph 810-10-15-14.) Some equity investments in a VIE that are determined to be not at risk by the application of that paragraph also may be variable interests if they absorb or receive some of the VIEs variability. If a VIE has a contract with one of its equity investors (including a financial instrument such as a loan receivable), a reporting entity applying this guidance to that VIE shall consider whether that contract causes the equity investors investment not to be at risk. If the contract with the equity investor represents the only asset of the VIE, that equity investment is not at risk. 810-10-55-23 Investments in subordinated beneficial interests or subordinated debt instruments issued by a VIE are likely to be variable interests. The most subordinated interest in a VIE will absorb all or part of the expected losses of the VIE. For a voting interest entity the most subordinated interest is the entitys equity; for a VIE it could be debt, beneficial interests, equity, or some other interest. The return to the most subordinated interest usually is a high rate of return (in relation to the interest rate of an instrument with similar terms that would be considered to be investment grade) or some form of participation in residual returns. 810-10-55-24 Any of a VIEs liabilities may be variable interests because a decrease in the fair value of a VIEs assets could be so great that all of the liabilities would absorb that decrease. However, senior beneficial interests and senior debt instruments with fixed interest rates or other fixed returns normally would absorb little of the VIEs expected variability. By definition, if a senior interest exists, interests subordinated to the senior interests will absorb losses first. The variability of a senior interest with a variable interest rate is usually not caused by changes in the value of the VIEs assets and thus would usually be evaluated in the same way as a fixed-rate senior interest. Senior interests normally are not entitled to any of the residual return. Step 3: Compute expected losses and expected residual returns The Fair Value Method, Cash Flow Method and Cash Flow Prime Method each measure variability resulting from interest rate fluctuations that result in variations in the amount and timing of cash proceeds received upon (1) anticipated sales of entity investments and (2) receipt of principal payments (or prepayments) on entity assets, although they measure them differently. Refer to Chapter 10 for additional discussion.
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After considering all of the relevant facts and circumstances, the variability the entity was designed to create and distribute fair value or cash flow is determined. The Fair Value Method is used to compute expected losses and expected residual returns for entities designed to create fair value risk. Either the Cash Flow Method or the Cash Flow Prime Method is used to compute expected losses and expected residual returns for entities designed to create cash flow risk. In general, the most significant difference between the Cash Flow Method and Cash Flow Prime Method is whether variability from periodic interest receipts from variable-rate financial instruments is measured; while the Cash Flow Method measures that variability by projecting the instruments cash flows under a variety of scenarios and discounts those cash flows using forward interest rates, the Cash Flow Prime Method projects the instruments cash flows using the same forward interest rates at which the cash flows are discounted, thus creating no variability from periodic interest receipts. Variability due to credit risk is measured under both methods. We generally expect the Cash Flow Prime Method will be used to calculate expected losses and expected residual returns in many cases in practice because: The Fair Value and Cash Flow Methods measure interest rate variability arising from periodic interest payments, and many entities are not designed to create and distribute that risk; and The Cash Flow Prime Method is generally the only approach that practically permits variability to be measured for entities that are businesses or that primarily hold or operate real estate or nonfinancial assets.
Because the by design approach is applied after considering all relevant facts and circumstances, certain instruments that may otherwise appear to absorb the entitys risks may not be considered variable interests. For example, ASC 810-10-55-81 through 55-86 illustrate how an entity may be designed to provide financing through a combination of forward contracts both purchases and sales. While one of those contracts may absorb risk under the different methods, by looking at the design of the entity, neither forward is a variable interest. That is, both instruments are considered to be creators of variability. The by design approach requires professional judgment, based on consideration of all relevant facts and circumstances. Illustrative examples The Variable Interest Model provides basic examples (ASC 810-10-55-55 through ASC 810-10-55-86) that illustrate how the nature of risks should be identified, the purpose for which the entity was created and the variability the entity was designed to create. The purpose of the following sections is to illustrate the process for evaluating an entitys variability and determining an entitys variable interest holders. Specifically, the following sections address various considerations including: Terms of interests issued Subordination Certain interest rate risk Certain derivative instruments Other arrangements and examples
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Trust preferred securities

Question 5.1 Does the sponsor of a trust preferred securities arrangement have a variable interest in the trust? Trust preferred securities have been marketed under a variety of acronyms such as TruPS (Trust Preferred Securities), MIPS (Monthly Income Preferred Stock), QUIPS (Quarterly Income Preferred Stock), QUICS (Quarterly Income Capital Securities) and TOPrS (Trust Originated Preferred Redeemable Stock). These securities have generally been treated as debt for tax purposes but, for some financial institutions, qualify as Tier I capital for regulatory purposes. Typically, a sponsor does not have a variable interest in the trust. Because these structures can vary, the evaluation of whether a sponsor has a variable interest is based on individual facts and circumstances. The sponsor of a trust preferred securities arrangement may have a variable in the trust in certain cases. The following summarizes a typical trust preferred securities arrangement. An enterprise (i.e., sponsor) organizes a newly-formed entity, usually in the form of a Delaware business trust (i.e., the trust) The enterprise purchases all of the trusts common equity securities or finances the purchase of the common equity securities directly with the trust. Typically, the common equity interest represents 3% of the overall equity of the trust, but it could be more The trust issues preferred securities to investors The trust uses the proceeds from the preferred securities issuance and the proceeds (if any) from the common equity securities issuance to make a deeply subordinated loan, with terms often identical or similar to those of the trust preferred securities, to the enterprise The debentures typically are callable by the trust at par at any time after a specified period (typically five years) Typically, the trust has written a call permitting the enterprise to settle the debentures and also has purchased a call option to settle the securities issued to the preferred investors The trust uses interest payments received from the enterprise to pay periodic dividends to the preferred investors Finally, the enterprise may provide a performance guarantee limited to the trusts activities rather than the credit worthiness of the trust (i.e., the enterprise may guarantee that the trust will make principal and interest payments on the preferred securities if the trust has the cash to make those payments but does not guarantee those proceeds will be available through the guarantee)
Typically in these arrangements, the trusts preferred investors have the rights of preferred shareholders and do not have creditor rights unless the enterprise directly issues an incremental credit guarantee to the investors. Additionally, the trusts preferred investors generally do not have voting rights in the trust. However, if the enterprise defaults on its issued debentures, the trustee can pursue its rights as a creditor. In some arrangements, however, the trusts preferred investors may have the right to act directly against the enterprise.
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The following diagram summarizes the cash flows for a typical issuance of trust preferred securities. The diagram does not include guarantees and other arrangements between the parties for simplicity.
Offering flows
Sponsor
Sponsor organizes a newly-formed entity, usually in the form of a Delaware business trust, and purchases all of the trusts common equity securities.
Cash proceeds
Subordinated debentures 2
Trust issues trust preferred securities to Investors for cash.
Trust Trust uses proceeds of the sale of the common securities (if any) and the trust preferred securities to purchase deeply subordinated debentures from Sponsor, with terms often identical or similar to those of the trust preferred securities.
Cash proceeds
Trust preferred securities
Investors
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This diagram summarizes the operating cash flows between Sponsor, Trust and Investors.
Operating cash flows Sponsor makes periodic interest payments on its subordinated debentures to Trust.
Sponsor
Interest payment on debentures 2
Trust uses debenture interest payments (received from Sponsor) to pay periodic dividends on trust preferred securities to Investors.
Trust 3
Investors receive interest income.
Preferred dividends
Investors
Holders of variable interests in the trust Preferred investors: Each of the trusts preferred investors is exposed to variability in the performance of the trust and, therefore, has a variable interest in the trust. Enterprise: The enterprises common stock investment typically is not a variable interest because an equity investment is a variable interest only to the extent that the investment is considered to be at risk. Because the enterprises investment in the trusts common stock often is funded by the trust (through the loan), it is not considered to be at risk (see ASC 810-10-55-22 for additional guidance). Additionally, the enterprises issued debentures, inclusive of the related call option, create rather than absorb variability of the trust. Finally, any guarantee provided by the enterprise is effectively a guarantee of its own performance (i.e., the trust is only able to pay interest and principal to preferred shareholders if the enterprise pays interest and principal on its debentures issued to the trust).
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Other structures In a variation of the trust preferred securities arrangement discussed above, we are aware of some structures in which an intermediary entity exists between what would otherwise be the typical sponsor and trust as described above. In these structures, the intermediary entity may exist for tax reasons and effectively acts as an additional trust through which securities are issued and proceeds are received. Following the entity by entity approach to consolidation evaluations, the trust that ultimately issues the trust preferred securities to outside investors should carefully consider whether it is the primary beneficiary of the intermediary trust.
5.2
Terms of interests issued

Consolidation Overall Recognition Terms of interests issued 810-10-25-31 An analysis of the nature of the legal entitys interests issued shall include consideration as to whether the terms of those interests, regardless of their legal form or accounting designation, transfer all or a portion of the risk or return (or both) of certain assets or operations of the legal entity to holders of those interests. The variability that is transferred to those interest holders strongly indicates a variability that the legal entity is designed to create and pass along to its interest holders.
5.3
Subordination
Consolidation Overall Recognition Subordination 810-10-25-32 For legal entities that issue both senior interests and subordinated interests, the determination of which variability shall be considered often will be affected by whether the subordination (that is, the priority on claims to the legal entitys cash flows) is substantive. The subordinated interest(s) (as discussed in paragraph 810-10-55-23) generally will absorb expected losses prior to the senior interest(s). As a consequence, the senior interest generally has a higher credit rating and lower interest rate compared with the subordinated interest. The amount of a subordinated interest in relation to the overall expected losses and residual returns of the legal entity often is the primary factor in determining whether such subordination is substantive. The variability that is absorbed by an interest that is substantively subordinated strongly indicates a particular variability that the legal entity was designed to create and pass along to its interest holders. If the subordinated interest is considered equity-at-risk, as that term is used in paragraph 810-10-15-14, that equity can be considered substantive for the purpose of determining the variability to be considered, even if it is not deemed sufficient under paragraphs 810-10-15-14(a) and 810-10-25-45.
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Determining whether subordination is substantive

Question 5.2 What factors should be considered in determining whether subordination is substantive? We believe that the determination of whether the entitys subordination is substantive can often be made qualitatively. This evaluation should consider the entitys activities, including terms of the contracts the entity has entered into and how the interests were negotiated with or marketed to potential investors. We believe the following factors should be considered in determining whether the subordination is substantive: Relative size of the debt tranches and equity issued. For example, the greater the ratio of equity to debt, the more likely that the subordination is substantive. Amount and relative size of investment grade ratings of the debt tranches issued, including their relative size to total of debt tranches and equity issued. For example, the more disparate the investment grade ratings, the more likely that the subordination is substantive. Effective interest rates on the various interests issued. For example, the more disparate the interest rates, the more likely that the subordination is substantive. Comparison of assets average investment grade rating to most senior beneficial interests ratings. For example, the more disparate the ratings, the more likely that the subordination is substantive. Comparison of total expected losses and expected residual returns computed to the amount of the subordinated interests. For example, the larger the amount of subordinated interests to the expected losses and expected residual returns becomes, the more likely that the subordination is substantive.
We believe the terms of equity investments that are not at-risk should be carefully evaluated in determining whether they should be included in the determination of whether the entitys subordination is substantive. For example, an entity may issue equity that is puttable by the investor to the entity at its purchase price. In that case, the equity investment would not be at-risk pursuant to ASC 810-10-15-14(a)(1) because it does not participate significantly in losses. Accordingly, we do not believe that equity should be considered in determining whether the subordination is substantive because the investor is not contractually required to absorb the entitys losses. Judgment will be required to determine whether an equity investment that is not at-risk should be included as part of the entitys subordinated interests issued. In determining whether an entitys subordination is substantive, equity that is at-risk but not sufficient to absorb expected losses pursuant to ASC 810-10-15-14(a) may be considered for purposes of determining whether the entitys subordination is substantive. For example, assume an entity has assets ($100) and has issued senior debt ($80), subordinated debt ($10) and equity ($10). If the entitys expected losses are greater than $10, the equity would not be sufficient (and thus would be a VIE), but the subordination from the combination of the subordinated debt and equity may be substantive (and thus the entity is designed to create and distribute credit risk) after considering all of the facts and circumstances.
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5.4
Certain interest rate risk

Consolidation Overall Recognition Certain Interest Rate Risk 810-10-25-33 Periodic interest receipts or payments shall be excluded from the variability to consider if the legal entity was not designed to create and pass along the interest rate risk associated with such interest receipts or payments to its interest holders. However, interest rate fluctuations also can result in variations in cash proceeds received upon anticipated sales of fixed-rate investments in an actively managed portfolio or those held in a static pool that, by design, will be required to be sold prior to maturity to satisfy obligations of the legal entity. That variability is strongly indicated as a variability that the legal entity was designed to create and pass along to its interest holders.
5.5
Interpretative guidance Certain interest rate risk

While not explicit, we generally believe that if there is an interest rate risk mismatch in an entity and that mismatch is not reduced through an interest rate swap agreement or other instrument,11 interest rate risk due to periodic interest payments should be presumed to be present in the entity. Additionally, the variability resulting from prepayments on an entitys assets should be considered as some entities are designed to create and distribute that risk to their holders.
Excluding variability from periodic interest receipts/payments

Question 5.3 What factors should be considered in determining whether an entity is designed to create variability from periodic interest receipts/payments? We believe that determining whether an entity was designed to create and pass on variability from periodic interest receipts/payments requires careful consideration of the specific facts and circumstances of the entitys design. However, we believe variability from periodic interest receipts/payments generally may be excluded if there is interest rate risk in an entity and that mismatch is reduced through an interest rate swap agreement or other instrument that is based on a market observable index and is equal in priority to at least the most senior interest in the entity. Conversely, if there is an interest rate risk in an entity (e.g., due to a mismatch) that is absorbed by an instrument that is either not based on a market observable index or not at least equal in priority to at least the most senior interest in the entity, variability from periodic receipts/payments generally should be included in the entitys total variability.
11
That is based on a market observable index and is equal in priority to at least the most senior interest in the entity. 66
llustraItion 5-1: Example 1 Facts
Evaluating variability from periodic interest receipts/payments
Assume a VIE has the following balance sheet:

Asset B-Rated bond Fixed interest rate $ 100 Liabilities Senior debt Floating rate Equity $ $ 80 20
The VIE enters into a fixed to floating (LIBOR) interest rate swap with an $80 notional amount that has at least the same priority of payment as the senior debt. Variability in the value of the VIEs asset will result from changes in market interest rates and the credit risk of the B-rated bond. Analysis In this example, we believe that because LIBOR is a market observable variable and the interest rate swap is pari passu or senior relative to other interest holders in the entity, the interest rate swap is not a variable interest. (Even though economically 80% of the interest rate variability in the fair value of the bond will be absorbed (expected losses) or received (expected residual returns) by the swap counterparty.) Consequently, the interest rate swap would be considered a creator of interest rate variability. If the entity was not designed to create interest rate risk from periodic interest receipts, the only variability in the entity would be from the credit risk of the bond. If the VIE did not enter into an interest rate swap, the variability otherwise absorbed by the interest rate swap counterparty would be absorbed by the equity holder (through its implicit pay-float, receivefixed interest rate swap), and because that exposure is not senior to the debt, we believe interest rate variability from periodic receipts/payments would be included in the variability of the entity. Example 2 Facts Assume a VIE has the following balance sheet
Asset B-Rated Bond Floating rate $ 100 Liabilities Senior debt Fixed rate Equity $ $ 80 20
The VIE enters into a floating (LIBOR) to fixed interest rate swap with an $80 notional amount that has at least the same priority of payment as the senior debt. Analysis In this example, the swap synthetically converts a portion of the floating rate B-rated bond into a fixed rate instrument. Variability in the values of the synthetic fixed rate instrument is created by changes in market interest rates and the credit risk of the B-rated bond. Because the interest rate swap is based on a market observable index and has the same level of seniority as the most senior interest, it is not a variable interest even though economically 80% of the interest rate variability from cash flows of the bond will be absorbed (expected losses) or received (expected residual returns) by the swap counterparty. Consequently, if the entity was not designed to create interest rate risk from periodic interest receipts, the only variability in the entity would be due to the credit risk of the B-rated bond.
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If the VIE did not enter into an interest rate swap, the variability otherwise absorbed by the interest rate swap counterparty would be absorbed by the equity holder (through its implicit pay-float, receivefixed interest rate swap), and because that exposure is not senior to the debt, we believe interest rate variability from periodic receipts/payments would be included in the variability of the entity.
Evaluating prepayment risk

Question 5.4 Should prepayment risk be evaluated separately from interest rate risk in determining the risks the entity was designed to create and distribute to its interest holders? In determining the risks the entity is designed to create and distribute, we believe prepayment risk should not be considered separately from interest rate risk that arises from periodic receipts. That is, if an entity is designed to create and distribute prepayment risk, we generally believe the entity also was designed to create interest rate risk arising from periodic receipts. In these circumstances, we believe use of the Fair Value Method may be required to measure variability because of the cause and effect relationship between changes in interest rates and prepayments. For example, residential mortgage loans often have prepayment provisions that create variability. If the loans prepayment risk is considered substantive based on an analysis similar to that of credit risk we believe that prepayment risk and the interest rate variability arising from periodic interest receipts should be used in calculating expected losses and expected residual returns.
5.6
Certain derivative instruments

Consolidation Overall Recognition Certain Derivative Instruments 810-10-25-34 A legal entity may enter into an arrangement, such as a derivative instrument, to either reduce or eliminate the variability created by certain assets or operations of the legal entity or mismatches between the overall asset and liability profiles of the legal entity, thereby protecting certain liability and equity holders from exposure to such variability. During the life of the legal entity those arrangements can be in either an asset position or a liability position (recorded or unrecorded) from the perspective of the legal entity. 810-10-25-35 The following characteristics, if both are present, are strong indications that a derivative instrument is a creator of variability: a. Its underlying is an observable market rate, price, index of prices or rates, or other market observable variable (including the occurrence or nonoccurrence of a specified market observable event). The derivative counterparty is senior in priority relative to other interest holders in the legal entity.
b.
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810-10-25-36 If the changes in the fair value or cash flows of the derivative instrument are expected to offset all, or essentially all, of the risk or return (or both) related to a majority of the assets (excluding the derivative instrument) or operations of the legal entity, the design of the entity will need to be analyzed further to determine whether that instrument should be considered a creator of variability or a variable interest. For example, if a written call or put option or a total return swap that has the characteristics in (a) and (b) in the preceding paragraph relates to the majority of the assets owned by a legal entity, the design of the entity will need to be analyzed further (see paragraphs 810-10-25-21 through 25-29) to determine whether that instrument should be considered a creator of variability or a variable interest. Implementation Guidance and Illustrations Forward Contracts 810-10-55-27 Forward contracts to buy assets or to sell assets that are not owned by the VIE at a fixed price will usually expose the VIE to risks that will increase the VIEs expected variability. Thus, most forward contracts to buy assets or to sell assets that are not owned by the VIE are not variable interests in the VIE. 810-10-55-28 A forward contract to sell assets that are owned by the VIE at a fixed price will usually absorb the variability in the fair value of the asset that is the subject of the contract. Thus, most forward contracts to sell assets that are owned by the VIE are variable interests with respect to the related assets. Because forward contracts to sell assets that are owned by the VIE relate to specific assets of the VIE, it will be necessary to apply the guidance in paragraphs 810-10-25-55 through 25-56 to determine whether a forward contract to sell an asset owned by a VIE is a variable interest in the VIE as opposed to a variable interest in that specific asset. Other Derivative Instruments 810-10-55-29 Derivative instruments held or written by a VIE shall be analyzed in terms of their option-like, forwardlike, or other variable characteristics. If the instrument creates variability, in the sense that it exposes the VIE to risks that will increase expected variability, the instrument is not a variable interest. If the instrument absorbs or receives variability, in the sense that it reduces the exposure of the VIE to risks that cause variability, the instrument is a variable interest. 810-10-55-30 Derivatives, including total return swaps and similar arrangements, can be used to transfer substantially all of the risk or return (or both) related to certain assets of an VIE without actually transferring the assets. Derivative instruments with this characteristic shall be evaluated carefully. 810-10-55-31 Some assets and liabilities of a VIE have embedded derivatives. For the purpose of identifying variable interests, an embedded derivative that is clearly and closely related economically to its asset or liability host is not to be evaluated separately.
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5.7
Interpretative guidance Certain derivative instruments

Derivative instruments may absorb a risk the entity was designed to create and distribute, but may not be considered variable interests. ASC 810-10-25-35 indicates that a derivative instrument generally is not a variable interest if it has an underlying that is a market observable variable and is with a counterparty that is exposed to little or no credit risk of the entity due to its seniority relative to other holders in the entity. For example, certain interest rate swaps may absorb the entitys interest rate variability, but if the underlying is based on LIBOR and amounts payable to the derivative counterparty are senior relative to other interest holders in the entity, it would not be considered a variable interest, regardless of the method selected to measure variability.
Application of the Variable Interest Models strongly indicated derivatives guidance

Question 5.5 Do all derivative counterparties hold variable interests in a VIE? How should derivative instruments be evaluated to determine if they represent variable interests in an entity? The Variable Interest Model indicates that the design of the entity is the basis for determining the variability the entity was intended to create and distribute to its interest holders. As described earlier in this Chapter, the nature of the risks in the entity and the purpose for which the entity was created are evaluated in determining the variability the entity was designed to create. It is not appropriate to base the determination as to what variability should be considered in applying provisions of the Variable Interest Model on a method for measuring the amount of variability in the entity. That is, variable interests should be identified after a determination is made of the risks the entity was designed to create and distribute. Careful consideration of all facts and circumstances is necessary when determining whether a derivative instrument is a variable interest. ASC 810-10-25-35 states that a derivative instrument is likely not a variable interest if it (1) is based on an observable market rate, price or index or other market observable variable and (2) exposes its derivative counterparty to little or no credit risk of the entity due to its seniority relative to other interest holders in the entity. The derivative likely is not a variable interest even if the derivative instrument economically absorbs the variability the entity was designed to create and distribute to its holders, except as provided later. We do not believe ASC 810-10-25-35 provides a scope exception for derivatives with these characteristics; instead, it states that the characteristics previously described are strong indicators that derivatives are creators of variability. However, if changes in the fair value or cash flows of the derivative instrument are expected to offset all (or essentially all) of the risk or return (or both) related to a majority of the assets (excluding the derivative instrument) or operations of the entity, further analysis of the entitys design is required to determine whether the derivative, by design, is a variable interest. We believe these conditions were created by the FASB to provide practical relief for holders of unsubordinated derivative instruments from reviewing each instrument particularly plain vanilla interest rate and foreign currency swap agreements to determine whether the instrument absorbs the entitys variability (and potentially to provide the Variable Interest Models disclosures with respect to the entity). We believe that the derivative contract must meet ASC 815s definition of a derivative instrument in order to apply ASC 810-10-25-35.
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In addition, we believe that in determining whether condition (1) has been met, the underlying must be observable based on market data obtained from sources independent of the reporting entity or its variable interest holders. In addition, as part of that determination, we believe consideration should be given to whether the underlying is readily convertible to cash, as that term is defined in ASC 815, to qualify as a market observable variable. A market price or rate can be estimated or derived from thirdparty sources in many circumstances. However, we believe the mere presence of a market quote, without sufficient liquidity in the derivative market or the market for the underlying, would not qualify as an observable market. Therefore, we believe liquidity of the derivative market or the underlying is an important element with respect to satisfying this criterion. For example, for interest rate swaps, we believe LIBOR is a market observable variable. Similarly, for a foreign currency swap agreement, we believe the spot price for Japanese yen, as a highly liquid currency, would have an underlying that has a market observable rate, but an illiquid currency may not have a market observable rate, even if a quote can be obtained in the marketplace. Judgment will be required to determine whether the underlying is based on a market observable variable. In order for condition (2) to be satisfied, we believe that the derivative instrument must be at least pari passu with the instrument that has the most senior claim on the entitys assets. Illustration 5-2: Derivative instruments
Example 1 Credit linked notes Facts Bank A, seeking to obtain credit protection on an investment in bonds (Investment Y), enters into a credit default swap with a newly-established trust. Investors purchase credit-linked notes, the proceeds from which are invested in US Treasury securities. Bank A pays a specified premium for credit protection, and, if a credit event occurs (as defined), the trust pays Bank A the notional amount and receives Investment Y. The credit-linked notes are satisfied through delivery of the defaulted bonds or by selling them and issuing cash. Analysis While all of the facts and circumstances must be considered, we believe the entity was designed to create and distribute the credit risk of Investment Y. Accordingly, even if the embedded derivative in the credit-linked notes meets conditions (1) and (2) described previously, the value of that embedded derivative is highly correlated with changes in the operations of the entity. That is, the entitys value is based almost exclusively on the credit of Investment Y, which is the underlying for the credit default swap. Accordingly, the credit default swap issued to Bank A would be a creator of variability. The credit linked notes are variable interests as they absorb the risk the entity was designed to create and distribute the credit of Investment Y. We believe that a similar analysis should be performed for financial guarantee contracts.
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Example 2 Total return swap Facts An entity holds one share of common stock of each of the companies listed in the S&P 500, which were purchased by issuing variable-rate debt to Investor Y. The entity enters into a total return swap with Investor X pursuant to which Investor X pays the entity a LIBOR-based rate and receives the total return of the S&P 500. Analysis We believe the entity was designed to create and distribute the price risk of the S&P 500 Index. While the S&P 500 Index is a market observable variable, the change in the value of the total return swap is expected to offset essentially all of the risk or return of all of the entitys assets. Accordingly, we believe Investor X has a variable interest in the entity. That is, we do not believe it would be appropriate to conclude that because the S&P 500 Index is a market observable variable, the derivative is a creator of variability, pursuant to ASC 810-10-25-35 through 25-36. Rather, based upon the design of the entity, which was to create and distribute price risk of the S&P 500, Investor X has a variable interest. Determining whether a derivative instrument is a creator or absorber of an entitys variability is based on individual facts and circumstances and requires the use of professional judgment. The following table lists certain common derivative contracts and provides a general framework for whether economically the contract absorbs fair value or cash flow variability. As described previously, variable interests are identified after the variability the entity was designed to create and distribute has been determined and after application of ASC 810-10-25-35 and 25-36 and consideration of all facts and circumstances (including whether the derivative instrument is a variable interest in specified assets). If the derivative instrument does not absorb variability, it is not a variable interest. If the derivative instrument absorbs variability, it may or may not be a variable interest depending on the application of the guidance in ASC 810-10-25-35 and 25-36 as discussed above:
Absorb variability VIE instrument Written put Written call Purchased put Purchased call Forward to buy Description Counterparty has an option to sell assets to the VIE Counterparty has an option to purchase assets from the VIE VIE has an option to sell assets to the counterparty VIE has an option to purchase assets from the counterparty VIE has entered into an arrangement to buy an asset at a fixed price from the counterparty in the future. The derivative instrument can be bifurcated into a: Written put Purchased call Fair Value No13 Yes Yes No No13 Cash Flow12 No13 Yes Yes No No13
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Under either the Cash Flow Method or Cash Flow Prime Method Credit risk should be considered, however. That is, if there is a significant likelihood that the VIE will be unable to perform according to the terms of the derivative contract due to the nature or amount of its assets, the counterparty may have a variable interest in the VIE. 72
Absorb variability VIE instrument Forward sell Description VIE has entered into an arrangement to sell an asset at a fixed price to the counterparty in the future. The derivative instrument can be bifurcated into a: Purchased put Written call The counterparty absorbs or receives variability in the value of the asset. Accordingly, it is a variable interest.14 VIE has purchased a put, or the option to sell assets, to the counterparty Counterparty has purchased a put, or the option to sell assets, to the VIE VIE makes variable interest rate payments on a notional amount to the counterparty in exchange for fixed interest payments VIE makes fixed interest rate payments on a notional amount to the counterparty in exchange for floating interest payments VIE pays total return relating to a specific asset or group of assets to a counterparty in exchange for a fixed return on a notional amount. Analogous to a forward to sell Counterparty pays total return relating to a specific asset or group of assets to the VIE in exchange for a fixed return on a notional amount. Analogous to a forward to buy Fair Value Yes Cash Flow12 Yes
Purchased guarantee Sold guarantee Floating for fixed interest rate swap Fixed for floating interest rate swap Total return swap out
Yes No13 No
Yes No13 Yes
Yes
No
Yes
Yes
Total return swap in
No
No
Total return swaps

Question 5.6 How should total returns swaps and similar arrangements be considered in applying the provisions of the Variable Interest Model? Total return swaps and similar arrangements may be used to transfer the risk or returns related to certain assets without actually transferring the assets. The design of the entity determines whether the swap counterparty has a variable interest in the entity. If the total return swaps underlying is a market observable variable and has seniority of payment of at least that of the most senior interest holder, ASC 810-10-25-35 and 25-36 indicates the total return swap may not be a variable interest unless changes in the value of the total return swap are expected to offset all, or essentially all, of the risk or return (or both) related to a majority of the assets (excluding the derivative instrument) or operations of the entity. When evaluating whether a total return swap or similar arrangement is a variable interest in an entity, the following should be determined: Is the total return swap a variable interest in a silo? We do not believe a total return swap in and of itself creates a silo. A total return swap may be a variable interest in a silo if the referenced asset, or group of assets, are held by the entity and are essentially the only source of payments for specified
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A forward to sell an asset to the counterparty in the future at the market price on that future date would not be a variable interest in the entity. 73
liabilities or specified other interests. In applying ASC 810-10-25-35 and 25-36, we believe the changes in the fair value of the total return swap should be compared with the changes in the majority of the siloed assets. If the referenced asset or group of assets is a silo, if the larger host entity is a VIE and if the total return swap is a variable interest in the silo, the swap counterparty should determine if it is the primary beneficiary of the silo (see the Interpretative guidance and Questions to Chapter 7). Illustration 5-3: Facts An entity, Finco, makes an investment of $100 in marketable debt securities maturing in three years. To finance the acquisition of the marketable debt securities, Finco borrows $100 on a nonrecourse basis. The fair value of Fincos total assets is $500. Finco enters into a total return swap with a counterparty, Investco, such that the total returns on the marketable debt securities are received by Investco. In exchange, Investco pays Finco LIBOR plus 50 basis points on a $100 notional for a three-year term. The total return swap is senior relative to the other interest holders in the entity. Analysis Because the marketable debt securities held by the entity are essentially the only source of payment for the lender, and essentially all of the expected residual returns of the referenced asset have been transferred from the holders of other variable interests in Finco to Investco, Investco has a variable interest in a silo. Because the changes in the value of the total return swap are expected to offset essentially all of the risk or return of a majority of the silos assets, we believe Investco has a variable interest in the silo. Accordingly, if Finco is a VIE (after exclusion of the silo see the Interpretative guidance and Questions to Chapter 7), Investco would be required to determine if it is the primary beneficiary of the silo and therefore should consolidate the marketable debt securities and the related nonrecourse debt. If the entity holds the referenced asset or group of assets, but the swap is not a variable interest in a silo, is the swap a variable interest in the entity as a whole? If the fair value of the referenced asset or group of assets that is held by the entity represents greater than one-half of the total fair value of the entitys assets, the swap counterparty should evaluate whether the total return swap is a variable interest in the entity. If the total return swap (1) does not have an underlying that is a market observable variable or (2) is not senior relative to other interest holders, it is a variable interest. Additionally, if those conditions are not met, it may still be a variable interest if it is expected to change in fair value in a manner that is expected to offset all or essentially all of the risk or return (or both) related to a majority of the entitys assets. If the total return swap is a variable interest, it must be determined if the entity is a VIE and, if so, whether it should consolidate the entity as the primary beneficiary. If the fair value of the referenced asset or group of assets that is held by the entity is less than half of the fair value of the entitys total assets, the total return swap is an interest in specified assets and is not a variable interest in the entity as a whole. Accordingly, the swap counterparty is not required to apply the provisions of the Variable Interest Model to determine whether it should consolidate the entity (see Question 8.1) nor is it required to provide disclosures relating to variable interests in VIEs. Total return swaps
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Total return swaps
An entity, Finco, has a note receivable from a third party due in three years and bearing interest at 8% per annum. The fair value of the note receivable is $300. The fair value of Fincos assets, in total, is $500. No silo is assumed to exist. Finco enters into a total return swap with a counterparty, Investco, such that the total return on the loan is received by Investco. In exchange, Investco pays Finco LIBOR plus 50 basis points on a $300 notional for a three-year term. Analysis Because the total return swap references assets held by Finco that have a fair value greater than onehalf of Fincos total assets, Investco has a variable interest in Finco.
Embedded derivatives
Question 5.7 Should the rights and obligations of an embedded derivative (whether or not it is bifurcated) be considered a variable interest? ASC 810-10-55-31 states that [f]or the purpose of identifying variable interests, an embedded derivative that is clearly and closely related economically to its asset or liability host is not to be evaluated separately. Determining whether an embedded derivative is clearly and closely related economically to the host instrument will be based on the applicable facts and circumstances. The evaluation should be based on a comparison of the nature of the underlying in the embedded derivative to the host instrument. We believe that if the underlying that causes the value of the derivative to fluctuate is inherently related to the host instrument, it should be considered clearly and closely related and should not be bifurcated from the host instrument and separately evaluated to determine if it is a variable interest. For purposes of applying the provisions of the Variable Interest Model, an embedded derivative generally should be considered clearly and closely related economically to the host instrument if the value of the embedded derivative reacts in a similar and proportionate (i.e., the derivative is not leveraged or deleveraged) manner (either in direct or inverse correlation) as the host instrument to the effects of changes in external factors. ASC 815 requires that in certain circumstances embedded derivatives be bifurcated from the host contract and accounted for in the same manner as freestanding derivatives. ASC 815 also focuses on whether the economic characteristics and risks of the embedded derivative are clearly and closely related to economic characteristics and risks of the host contract for purposes of making the determination as to whether an embedded derivative should be bifurcated from the host instrument. Based on discussions with the FASB staff, we understand, however, that the determination as to whether an embedded derivative is a variable interest is not to be based solely on ASC 815s bifurcation guidance (e.g., an embedded derivative may not require bifurcation under ASC 815 for reasons other than the clearly and closely related test). However, we do believe that ASC 815s clearly and closely related provisions should be viewed as similar to the guidance in ASC 810-10-55-31 in the Variable Interest Model. The following describes common host instruments and embedded derivatives contained therein and whether such embedded derivatives generally should be bifurcated and evaluated separately to determine if the embedded derivative is a variable interest. This guidance primarily is based on that found in ASC 815.
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Host debt instruments: Interest-rate indices An interest rate or interest-rate index generally should be considered clearly and closely related to the host debt instrument provided (1) a significant leverage factor is not involved or (2) the instrument cannot be settled in such a way that the investor would not recover substantially all of its recorded investment. Inflation-indexed provisions Interest rates and the rate of inflation in the economic environment for the currency in which a debt instrument is denominated are clearly and closely related provided a significant leverage factor is not involved. Credit sensitive payments The creditworthiness of a debtor and the interest rate on a debt instrument issued by that debtor are clearly and closely related. Thus, interest rates that reset on an event of default, upon a change in the debtors credit rating, or on a change in the debtors credit spread over treasury bonds all would be considered clearly and closely related. However, a reset based on a change in another entitys credit rating or its default would not be considered clearly and closely related. Calls and puts on debt instruments Call or put options are generally clearly and closely related unless the debt involves a substantial premium or discount (such as found in zero-coupon bonds), and the option is only contingently exercisable. Interest-rate floors, caps and collars Interest rate floors, caps, and collars (i.e., a combination of a floor and cap) within a host debt instrument are generally clearly and closely related provided the floor is at or below the current market rate at issuance and the cap is at or above the current market rate at issuance, and there is no leverage. Equity-indexed interest payments Changes in the fair value of a specific common stock or on an index based on a basket of equities are not clearly and closely related to the interest return on a debt instrument. Commodity-indexed interest or principal payments Changes in the fair value of a commodity are not clearly and closely related to the interest return on a debt instrument. Conversions to equity features The changes in fair value of an equity interest and the interest rates on a debt instrument are not clearly and closely related. Thus, conversion to equity features embedded in a host debt instrument issued by a VIE should be accounted for as a variable interest.
Host equity instruments: Calls and puts on equity instruments Put and call options that require the VIE to reacquire the instrument or give the holder the right to require repurchase of the instrument are not clearly and closely related to the equity instrument. An equity instrument host is characterized by a claim to the residual ownership interest in an entity, and put and call features are not considered to possess that same economic characteristic. Additionally, an equity instrument issued by a VIE subject to puts and calls may not qualify as an equity investment at risk for purposes of applying the provisions of the Variable Interest Model (see the Interpretative guidance and Questions to Chapter 9).
Host lease instruments: Inflation-indexed rentals Rentals for the use of leased assets and adjustments for inflation on similar property are considered to be clearly and closely related. Thus, unless a significant leverage factor is involved, an inflation-related derivative embedded in an inflation-indexed lease contract should not be separated from the host contract and separately evaluated as a potential variable interest.
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Term-extending options An option that allows either the lessee or lessor to extend the term of the lease at a fixed rate is not clearly and closely economically related to changes in the value of the leased asset and is a variable interest. However, options to extend the lease term at the then current market rental for the asset are clearly and closely economically related. Contingent rentals based on lessee sales Lease contracts that include contingent rentals based on certain sales of the lessee generally would be clearly and closely related to the value of the leased asset. Contingent rentals based on a variable interest rate The obligation to make future payments for the use of leased assets and the adjustment of those payments to reflect changes in a variable market interest rate index (e.g., prime or LIBOR) generally would be considered clearly and closely related. Residual value guarantees An obligation of the lessee to make a payment to the lessor if the value of the leased asset is below a pre-determined amount at a future date. Because residual value guarantees are commonly used to transfer substantial risk of decreases in values of assets from a lessor to a lessee in a manner similar to a purchased put (see Question 5.5), they should be considered a variable interest. Purchase options A right of the lessee to acquire the leased asset from the lessor at a future date. Because fixed price purchase options are commonly used to transfer the right to receive appreciation in values of leased assets from a lessor to a lessee in a manner similar to a written call (see Question 5.5), they should be considered a variable interest. However, options allowing the lessee to acquire the leased asset at the assets fair value at the date the option is exercised are not variable interests.
Notional amounts are not specified assets

Question 5.8 Should an interest rate swap with a notional amount that is less than half of the fair value of the VIEs assets be accounted for as a variable interest in specified assets of the VIE? Amounts owed pursuant to interest rate swap contracts are usually general obligations of an enterprise, and payments made to the derivative counterparty are typically not dependent on the cash flows of specific assets of the VIE. An interest rate swap that is a general obligation of an enterprise should be evaluated to determine if it is a variable interest in the VIE (see Question 5.5), regardless of whether it has a notional amount that is less than half of the fair value of a VIEs assets.
Variable rate liabilities owed to a VIE

Question 5.9 Is a variable rate liability owed to a VIE a variable interest in the entity? A variable rate liability owed to a VIE (e.g., a note receivable recognized as an asset on the balance sheet of the VIE) will have cash flows that vary based on changes in the market index upon which the floating interest payments are determined. A variable rate liability owed to a VIE can be viewed as comprising two instruments a fixed rate instrument and an interest rate swap that transfers risk associated with changes in the fair value of the instrument due to changes in market rates from the VIE to the obligor. Because the obligor has assumed the risk of changes in fair value of the instrument through the embedded interest rate swap, it could be argued that the debtor has a variable interest in the entity in certain cases (see Question 5.5). However, ASC 810-10-55-31 specifies that [s]ome assets and liabilities of a VIE have embedded derivatives. For the purpose of identifying variable interests, an embedded derivative that is clearly and closely related economically to its asset or liability host is not to be evaluated separately. We generally believe that interest rate swaps embedded in debt instruments owed to a VIE are clearly and closely related economically to the host debt instrument and should therefore not be bifurcated from the host. Accordingly, variable-rate liabilities owed to a VIE generally are not a variable interest in the entity.
5.8
Other arrangements and examples
Identification of the risks the entity is designed to create is based on underlying economics, not accounting or legal form
Question 5.10 Should the risks the entity is designed to create be identified based on the entitys underlying economics? How should the transactions legal form or their accounting be considered in that identification? ASC 810-10-25-26 states that the role of a contract or arrangement in the design of an entity regardless of its legal form or accounting classification dictates whether that contract or arrangement is a variable interest. We believe the economics underlying the entitys transactions, and not their accounting or legal forms, should be used in identifying the entitys risks. Illustration 5-5: Identification of risks based on underlying economics
Transfer to a VIE accounted for as a secured borrowing Company A transfers financial assets ($500) to a newly-created VIE that will pay for the transferred assets by issuing senior beneficial interests ($400) to unrelated third parties. Company A retains a subordinated interest ($100) in the transferred financial assets. Assume the transfer legally isolates the transferred assets from the transferor but is to be accounted for as a secured borrowing pursuant to ASC 860. We believe the provisions of the Variable Interest Model should be applied based on the VIEs underlying economics, not how the transferor accounted for the transfer. We believe in this example the VIE was designed to be exposed to the credit risk of the transferred assets. While for accounting purposes the VIEs asset is a receivable from the transferor, the VIE is not exposed to the transferors credit risk. Indeed, while the VIE does not recognize the transferred assets for accounting purposes, economically, the senior beneficial interest holders are exposed to variability in the transferred assets, and not the transferors credit risk. Legally, the VIE holds title to the transferred assets. We do not believe it would be appropriate to conclude that the transferor does not have a variable interest in the entity because it accounted for the transfer as a secured borrowing. Assuming the subordination is substantive, we believe the VIE was designed to create and distribute credit risk from the transferred assets. The transferor (through its retained interest) and senior beneficial interest holders would each have variable interests in the entity.
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Product financing arrangements (modified from Case F in ASC 810-10-55-75 through 55-77) Assume an entity is created by a furniture manufacturer and a financial investor to sell furniture to retail customers in a particular geographic region. The entity is created with $100 and $200, contributed by the furniture manufacturer and financial investor, respectively. The entity has entered into a fixed price purchase agreement for inventory with the furniture manufacturer, but any purchased inventory can be sold back to the furniture manufacturer for cost at any time. We believe that although the furniture manufacturer is not able to record the sale of the inventory to the entity for accounting purposes through application of ASC 470-40, the entity has economic exposure to price declines of the inventory through the fixed price purchase agreement. Accordingly, inventory price risk is a risk the entity was designed to create and distribute to its interest holders. (The furniture manufacturer absorbs the inventory price risk through the put option written to the entity and, accordingly, has a variable interest in the entity.) In this example, the entity generally is also exposed to sales volume and price risk, operating cost risk and credit risk of the furniture manufacturer.
Financial guarantees as variable interests

Question 5.11 How should financial guarantees be considered in applying the provisions of the Variable Interest Model?

Consolidation Overall Implementation Guidance and Illustrations Guarantees, Written Put Options, and Similar Obligations 810-10-55-25 Guarantees of the value of the assets or liabilities of a VIE, written put options on the assets of the VIE, or similar obligations such as some liquidity commitments or agreements (explicit or implicit) to replace impaired assets held by the VIE are variable interests if they protect holders of other interests from suffering losses. To the extent the counterparties of guarantees, written put options, or similar arrangements will be called on to perform in the event expected losses occur, those arrangements are variable interests, including fees or premiums to be paid to those counterparties. The size of the premium or fee required by the counterparty to such an arrangement is one indication of the amount of risk expected to be absorbed by that counterparty. 810-10-55-26 If the VIE is the writer of a guarantee, written put option, or similar arrangement, the items usually would create variability. Thus, those items usually will not be a variable interest of the VIE (but may be a variable interest in the counterparty). We believe a financial guarantee generally should be analyzed first to determine whether it is deemed to be a variable interest in the entity as a whole or whether it is a variable interest in specified assets.
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While a determination must be made of the nature of the risks in the entity, the purpose for which the entity was created and the variability the entity was designed to create and distribute, we generally believe a third-party financial guarantee, by design, absorbs the credit risk associated with the possible default on the entitys assets or liabilities. Accordingly, we generally believe it would not be appropriate to conclude that the entity was designed to create and distribute the financial guarantors credit risk to the entitys variable interest holders. That is, we generally believe the financial guarantee would, by design, absorb the credit risk of the entitys assets or liabilities, and consequently, the financial guarantor would have a variable interest in the entity. Illustration 5-6: Facts An entity holds a portfolio of fixed rate BBB-rated bonds, which it acquired in the market by issuing debt to unrelated investors. The bonds will be held to their maturities. The entity obtains a financial guarantee from ABC Co., which guarantees the timely collection of principal and interest payments due on the bonds. ABC Co.s credit rating is AAA. The entity markets the debt as an investment in AAA-rated securities. Analysis The entity has (1) credit risk from the BBB-rated bonds, (2) fair value interest rate risk related to the BBB-rated bonds periodic interest payments and (3) credit risk related to the AAA-rated financial guarantor. We generally do not believe that variability arising from the periodic interest payments on the fixed rate bonds would be considered in applying the provisions of the Variable Interest Model because the bonds are to be held to their maturities, and the entity was not designed to create and distribute fair value variability to the individual debt holders. While the entity was marketed to the investors as an investment in AAA-rated bonds, we believe that, by design, the entity was designed to create and distribute the risk related to the BBB-rated bonds, which is absorbed by ABC Co., through its financial guarantee. As ABC Co.s interest is considered to be an interest in the entity as a whole pursuant to ASC 810-10-25-55, ABC Co. has a variable interest in the entity. In some cases, the reporting entity that has received the proceeds from the borrowing issues the guarantee. In those cases, we generally do not believe the reporting entity has a variable interest because it is, in effect, guaranteeing its own performance. Financial guarantees
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Financial guarantees
Company A establishes a trust that issues debt to unrelated third parties and, in turn, loans the funds to Company A. The terms of the debt owed by Company A mirror those of the trust to its creditors. Company A also separately guarantees the trusts debt. Analysis We believe the trust was designated to create and distribute Company As credit risk to the trusts debt holders. Accordingly, Company A does not have a variable interest in the entity. Moreover, Company As guarantee of the trusts debt is, in effect, a guarantee of its own performance because the trusts only asset is a receivable from Company A.
Purchase and supply contracts as variable interests

Question 5.12 Are purchase and supply contracts variable interests? Purchase and supply contracts should be evaluated as potential variable interests in a manner similar to other forward contracts. If the contract is a derivative instrument, the contract should be evaluated in accordance with ASC 810-10-25-35 and 25-36. Refer to Question 5.5 for further guidance. We believe the risks the entity was designed to create and distribute and the terms of the supply contract should be considered to determine whether the contract is a variable interest. First, we believe a supply contracts terms should be evaluated to determine whether they are at-market or contain embedded subordinated financial support. A contracts off-market terms may provide financing or other support to an entity, which generally leads to a conclusion that the contract is a variable interest. We believe that after determining whether a purchase or supply contract has embedded financing, its terms should be evaluated to determine whether it creates or absorbs variability. The contracts volume should be compared to those of the underlying entity in making this decision. The following chart which is consistent with the guidance in Question 5.5 also may be used as a general guide in making this determination.
Contract pricing Fixed Reporting enterprise purchases product from entity Variable interest absorbs entitys variability15 Fair value Not a variable interest as there is no variability Not a variable interest as there is no variability
Reporting enterprise sells product to entity Not a variable interest; creates entitys variability
Determining whether a purchase or supply contract is a variable interest should be based on careful consideration of all facts and circumstances and requires the use of professional judgment.
15
Except when the supply contract is a derivative instrument that is determined not to be a variable interest in accordance with ASC 810-10-25-35 through 25-36 81
Operating leases as variable interests

Question 5.13 Is an operating lease with no residual value guarantee, purchase option or other similar features a variable interest in a VIE? If an operating lease has a residual value guarantee, purchase option or other similar feature, should the variability in the lease payments be considered a variable interest or should only variability absorbed by the additional feature be evaluated?

Consolidation Overall Implementation Guidance and Illustrations Operating Leases 810-10-55-39 Receivables under an operating lease are assets of the lessor entity and provide returns to the lessor entity with respect to the leased property during that portion of the assets life that is covered by the lease. Most operating leases do not absorb variability in the fair value of a VIEs net assets because they are a component of that variability. Guarantees of the residual values of leased assets (or similar arrangements related to leased assets) and options to acquire leased assets at the end of the lease terms at specified prices may be variable interests in the lessor entity if they meet the conditions described in paragraphs 810-10-25-55 through 25-56. Alternatively, such arrangements may be variable interests in portions of a VIE as described in paragraph 810-10-25-57. The guidance in paragraphs 810-10-55-23 through 55-24 related to debt instruments applies to creditors of lessor entities. ASC 810-10-55-39 states that [r]eceivables under an operating lease are assets of the lessor entity and provide returns to the lessor entity with respect to the leased property during the portion of the assets life that is covered by the lease. Most operating leases do not absorb variability in the fair value of the entitys net assets because they are a component of that variability. Therefore, we believe that operating leases with lease terms that are consistent with market terms at the inception of the lease and that do not otherwise include provisions such as a residual value guarantee, fixed price purchase option or similar features are not variable interests in the lessor entity. Rather, they introduce variability into the lessor entity that is absorbed or received by the entitys variable interest holders. ASC 810-10-55-39 also states that [g]uarantees of the residual values of leased assets (or similar arrangements related to leased assets) and options to acquire leased assets at the end of the lease terms at specified prices may be variable interests in the lessor entity... We believe that if an operating lease has a residual value guarantee, fixed price purchase option or similar feature, only the variability absorbed by that feature should be used in applying the provisions of the Variable Interest Model (i.e., while the operating lease is a variable interest in the lessor entity, the variability absorbed by the lessee through its lease payments should not be evaluated). While not explicitly addressed in the Variable Interest Model, we believe that a lessor entity has a variable interest in the entity to which it leases an asset (for both operating and capital leases). We believe that the lease interest is analogous to a debt interest, or a financing arrangement.
Prepaid rent as variable interests

Question 5.14 Are lease prepayments to a lessor VIE a variable interest in the entity? We believe lease prepayments to a lessor VIE are in substance a loan to the entity that will be repaid through the use of the leased asset(s). Because a loan to a VIE is generally a variable interest in the entity, prepayments of rent should be considered a variable interest.
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Local marketing agreements and joint service agreements in the broadcasting industry as variable interests
Question 5.15 How should the provisions of the Variable Interest Model be applied to local marketing agreements (LMAs) and joint service agreements (JSAs) that are used in the broadcasting industry? LMAs and JSAs are used regularly in the broadcasting industry to enable enterprises to achieve economies of scale by combining the operations of stations in certain markets where FCC regulations would otherwise prohibit an acquisition. Because FCC licenses and the related broadcasting assets generally are held in a separate legal entity, the provisions of the Variable Interest Model generally are applicable to arrangements relating to the stations. Local marketing agreements Although LMAs may take many forms, generally an enterprise will obtain the right to operate the broadcast assets of a station. The licensee (operator) will operate the station as a leased asset, making all programming and employment decisions, selling advertising and controlling substantially all operating cash inflows and outflows, subject to FCC-mandated limitations. Generally, enterprises operating a station pursuant to an LMA pay a fixed monthly fee to the licensor (seller). LMAs commonly are entered into because: Station owners may realize the efficiencies of operating multiple stations in a single market without actually acquiring additional broadcast licenses. FCC approval of the sale of the broadcast license is pending. The pending sale of a broadcast license is public information, which may lead to decreased ratings, advertising sales and the loss of employees prior to the acquirer assuming control of the station. LMAs allow the buyer to begin operating the station prior to approval of the license transfer, thereby minimizing some potential negative economic effects.
Under the terms of an LMA, the licensor and operator both maintain responsibility for the compliance of the stations programming with FCC rules and regulations, among other requirements. Accordingly, an LMA must give the licensor (1) the ability to terminate the agreement or (2) veto power over programming that it believes would not comply with FCC standards. We believe that an LMA may represent a variable interest in the entity that owns the station assets. In order to make this determination, we believe the terms of the LMA should be evaluated to determine whether the agreement is analogous to the lease of property, plant and equipment subject to the provisions of ASC 840. While ASC 840 specifically excludes intangible assets from its scope, we believe that the operator of an LMA should determine if, by analogy to ASC 840, the arrangement is similar to an operating lease for the use of property, plant and equipment. As discussed in Question 5.13, operating leases with lease terms that are consistent with market terms at the inception of the lease and do not include a residual value guarantee, fixed price purchase option or similar feature generally will not represent a variable interest in an entity. Accordingly, if an enterprise is operating a broadcast station pursuant to an LMA that is analogous to an operating lease, we believe the LMA generally would not be deemed a variable interest in the entity holding the license and related broadcasting assets. Conversely, if an LMA is not determined to be analogous to an operating lease, generally we believe the contract represents a variable interest, and the provisions of the Variable Interest Model should be applied accordingly.
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Joint service agreements Generally, pursuant to a JSA, an enterprise that owns a station in a given market will act as a service provider to an enterprise that owns the FCC license and related station, tower and broadcasting equipment of a second station in the same market, combining the stations selling, marketing and bookkeeping functions. The enterprises each retain ownership of their respective assets. The enterprise acting as the service provider is responsible for the sale of advertising for both stations, administrative, operational and business functions, maintenance, repair and replacement of equipment and facilities. The service provider generally is required to obtain the second enterprises approval of annual budgets and any capital expenditures. The enterprise acting as the service provider retains control over the programming and all other operations of the station it owns. It also consults with the second enterprise relating to the programming that is aired on the second station, but that enterprise, as the FCC license holder, retains the exclusive control over the programming, as well as employment decisions and financing of the second station. The enterprise acting as the service provider collects and retains the operating revenues of both stations and remits a portion of the second stations cash flows to the second enterprise. The terms of a JSA should be evaluated by the service provider to determine whether the arrangement is a variable interest in the entity that owns the broadcast station. Pursuant to ASC 810-10-55-37, fees paid to an entitys decision maker(s) or service providers are not a variable interest if certain conditions are met. Refer to Chapter 6 for discussion of those conditions. It is important that all of the relevant terms and conditions of an LMA or JSA are understood before applying the provisions of the Variable Interest Model. LMAs and JSAs may contain provisions (or may be entered into in conjunction with other agreements) for certain put and (or) call options on the stations assets at a future date. Additionally, other contractual provisions may provide protection against a decrease in the fair value of the station assets (e.g., a nonrefundable deposit received by the station owner that may be applied against the exercise price of a call option, if and when exercised, by the option purchaser). These terms should be evaluated carefully against the provisions of the Variable Interest Model because (1) the entity owning the station may be a VIE, and (2) the operator or service provider may be that entitys primary beneficiary.
Purchase and sale contracts for real estate as variable interests

Question 5.16 Is a purchase and sale contract for real estate a variable interest? We believe that the design of the entity holding the real estate should be considered in determining whether a purchase and sale contract for real estate is a variable interest. Because real estate held by an entity may have operations and often is transferred from sellers to buyers, we do not believe the Variable Interest Models provisions were designed to require purchasers of real estate to consolidate the entities holding that real estate upon entering a typical purchase and sale contract, effectively overriding ASC 976 and ASC 360-20s provisions. We generally do not believe that a typical purchase and sale contract for real estate that provides for conditions precedent to closing is a variable interest because (1) ASC 360-20-40-5 provides that, among other conditions, profit on real estate transactions is not to be recognized until a sale has been consummated, and (2) by design, a purchase and sale contract does not transfer to the buyer the usual benefits of ownership of the real estate. Therefore, the purchase and sale contract should not, in and of itself, require the purchaser to consolidate the entity holding the real estate. We believe a real estate purchase and sale contracts terms should be evaluated to determine, based upon all facts and circumstances, whether the purchaser has a substantive right to terminate the contract and receive the return of its escrow deposit. If the purchasers rights to terminate the contract and to receive its deposit are substantive, generally we believe the purchase and sale contract is a type of contingent forward contract that would not be a variable interest.
Generally, we believe the following conditions, among others, should be considered in determining whether the conditions precedent to the purchasers obligation to close are substantive: Must the existing lender consent to the transfer of the property and the assumption of the existing loan? Has that consent been obtained? Do title requirements exist that the seller is required to comply with? Are there any specified violations that must be cured prior to the closing date? What is the nature of those violations? Is the seller required to obtain estoppel certificates? Is the contract terminable upon the event of a material casualty to the property prior to closing? Who bears the risk of loss on the property? What are the sellers representations and warranties? For example, could the termination of a tenant lease or a material default by a tenant permit the purchaser to terminate the contract and receive a refund of the escrow deposit?
In contrast, generally we believe that a purchase and sale contract that, by design, provides the purchaser with no rights or nonsubstantive rights to terminate the contract and has passed the risks and rewards of the real estate to the buyer would be a variable interest in the entity. Additionally, we generally believe a lot option contract to control a supply of land to be used in future construction by homebuilders is subject to the Variable Interest Models provisions.
Netting or offsetting contracts

Question 5.17 May positions be netted or offset in applying the provisions of the Variable Interest Model? We generally believe the application of the Variable Interest Model requires each instrument or contract to be identified as either a creator or absorber of variability based on the role of that instrument and the risk the entity was designed to create and distribute to its interest holders. While application of the provisions of the Variable Interest Model may result in the variability of instruments offsetting each other because they are both deemed to be creators of variability, it is not appropriate for the reporting enterprise or the entity to net contracts and conclude that the entity was not designed to create and distribute the underlying risk. To illustrate, assume an entity holds a portfolio of financial assets, which was funded by issuing senior debt, subordinated debt and equity. It would not be appropriate to net the credit risk absorbed by the subordinated debt and equity against the assets and conclude that the risk the entity was designed to create and distribute is the credit risk to be absorbed by the senior debt holder. Similarly, in applying the provisions of the Variable Interest Model, we generally do not believe it is appropriate to net or offset synthetic positions. For example, if the entity above purchased credit protection through either a guarantee or credit default swap, the risk absorbed by the guarantor or the writer of the credit default swap cannot be netted against the credit risk in the assets. Instead, each contract should be evaluated as a potential absorber of the entitys designed variability (considering ASC 810-10-25-35 and 25-36). However, the entitys design considering all facts and circumstances may lead to a conclusion that, in certain circumstances, an instrument should be netted in applying the provisions of the Variable Interest Model.
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Netting or offsetting contracts
Bank A, seeking to obtain protection for Investment Y, enters into a credit default swap with a newlyestablished trust. Investors purchase credit-linked notes, the proceeds from which are invested in US Treasury securities. Bank A pays a specified premium for credit protection, and if a credit event (as defined) occurs, the trust pays Bank A the notional amount and receives Investment Y. The credit linked notes are satisfied through delivery of the defaulted bonds or by selling them and paying cash. Bank A also contributes cash to the entity in exchange for equity. That equity investment absorbs the first dollar risk of loss created by the credit default swap. The arrangement is depicted as follows:
Protection Premium
Cash
BankA
Cash Cash Equity
Issuer
CLNs Bondyield
CLNholder
US Treasury Bond
Analysis We believe the trust was designed to create and distribute the credit risk of Investment Y. Accordingly, the credit default swap issued to Bank A would be a creator of variability. The credit linked notes are variable interests as they absorb the risk the entity was designed to create and distribute, the credit of Investment Y. We do not believe Bank As equity investment is a variable interest because, by design, Bank A absorbs losses that it created through its credit default swap. That is, on a net basis by design Bank A has no risk for this equity investment. Any loss absorbed by Bank A in its equity is, by design, equal to its gain on the credit default swap, leaving it neutral to the credit risk of Investment Y for the amount of the equity investment. Economically, we believe Bank A effectively has created a deductible to its credit protection. That is, Bank A effectively has obtained an insurance policy from the credit linked note holders, and that policy provides protection for losses only in excess of Bank As equity investment. We believe Bank A could have structured the transaction similarly by having the credit default swaps terms state that Bank A was entitled to payment only after losses exceeded a deductible amount. Under either alternative, we believe the accounting should be the same; the trust was designed to create and distribute credit risk that is absorbed only by the credit linked note holders. The basic terms of this structure may be used in different arrangements including financial guarantees and insurance/reinsurance. We believe there may be other views in the accounting for these arrangements. Accordingly, readers are cautioned to carefully evaluate the structures design considering all of the individual facts and circumstances in applying the provisions of the Variable Interest Model.
Implicit variable interests

Question 5.18 Should a reporting enterprise consider whether it holds an implicit variable interest in a VIE or potential VIE? If so, how should that determination be made?

Consolidation Overall Recognition Implicit Variable Interests 810-10-25-48 Implicit variable interests commonly arise in leasing arrangements among related parties, and in other types of arrangements involving related parties and unrelated parties. 810-10-25-49 The following guidance addresses whether a reporting entity should consider whether it holds an implicit variable interest in a VIE or potential VIE if specific conditions exist. 810-10-25-50 The identification of variable interests (implicit and explicit) may affect the following: a. b. c. The determination as to whether the potential VIE shall be considered a VIE The calculation of expected losses and residual returns The determination as to which party, if any, is the primary beneficiary of the VIE.
Thus, identifying whether a reporting entity holds a variable interest in a VIE or potential VIE is necessary to apply the provisions of the guidance in the Variable Interest Entities Subsections. 810-10-25-51 An implicit variable interest is an implied pecuniary interest in a VIE that changes with changes in the fair value of the VIEs net assets exclusive of variable interests. Implicit variable interests may arise from transactions with related parties, as well as from transactions with unrelated parties. 810-10-25-52 The identification of explicit variable interests involves determining which contractual, ownership, or other pecuniary interests in a legal entity directly absorb or receive the variability of the legal entity. An implicit variable interest acts the same as an explicit variable interest except it involves the absorbing and (or) receiving of variability indirectly from the legal entity, rather than directly from the legal entity. Therefore, the identification of an implicit variable interest involves determining whether a reporting entity may be indirectly absorbing or receiving the variability of the legal entity. The determination of whether an implicit variable interest exists is a matter of judgment that depends on the relevant facts and circumstances. For example, an implicit variable interest may exist if the reporting entity can be required to protect a variable interest holder in a legal entity from absorbing losses incurred by the legal entity. See Example 4 (paragraph 810-10-55-87) for an illustration of this guidance. 810-10-25-53 The significance of a reporting entitys involvement or interest shall not be considered in determining whether the reporting entity holds an implicit variable interest in the legal entity. There are transactions in which a reporting entity has an interest in, or other involvement with, a VIE or potential VIE that is not considered a variable interest, and the reporting entitys related party holds a variable
interest in the same VIE or potential VIE. A reporting entitys interest in, or other pecuniary involvement with, a VIE may take many different forms such as a lessee under a leasing arrangement or a party to a supply contract, service contract, or derivative contract. 810-10-25-54 The reporting entity shall consider whether it holds an implicit variable interest in the VIE or potential VIE. The determination of whether an implicit variable interest exists shall be based on all facts and circumstances in determining whether the reporting entity may absorb variability of the VIE or potential VIE. A reporting entity that holds an implicit variable interest in a VIE and is a related party to other variable interest holders shall apply the guidance in paragraph 810-10-25-44 to determine whether it is the primary beneficiary of the VIE. That is, if the aggregate variable interests held by the reporting entity (both implicit and explicit variable interests) and its related parties would, if held by a single party, identify that party as the primary beneficiary, then the party within the related party group that is most closely associated with the VIE is the primary beneficiary. The guidance in paragraphs 810-10-25-48 through 25-54 applies to related parties as defined in paragraph 810-10-25-43. For example, the guidance in paragraphs 810-10-25-48 through 25-54 applies to any of the following situations: a. b. c. A reporting entity and a VIE are under common control. A reporting entity has an interest in, or other involvement with, a VIE and an officer of that reporting entity has a variable interest in the same VIE. A reporting entity enters into a contractual arrangement with an unrelated third party that has a variable interest in a VIE and that arrangement establishes a related party relationship.
ASC 810-10-55-25 states that [g]uarantees of the value of the assets or liabilities of a VIE (explicit or implicit) are variable interests if they protect holders of other interests from suffering losses. Although ASC 810-25-55-25 refers to guarantees as one type of implicit variable interest, there are other types. Implicit variable interests should be considered in applying all of the provisions of the Variable Interest Model. Implicit variable interests may cause an entity to be a VIE (e.g., an implicit variable interest could protect the holders of the entitys equity investment at risk). Implicit variable interests are the same as explicit variable interests in that they both absorb the entitys variability. Implicit variable interests, however, indirectly (as opposed to directly) absorb the entitys variability. Implicit variable interests may arise from transactions with both related and unrelated parties. While the determination of whether an implicit variable interest exists is based on the facts and circumstances, transactions in which (1) the reporting enterprise has an explicit variable interest in, or other involvement with, an entity and (2) a related party has a variable interest with the same entity, should be closely examined in determining whether there are any implicit variable interests. Factors that should be considered in determining whether the reporting enterprise has an implicit variable interest in entities involving related parties include: What is the nature of the related party relationship? An implicit variable interest may exist when a related party has the ability to control or significantly influence the reporting enterprise. For example, assume the Chief Executive Officer (CEO) of a reporting enterprise is also the CEO and sole owner of an entity that provides services to the reporting enterprise. The nature of the related party relationship may indicate that the CEO may require the reporting enterprise to reimburse the entity for losses incurred (losses that otherwise would be absorbed by the CEO). What is the economic impact, if any, to the reporting enterprise or related party? For example, if the reporting enterprise and related party were wholly-owned subsidiaries of the same parent, there would be no net economic benefit to the parent from the implicit guarantee. However, an economic
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incentive may exist if the reporting enterprise was not wholly-owned and a portion of the losses, for example, on a guarantee, could be allocated to the reporting enterprises noncontrolling owners. Under what constraints do the reporting enterprise and related party operate? Are all related party transactions separately evaluated by senior management? Is the reporting enterprise or related party subject to regulation? Do other parties involved with the reporting enterprise or the related party believe implicit variable interests exist? For example, in setting the interest rate on the reporting enterprises newly issued debt, did the financial institution believe there were any guarantees or other forms of credit support that were not reflected in the reporting enterprises financial statements? Have any transactions occurred that should have contemplated implicit variable interests, but did not? Why werent the implicit variable interests considered in applying the provisions of the Variable Interest Model to the prior transactions?
Implicit variable interests may also arise in situations in which an enterprise, by design, enters into contracts with variable interest holders outside the entity that effectively protect those holders from absorbing a significant amount of the entitys variability. Factors that should be considered in determining whether the reporting enterprise has an implicit variable interest in entities in these situations include: Was the arrangement entered into in contemplation of the entitys formation? Was the arrangement entered into contemporaneously with the issuance of a variable interest? Why was the arrangement entered into with a variable interest holder instead of with the entity? Did the arrangement reference specified assets of the variable interest entity?
The determination of whether an implicit variable interest exists is a matter based on facts and circumstances, requiring the use of professional judgment. The following example provides an illustration of implicit variable interests:

Consolidation Overall Implementation Guidance and Illustrations Example 4: Implicit Variable Interests 810-10-55-87 This example illustrates the guidance in paragraphs 810-10-25-48 through 25-54. 810-10-55-88 One of the two owners of Manufacturing Entity is also the sole owner of Leasing Entity, which is a VIE. The owner of Leasing Entity provides a guarantee of Leasing Entitys debt as required by the lender. Leasing Entity owns no assets other than the manufacturing facility being leased to Manufacturing Entity. The lease, with market terms, contains no explicit guarantees of the residual value of the real estate or purchase options and is therefore not considered a variable interest under paragraph 81010-55-39. The lease meets the classification requirements for an operating lease and is the only contractual relationship between Manufacturing Entity and Leasing Entity.
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810-10-55-89 Manufacturing Entity should consider whether it holds an implicit variable interest in Leasing Entity. Although the lease agreement itself does not contain a contractual guarantee, Manufacturing Entity should consider whether it holds an implicit variable interest in Leasing Entity as a result of the leasing arrangement and the relationship between it and the owner of Leasing Entity. For example, Manufacturing Entity would be considered to hold an implicit variable interest in Leasing Entity if Manufacturing Entity effectively guaranteed the owners investment in Leasing Entity. The guidance in paragraphs 810-10-25-48 through 25-54 shall be used only to evaluate whether a variable interest exists under the Variable Interest Entities Subsections and shall not be used in the evaluation of lease classification in accordance with Topic 840. Paragraph 840-10-25-26 addresses leases between related parties. Manufacturing Entity may be expected to make funds available to Leasing Entity to prevent the owners guarantee of Leasing Entitys debt from being called on, or Manufacturing Entity may be expected to make funds available to the owner to fund all or a portion of the call on Leasing Entitys debt guarantee. The determination as to whether Manufacturing Entity is effectively guaranteeing all or a portion of the owners investment or would be expected to make funds available and, therefore, an implicit variable interest exists, shall take into consideration all the relevant facts and circumstances. Those facts and circumstances include, but are not limited to, whether there is an economic incentive for Manufacturing Entity to act as a guarantor or to make funds available, whether such actions have happened in similar situations in the past, and whether Manufacturing Entity acting as a guarantor or making funds available would be considered a conflict of interest or illegal.
Impact on acquisition date provisions in ASC 805

Question 5.19 Does the Variable Interest Model affect the acquisition date provisions in ASC 805? ASC 805 provides that the acquisition date of a business combination is typically the closing (or consummation) date but may be an earlier designated date if, among other conditions, the parties reach a firm purchase agreement and effective control of the acquired enterprise, including the risks and rewards of ownership, are transferred to the acquiring enterprise as of the designated date. Generally, we do not believe that the provisions of the Variable Interest Model were designed to effectively amend or affect ASC 805s acquisition date guidance. Accordingly, we believe that, in and of itself, a firm agreement to acquire a business, by design, does not necessarily represent a variable interest in a VIE that is required to be consolidated by the acquirer at the date of the firm agreement. However, the determination of whether the provisions of the Variable Interest Model apply to a firm agreement to acquire a business should be made after considering all of the relevant facts and circumstances.
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Illustrative example Identification of variable interests commercial real estate

Question 5.20 How do you identify variable interests in a VIE designed to acquire and manage commercial real estate? Illustration 5-9: Facts Assume that an LLC is formed to acquire and rent commercial real estate. The LLC is funded by an equity participant that contributes capital of 10% of the real estates cost. The LLC finances the rest of its acquisition with fixed-rate senior debt (60% of the LLCs capitalization) and variable rate subordinated debt (LIBOR-based) (30% of the LLCs capitalization). Real estate acquired by the LLC cannot be sold without the approval of the lenders. The LLC acquires a newly constructed office building and engages a property management company to manage the property on its behalf. The property management company is responsible for establishing operating budgets, managing to the budget, screening and selecting tenants, negotiating lease terms, etc., and receives a fee for its service. The property management company leases the facility to a single tenant for a ten-year period. Lease terms are market-based at inception of the lease. The lease does not contain a fixed-price purchase option, residual value guarantee or other similar features. The LLC enters into a market-based interest rate swap to hedge the variable rate interest payments on the subordinated borrowings. Analysis Equity Participant The equity participant has a variable interest in the LLC through its equity investment. Subordinated Lender The subordinated lender has a variable interest in the LLC. Senior Lender The senior lender has a variable interest in the LLC. Lessee Because the terms of the lease were market-based at inception and the lease contains no fixed-price purchase options, residual value guarantees or other features, the lessee does not have a variable interest in the LLC. Property Management Company The property management company may or may not have a variable interest in the LLC depending on whether the fees it receives meet the conditions described in ASC 81010-55-37 (see Chapter 6 for further discussion of fees paid to a decision maker or service provider). Interest Rate Swap Counterparty The counterparty to the interest rate swap does not have a variable interest in the LLC (see Question 5.5). Commercial real estate
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Variable interests fees paid to decision makers or service providers

Consolidation Overall Implementation Guidance and Illustrations Fees Paid to Decision Makers or Service Providers 810-10-55-37 Fees paid to a legal entitys decision maker(s) or service provider(s) are not variable interests if all of the following conditions are met: a. b. c. The fees are compensation for services provided and are commensurate with the level of effort required to provide those services. Substantially all of the fees are at or above the same level of seniority as other operating liabilities of the VIE that arise in the normal course of the VIEs activities, such as trade payables. The decision maker or service provider does not hold other interests in the VIE that individually, or in the aggregate, would absorb more than an insignificant amount of the VIEs expected losses or receive more than an insignificant amount of the VIEs expected residual returns. The service arrangement includes only terms, conditions, or amounts that are customarily present in arrangements for similar services negotiated at arms length. The total amount of anticipated fees are insignificant relative to the total amount of the VIEs anticipated economic performance. The anticipated fees are expected to absorb an insignificant amount of the variability associated with the VIEs anticipated economic performance.
d. e. f.
810-10-55-37A For purposes of evaluating the conditions in the preceding paragraph, the quantitative approach described in the definitions of the terms expected losses, expected residual returns, and expected variability is not required and should not be the sole determinant as to whether a reporting entity meets such conditions. In addition, for purposes of evaluating the conditions in the preceding paragraph, any interest in the entity that is held by a related party of the entitys decision maker(s) or service provider(s) should be treated as though it is the decision makers or service providers own interest. For that purpose, a related party includes any party identified in paragraph 810-10-25-43 other than: a. An employee of the decision maker or service provider (and its other related parties), except if the employee is used in an effort to circumvent the provisions of the Variable Interest Entities Subsections of this Subtopic An employee benefit plan of the decision maker or service provider (and its other related parties), except if the employee benefit plan is used in an effort to circumvent the provisions of the Variable Interest Entities Subsections of this Subtopic.
b.
810-10-55-38 Fees paid to decision makers or service providers that do not meet all of the conditions in the preceding paragraph are variable interests.
6 Variable interests fees paid to decision makers or service providers
6.1
Note: In February 2010, the FASB issued an Accounting Standards Update (ASU) primarily to address concerns with the application of Statement 167 for reporting enterprises in the asset management industry by deferring the effective date of Statement 167 for certain investment funds. As currently written, Statement 167 would have resulted in asset managers consolidating many hedge funds, private equity funds and other investment funds that they manage. Additionally, the ASU deferred the effective date of Statement 167 for money market funds (MMFs) that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940. For further discussion of this ASU, refer to Chapter 21. The FASB currently has a project on its agenda that would eliminate the deferral discussed above. In addition, the FASBs tentative decisions would modify the Variable Interest Models provisions for evaluating an enterprise as a principal or an agent (discussed in this Chapter) and the provisions for evaluating the substance of kick-out rights and participating rights (see Chapters 9 and 14), among other things. Readers should monitor developments in this area closely. The Variable Interest Model defines variable interests as contractual, ownership, or other pecuniary interests in an entity that change with changes in the fair value of the VIEs net assets in ASC 810-1020. In applying the provisions of the Variable Interest Model, an enterprise first must determine whether it has a variable interest in the entity being evaluated for consolidation. An enterprise should consider the purpose of the entity and the risks that the entity was designed to create and pass along to its interest holders in making that determination. Refer to the Interpretative guidance to Chapter 5 for a more detailed discussion of general considerations with respect to the identification of variable interests. The Variable Interest Model provides specific guidance for evaluating whether fees paid to a decision maker or service provider are variable interests. Statement 167 amended this guidance. The most significant change is that a decision maker or service provider no longer need be subject to removal through substantive kick-out rights to conclude that it does not hold a variable interest. The FASB has indicated that the amendment to remove the kick-out rights criterion was to promote consistency between the determination of whether an enterprise has a variable interest in a VIE and whether an enterprise is the primary beneficiary of a VIE. As described in detail in Chapter 14, the FASB concluded that kick-out rights should not be considered in the primary beneficiary determination unless a single enterprise (including its related parties and de facto agents) has the unilateral ability to exercise such rights. Additionally, Statement 167 replaced the quantitative thresholds of trivial and not large with the term insignificant for purposes of assessing the magnitude of a decision makers or service providers fees or the amount of variability that could be absorbed by the fees or its other variable interests. This change was made to provide a consistent threshold throughout the analysis of a decision makers or service providers fees. The other amendments primarily consolidate the criteria included in the Variable Interest Model into two paragraphs as reproduced above. The conditions in ASC 810-10-55-37 focus on the nature of the services and the amount of the fees (including the decision maker or service provider and its related parties). Specific items to note are: Criteria (a) and (d) may require a decision maker or service provider to analyze similar arrangements among parties outside of the relationship being analyzed to assess whether it meets these criteria
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Criteria (c), (e) and (f) may include elements of a quantitative assessment, in certain circumstances, and will require an assessment of what meets the definition of insignificant. While fee percentages (e.g., 2% of assets under management, 20% of profits) often are stated in contractual arrangements, a decision maker or service provider may be required to perform a quantitative analysis, in certain cases, to determine the magnitude and variability of fees that may be earned. It is important to note that with criteria (e) and (f), the fees and economic performance being evaluated are what are anticipated. Therefore, this may require an enterprise to consider probabilistic outcomes over time, rather than what could potentially occur if probability was ignored. It should be noted that the FASB has provided no bright-lines for the quantitative thresholds contained in these criteria Criterion (c) requires an enterprise to evaluate its other interests in the entity. These interests could include implicit variable interests. Refer to Question 5.18 for further discussion of implicit variable interests When evaluating fees paid to a decision maker or service provider, interests held by related parties, (except for certain employees and employee benefits plans discussed in ASC 810-10-55-37A) should be treated as though they are the decision makers or service providers own interest. Refer to ASC 810-10-25-43 (see Chapter 15) for the Variable Interest Models definition of related parties When giving consideration to interests held by separate accounts of an insurance enterprise as possible related parties of the decision maker or service provider, refer to Question 15.5 In assessing significance pursuant to ASC 810-10-55-37, the quantitative approach described in the definitions of the terms expected losses, expected residual returns and expected variability in the ASC Master Glossary is not required and should not be the sole determinant
The revised guidance for determining whether fees paid to a decision maker or service provider (and its related parties) represent a variable interest in a VIE is fundamentally attempting to determine whether an enterprise is acting in a fiduciary capacity as an agent to the VIE or whether the enterprise is a principal. The FASB expects that an enterprise that acts solely as a fiduciary or agent typically would not have a variable interest in a VIE as its fees and variable interests, if any, would typically meet the criteria in ASC 810-10-55-37. If an enterprises fees or other variable interests do not meet these criteria, the FASB believes that an enterprise is a principal to the transaction. To illustrate, a general partner in a partnership arrangement may receive a carried interest that allows the general partner to participate significantly in the profits of the partnership (e.g., 20%). In these situations, a general partner likely will conclude that their equity interest does provide them with a variable interest. If an enterprise concludes that it does not have a variable interest in an entity after evaluating the provisions of ASC 810-10-55-37 and considering any other interests in the entity, we believe that the enterprise is not required to evaluate the provisions of the Variable Interest Model further to account for its interest. This includes determining whether the enterprise is the primary beneficiary of the entity and whether the enterprise is subject to the disclosure provisions of the Variable Interest Model. If an enterprise does have a variable interest in an entity, the next step is to evaluate whether the entity is a VIE. Several changes to the Variable Interest Model will increase the emphasis on the analysis of fees paid to decision makers. The determination of the primary beneficiary of a VIE is based upon a qualitative analysis, which requires an enterprise to determine whether it has (1) the power to direct the activities of a VIE that most significantly impact the entitys economic performance (power) and (2) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE (benefits). As a result, an arrangement with a decision maker that constitutes a variable interest takes on greater importance in
the application of the Variable Interest Model, as amended by Statement 167. If a decision maker has a variable interest, it may have power and benefits and, therefore, be the primary beneficiary. Refer to Chapter 14 for Interpretative guidance and related Questions with respect to the determination of the primary beneficiary. Frequently, decision maker and service provider arrangements do not include provisions whereby the decision maker or service provider can be removed. Prior to Statement 167s amendments, those arrangements were considered variable interests. In addition, prior to Statement 167s amendments, some enterprises in practice may have considered whether such arrangements, in combination with other variable interests, would have caused the enterprise to be the primary beneficiary of the VIE through absorption of a majority of the expected losses and expected residual returns. If the arrangement could not have caused the enterprise to be the primary beneficiary, those enterprises may not have performed a formal evaluation of whether the arrangement was a variable interest. Specifically, the enterprise may not have evaluated all of the conditions included in ASC 810-10-55-33 through 5538 prior to Statement 167s amendments to determine whether the arrangement is a variable interest. Additionally, some may find that interpretations of the quantitative thresholds of trivial and not large are different from insignificant. As noted in certain comment letters on the Exposure Draft, some practitioners had interpreted more than trivial as anything more than zero. Therefore, as a result of the discussed changes to these provisions, previous consolidation conclusions should be revisited upon the adoption of Statement 167. A decision makers or service providers evaluation of whether an arrangement is a variable interest under the provisions of ASC 810-10-55-37 will require a careful examination of the facts and circumstances and the use of professional judgment. By virtue of the rights to make decisions in the service contract, a decision maker that holds a variable interest could be deemed the primary beneficiary of a VIE.
Evaluation of same level of seniority as other operating liabilities of the entity

Question 6.1 In ASC 810-10-55-37(b), what is the meaning of the same level of seniority as other operating liabilities of the entity? Fees paid to an entitys decision maker(s) or service provider(s) are not variable interests in an entity if, among other things, [s]ubstantially all of the fees are at or above the same level of seniority as other operating liabilities of the entity that arise in the normal course of the entitys activities, such as trade payables. We believe that this provision is referring to the priority of the decision makers or service providers claim on the entitys assets after the fee is calculated and is payable. Therefore, we do not believe that the mere fact that a performance fee is determined based on a defined performance metric violates this provision. However, if the performance fee, once calculated, is contractually subordinate in payment priority to other liabilities (e.g., trade payables) of the entity, the fee would constitute a variable interest. The enterprise must evaluate carefully the individual facts and circumstances when evaluating the seniority of a fee payable. To illustrate, assume that a servicer in a collateralized loan obligation (CLO) arrangement receives both a fixed fee and a performance fee for the services that it provides. While the fixed fee is pari passu to senior debt and other operating payables with respect to priority of claim, the performance fee ranks subordinate to the senior debt and other operating payables. In this instance, the enterprise must evaluate whether the fixed fee represents substantially all the fees that will be received in the fee arrangement. If not, the servicing fee would be deemed a variable interest pursuant to ASC 810-10-55-37(b).
To further illustrate, assume that a decision maker of an operating entity receives a performance fee that is calculated as a percentage of operating income (prior to consideration of the performance fee). In arriving at operating income, the entity deducts all operating expenses including salaries, utility expenses and repairs and maintenance. While the performance fee is calculated after all operating expenses have been deducted from sales, the calculated performance fee ranks pari passu with other operating payables in the entity with respect to priority of claim. As a result, the performance fee does not violate the provision of ASC 810-10-55-37(b).
Estimating an entitys anticipated economic performance

Question 6.2 How should an enterprise estimate an entitys anticipated economic performance? What are the most appropriate performance metrics to consider when measuring anticipated economic performance (sales, operating margin, net income or some other metric)? In making the determination of whether fees paid to an entitys decision maker(s) or service provider(s) represent a variable interest, ASC 810-10-55-37(e) and (f) require an evaluation of an entitys anticipated economic performance. However, the Variable Interest Model does not provide examples or detailed implementation guidance regarding this concept. In evaluating anticipated economic performance, we believe that it is important to consider the purpose and design of the entity. In addition, because these provisions refer to anticipated economic performance, we believe that an entitys anticipated economic performance likely will be measured by considering probabilistic (i.e., probabilityweighted) outcomes over the life of the entity. That is, anticipated economic performance should reflect expectations rather than emphasize current performance or economic conditions. For example, when considering the anticipated economic performance of a CLO, one might consider the historical returns for similar CLOs over the life of the enterprise or over the anticipated life cycle of the CLO. Thus, we believe that short-term market conditions may not be relevant when considering an entity with a longterm performance horizon if those conditions are not consistent with the long-term outlook and purpose and design of the entity at inception or upon an enterprises involvement with the entity. We believe that a determination of the metrics to be used to measure anticipated economic performance will require a careful consideration of entitys purpose and design. We also believe that performance metrics that are closely monitored by an entitys investors often will provide insight into metrics to be considered for this purpose. Therefore, we believe that the metrics used to measure economic performance likely will vary by entity. In addition, we believe that it may be relevant for an enterprise to consider multiple metrics in this evaluation. To illustrate, oftentimes a servicer receives a fee that is a fixed percentage of the unpaid principal balance on the underlying assets. However, for many securitization trusts, we would expect investors to look to the return of the trust or their beneficial interests to evaluate the trusts economic performance, which is a different metric than that used to calculate the fees due to the servicer. As such, the fee is only indirectly related to performance (i.e., the fee is related to the unpaid principal balance on the underlying assets and not to the total return of the trust or of the beneficial interests). Therefore, it may be appropriate for a servicer to consider this indirect relationship of its fees to the entitys performance as a factor when evaluating whether its fee is insignificant in relation to the anticipated economic performance of the entity. That is, because the fee is not calculated based on economic performance of the entity, it may be less likely that the fee will be considered significant compared to the anticipated performance of the entity.
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Determination of what level of other interests meets the definition of more than an insignificant amount (ASC 810-10-55-37(c))
Question 6.3 How should an enterprise determine what is considered a more than an insignificant amount for purposes of assessing whether fees paid to a decision maker or service provider represent a variable interest (ASC 810-10-55-37(c))? In making the determination of whether fees paid to an entitys decision maker(s) or service provider(s) (and its related parties) represent a variable interest, ASC 810-10-55-37(c) indicates that the decision maker or service provider and its related parties cannot hold other interests that would absorb more than an insignificant amount of the entities expected losses or residual returns. This threshold is used for purposes of evaluating the magnitude of the other interest(s) held by an entitys decision maker or service provider. The FASB has not provided any detailed implementation guidance or bright-lines for considering the quantitative thresholds contained in these criteria. We believe the provisions of ASC 810-10-55-37 are based upon the objective of determining whether an enterprise is acting as a fiduciary (or agent) or a principal in its role as a decision maker or service provider. The FASB believes that the larger the other variable interest(s) held by the decision maker or service provider become, then the more likely the decision maker or service provider is acting as a principal. Therefore, the FASB provided the threshold of more than an insignificant amount for making this assessment. We believe that more than insignificant should be interpreted to mean the same as significant. We also believe that an evaluation of the threshold of more than insignificant will require a careful evaluation of the purpose and design of each entity in which the enterprise has involvement and will require significant professional judgment. In addition, qualitative factors may be relevant in making this threshold determination. In particular, we believe that it is relevant to consider the nature of the other variable interests held (e.g., senior vs. subordinated interests) rather than the pure magnitude of those interests. The following are some additional considerations: We believe that an enterprise may determine that it can hold a higher dollar amount of senior interests and still meet the more than an insignificant amount threshold than if the interests held were subordinated or residual interests. That is, if the senior interest is not expected to absorb a significant amount of expected losses or expected residual returns, a relative high ownership level of such interests would not necessarily cause the service providers fees to be considered a variable interest. It may be relevant to compare the significance of the interests held by the enterprise to other similar arrangements in an evaluation of commonality across structures. That is, if the enterprises other interests are significantly higher than those of others providing similar services, then the other interests are more likely to be viewed as significant.
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Determination of what meets the definition of more than an insignificant amount (ASC 810-10-55-37(c)) vs. the determination of whether an equity investment is substantive in the VIE assessment
Question 6.4 Does the determination that an equity investment is substantive for purposes of the VIE determination mean that the equity interest should be viewed as absorbing more than an insignificant amount of the entitys expected losses or receiving more than an insignificant amount of the entitys residual returns? Not necessarily. We generally believe there is a rebuttable presumption that an equity investment is substantive if it is at least 1% or more of the entitys assets (or equity) (refer to Question 9(b)(1).-6 for complete discussion of this view). This threshold relates to the determination of whether an equity holder should be viewed as an at-risk equity holder for purposes of assessing whether the entity is a VIE (i.e., whether the at-risk equity holders (as a group) have power). However, it should be noted that the Variable Interest Model does not introduce a threshold definition (e.g., more than insignificant amount) for purposes of this assessment. We do not believe that the FASB intended for all at-risk equity investments to satisfy the criteria for absorbing more than an insignificant amount of expected losses or receiving more than an insignificant amount of expected returns. Therefore, we do not believe that there is symmetry between what would be considered an at-risk equity holder and an equity investment that would absorb more than an insignificant amount of variability. Thus, we believe that it is possible for a decision maker or service provider to conclude that it holds a substantive equity investment that does not absorb more than an insignificant amount of variability. For example, a 2% interest in the equity at risk would be substantive for purposes of determining whether the investor should be included in group of at-risk equity holders, but likely would not absorb more than an insignificant amount of expected losses or receive more than an insignificant amount of expected returns.
Determination of whether the magnitude of fees meets the definition of insignificant (ASC 810-10-55-37(e) and (f))
Question 6.5 How should an enterprise determine what is considered insignificant for purposes of assessing whether fees paid to decision maker or service provider represent a variable interest (ASC 810-1055-37(e) and (f))? In making the determination of whether fees paid to an entitys decision maker(s) or service provider(s) (and its related parties) represent a variable interest, ASC 810-10-55-37 (e) and (f) incorporate a threshold of insignificant. This threshold is used for purposes of evaluating the magnitude of the fees received by an entitys decision maker or service provider. For the fees not to be considered a variable interest, they must be insignificant to the total anticipated economic performance of the entity and must absorb an insignificant amount of variability of the entitys anticipated economic performance. The FASB has not provided any detailed implementation guidance or bright-lines for considering the quantitative thresholds contained in these criteria. We believe the provisions of ASC 810-10-55-37 are based upon the objective of determining whether an enterprise is acting as a fiduciary (or agent) or a principal in its role as a decision maker or service provider. The criteria in this paragraph imply that the larger the fees become, then the more likely the decision maker or service provider is acting as a principal.
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We believe that an evaluation of the threshold of insignificant will require a careful evaluation of the purpose and design for each entity in which the enterprise has involvement and will require significant professional judgment. Given variations in structures and arrangements across industries and entities within those industries, we generally do not believe that a bright-line for determining what is insignificant should be established. Rather, we believe that, in many cases, qualitative factors may be relevant in making this threshold determination. We believe that it is relevant to consider, among other things, the manner in which the fees are computed (e.g., fixed fees vs. performance-based fees). The following are some additional considerations: Performance fees may require a careful analysis. Many management arrangements contain a performance fee that could cause a fee arrangement to not meet the insignificant threshold. For example, a servicer in an arrangement may receive a performance fee that allows the servicer to participate significantly in the profits of the entity. In these situations, the servicer may conclude that their fee arrangement provides them with a variable interest. It may be relevant to consider the nature of the fee relationship in relation to other similar arrangements. For example, it may be viewed as common for a servicer to earn a fixed fee of 50 basis points on the assets that they service. However, it may be viewed as uncommon for a servicer to receive a 5% incentive fee associated with servicing the same assets.
Concept of insignificant in the evaluation of fees paid to a decision maker or service provider vs. could be potentially significant in the determination of the primary beneficiary
Question 6.6 Is the concept of insignificant in the evaluation of whether an enterprises fees represent a variable interest under ASC 810-10-55-37 the same as could be potentially significant in the determination of whether an enterprise has benefits in the primary beneficiary assessment? No. We believe that they are different thresholds. In ASC 810-10-55-37, we believe that the assessment of significance considers expected or probabilistic outcomes. The FASBs use of the phrases anticipated economic performance (ASC 810-10-55-37(e) and (f)) and would absorb (ASC 810-10-55-37(c)) imply that expected outcomes are the barometer by which the fees or other variable interests are measured against. In contrast, we believe that the assessment of significance as part of the primary beneficiary determination contemplates possible outcomes. In other words, we believe that a consideration of the likelihood or probability of the outcome generally is not relevant for this assessment. The FASBs use of the phrase could potentially be significant implies that the threshold is not what would happen, but what could happen. Accordingly, an enterprise would meet the benefits criterion if it could absorb significant losses or benefits, even if the events that would lead to such losses or benefits are not expected. As a result of these differences, we believe that it would be rare that an enterprise would conclude that a decision makers or service providers fees meet the definition of a variable interest by virtue of provisions (c), (e) or (f), but the fees do not meet the benefits criterion for the purposes of determining the primary beneficiary of a VIE.
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Consideration of a decision maker that does not hold a variable interest

Question 6.7 Assume that the power to direct the activities of the entity that most significantly impact the entitys economic performance (power) is held by a decision maker through its fee arrangement. Also, assume that the fees do not constitute a variable interest under ASC 810-10-55-37. Is the decision maker required to evaluate whether the power held through its fee arrangement may cause it to be the primary beneficiary? No. If a decision maker concludes that its fee arrangement does not constitute a variable interest in an entity after evaluating the provisions of ASC 810-10-55-37 and considering any other interests in the entity, we believe that the decision maker is not required to evaluate the provisions of the Variable Interest Model further to account for its interest. This includes determining whether the decision maker is the primary beneficiary of the entity and whether the decision maker is subject to the disclosure provisions of the Variable Interest Model. In the Basis for Conclusions to Statement 167, the FASB indicated the following: The Board also concluded that the revised guidance for determining whether decision maker fees and service provider fees represent a variable interest in a variable interest entity in paragraphs B22 and B23 of Interpretation 46(R), as amended by this Statement, is sufficient for determining whether an enterprise is acting in a fiduciary role in a variable interest entity, particularly because the Board removed the consideration of kick-out rights and cancellation provisions from those paragraphs. In other words, the Board expects that the fees paid to an enterprise that acts solely as a fiduciary or agent should typically not represent a variable interest in a variable interest entity because those fees would typically meet the conditions in paragraph B22 of Interpretation 46(R), as amended by this Statement. If an enterprises fee did not meet those conditions, the Board reasoned that an enterprise is not solely acting in a fiduciary role. If the enterprise has (a) the power to direct the activities that most significantly impact the economic performance of the entity and (b) the obligation to absorb losses or the right to receive benefits of the entity that could potentially be significant to the variable interest entity, that enterprise would be the primary beneficiary of the entity. The Board observed that the conditions in paragraph B22 would allow an enterprise to hold another variable interest in the entity that would absorb an insignificant amount of the entitys expected losses or receive an insignificant amount of the entitys expected returns. The Board concluded that an enterprise holding such an interest would still be acting in a fiduciary role as long as the other conditions in paragraph B22 were met and that enterprise would not be the primary beneficiary of the entity [emphasis added]. Based on the above, we believe that it is clear that fees paid to a decision maker that meet the criteria in ASC 810-10-55-37 to not be considered a variable interest indicate that the decision maker is acting as a fiduciary rather than as a principal to the arrangement. Thus, a fiduciary (or agent) who acts on behalf of principal investors would not be the primary beneficiary. We also note that the provisions of the VIE determination indicate that a decision maker does not prevent the equity holders from having the power unless the fees paid to the decision maker represent a variable interest based on ASC 810-10-55-37 and 55-38. ASC 810-10-25-38 also indicates that [a] reporting entity shall consolidate a VIE when that reporting entity has a variable interest (or combination of variable interests) that provides the reporting entity with a controlling financial interest [emphasis added] on the basis of the provisions in paragraphs 81010-25-38A through 25-38G. Therefore, we do not believe that the power criterion would be met through an interest that has been deemed not to be a variable interest. It is possible that a decision makers fees may not be considered a variable interest but the decision maker has another variable interest (e.g., a small equity interest). In that circumstance, the power held through the fee arrangement
should not be considered in the evaluation of whether the enterprise is the primary beneficiary of the VIE. Of course, if the other variable interest were significant, the requirements of ASC 810-10-55-37(c) would not be satisfied and the decision-maker would be the primary beneficiary.
Reconsideration of a decision makers or service providers fees as variable interests

Question 6.8 When should a decision maker or service provider reconsider whether its fees represent variable interests? When a decision maker or service provider first becomes involved with an entity, it is required under the provisions of the Variable Interest Model to evaluate whether its fees represent variable interests. We believe the purpose of this evaluation is to determine whether the decision maker or service provider is acting as a principal or agent with respect to the entity. This evaluation considers the terms and conditions of the fee relationship. In addition, ASC 810-10-55-37(c) requires consideration of other interests that an enterprise may hold in determining whether the fees constitute variable interests. Subsequent to the initial determination of whether the fees constitute variable interests, an enterprise should assess whether events have occurred that would require a reconsideration of that determination. In making the initial determination of whether an enterprise holds a variable interest, we believe that an enterprise should consider the purpose of the entity and the risks that the entity was designed to create and pass along to its interest holders. Thus, in assessing whether fees paid to a decision maker or service provider represent variable interests, we believe that the purpose and design of the entity is an important consideration in evaluating the characteristics of the fee as well as the other interests held by the enterprise. Therefore, we generally believe that changes to the purpose or design of the entity would require reconsideration of the fees as variable interests. Also, we believe that substantive changes to a fees contractual terms may require an enterprise to reevaluate its fees in the context of ASC 810-10-55-37(a),(b),(d),(e) and (f) as variable interests. In the event that a decision maker or service provider is required to reconsider its variable interests in an entity as a result of substantive changes to the fees contractual terms, we believe that the enterprise should carefully evaluate the provisions of ASC 810-10-55-37. Generally, we believe that absent a fundamental change in the fees contractual terms, it is unlikely that an enterprises original determination of whether its fees indicate that it is acting as a principal or an agent would change. In addition, if a decision makers or service providers other interests change through acquisition or disposition of interests (e.g., complete disposition or disposition of a substantive portion) through sale or transfer, we believe that an enterprise should reevaluate ASC 810-10-55-37(c). Upon reconsideration, the enterprise may conclude that the evaluation of the significance of the variability absorbed by those interests has changed. Also, we believe that a VIE reconsideration event as defined in ASC 810-10-35-4 requires an enterprise to reconsider its fees as variable interests under all of the provisions of ASC 810-10-55-37. The VIE reconsideration events listed under ASC 810-10-35-4 of the Variable Interest Model are discussed in greater detail in Chapter 12. We generally do not believe that an enterprise should reevaluate the status of its fees as variable interests under any of the provisions of ASC 810-10-55-37 simply because of a change in the economics of the entity driven by market conditions, entity-specific conditions or otherwise. For example, an enterprise that holds a residual interest in an entity would not reconsider whether its fees constitute variable interests simply because the enterprise has written down its investment (e.g., prior to the adoption of Statement 167). We do not believe that it was the FASBs intent for a decision maker or service provider to reevaluate its status as a principal or an agent when there have been changes to the entitys economic performance. Otherwise, the fees could change to or from variable interests with
market fluctuations. We believe that the rationale for this position is similar to that for reconsidering whether an entity is a VIE. The FASB concluded for purposes of ASC 810-10-35-4 that the status of an entity as a VIE should be reconsidered only upon specified events, in part to avoid situations in which changes in the entitys anticipated economic performance would change the entitys status as a VIE. However, there may be certain limited circumstances in which an enterprise determines that its investment (through interests other than its fee) in an entity is worthless. For example, an enterprise may conclude that there is only a de minimis potential for an investment (through interests other than its fee) to provide future cash flows to the enterprise. In the event that an enterprise makes this determination, we believe that the enterprise may reconsider the provisions of ASC 810-10-55-37(c) and reconsider whether its fees are variable interests (i.e., whether the enterprise is no longer a principal to the transaction). In evaluating whether an investment is considered worthless, an enterprise carefully should consider all facts and circumstances. One important element to consider may include whether there is a potential scenario (based on consideration of realistic assumptions) that the enterprise will receive cash flows associated with its investment or otherwise receive some future return. Such a scenario may suggest that an investment is not worthless. We would expect that an enterprise would develop a consistent policy and approach for determining whether an interest is considered to be worthless for purposes of the ASC 810-10-55-37 assessment. Additionally, we expect the scenarios in which an investment is deemed worthless will be infrequent. It is important to note that upon reconsideration, an enterprise may or may not conclude that its role as a principal or agent has changed based upon a qualitative assessment of the conditions in ASC 810-10-55-37 (e.g., fees may remain subordinate).
Related parties in evaluating fees paid to a decision maker(s) or service provider(s)

Question 6.9 Should interests held by related parties of the reporting enterprise be considered in evaluating whether fees paid to a decision maker(s) or service provider(s) represent a variable interest? Yes. For purposes of evaluating whether the fees paid to decision maker(s) or service provider(s) represent a variable interest, ASC 810-10-55-37A states that any interest in the entity that is held by a related party of the entitys decision maker(s) or service provider(s) should be treated as though it is the decision makers or service providers own interest. A related party includes any party identified in ASC 810-10-25-43 other than employees and employee benefit plans of a reporting enterprise and its other related parties (unless they are used in an effort to circumvent the provisions of the Variable Interest Model). Refer to Question 6.10 for further guidance on how to consider employee benefit plans in evaluating fees paid to decision maker(s) or service provider(s). Refer to Question 15.5 for discussion of the consideration of interests held by separate accounts of insurance enterprises.
Employee benefit plans

Question 6.10 Is a reporting enterprises employee benefit plan considered to be a related party for the purpose of evaluating whether fees paid to decision maker(s) or service provider(s) represent a variable interest? Generally, no. For purposes of evaluating the fees paid to a decision maker(s) or service provider(s), ASC 810-10-55-37A indicates that an employee benefit plan of a reporting enterprise, including those of its related parties, would be excluded from the related party group provided that the employee benefit plan is not used in an effort to circumvent the provisions of the Variable Interest Model. Accordingly, variable interests held by the employee benefit plan of a reporting enterprise, including those of its related parties, in an entity are not aggregated with that of the reporting enterprise in evaluating whether fees paid to it as a decision maker or service provider represent a variable interest. Further, the FASB believes that the term employee benefit plan would include defined contribution and defined benefit plans.
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Consideration of quantitative analysis in evaluating fees paid to decision maker(s) or service provider(s) as variable interests
Question 6.11 Is a reporting enterprise required to utilize a quantitative analysis to determine whether fees paid to a decision maker(s) or service provider(s) represent variable interests pursuant to ASC 810-10-5537(c) and 55-37(f)? No. ASC 810-10-55-37A indicates that the quantitative approach described in the Master Glossary definitions of the terms expected losses, expected residual returns and expected variability is not required to determine (1) whether fees are insignificant relative to the entitys anticipated economic performance and (2) whether other variable interests held by the reporting enterprise and its related parties would absorb or receive more than an insignificant amount of the entitys expected losses or residual returns, respectively. If the quantitative approach is used, the results should not be the sole determinant when concluding whether a service providers or decision makers fees represent variable interests in the entity. The FASB believes this provision aligns the qualitative assessment of power with determinations of whether a decision maker or service provider is acting in the role as a principal or agent.
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Silos
Consolidation Overall Recognition Variable Interest and Interests in Specific Assets of a VIE 810-10-25-57 A reporting entity with a variable interest in specified assets of a VIE shall treat a portion of the VIE as a separate VIE if the specified assets (and related credit enhancements, if any) are essentially the only source of payment for specified liabilities or specified other interests. (The portions of a VIE referred to in this paragraph are sometimes called silos.) That requirement does not apply unless the legal entity has been determined to be a VIE. If one reporting entity is required to consolidate a discrete portion of a VIE, other variable interest holders shall not consider that portion to be part of the larger VIE. 810-10-25-58 A specified asset (or group of assets) of a VIE and a related liability secured only by the specified asset or group shall not be treated as a separate VIE (as discussed in the preceding paragraph) if other parties have rights or obligations related to the specified asset or to residual cash flows from the specified asset. A separate VIE is deemed to exist for accounting purposes only if essentially all of the assets, liabilities, and equity of the deemed VIE are separate from the overall VIE and specifically identifiable. In other words, essentially none of the returns of the assets of the deemed VIE can be used by the remaining VIE, and essentially none of the liabilities of the deemed VIE are payable from the assets of the remaining VIE.
7.1
Portions of entities such as divisions, departments and branches of an entity generally are not considered separate entities for purposes of applying the provisions of the Variable Interest Model (see Interpretative guidance and Questions in Chapter 4). However, as noted above, the Variable Interest Model does provide that an enterprise with a variable interest in specified assets of a VIE should consider those assets, and related liabilities, as a distinct VIE (known as a silo) that is separate from the larger host VIE, if the specified assets (and related credit enhancements, if any) are essentially the only source of payment for specified liabilities or other specified variable interests (e.g., fixed price purchase options, residual value guarantees). Determining whether a silo exists directly affects the conclusion as to (1) whether the entity is a VIE and (2) who should consolidate which portion of the VIE. When a silo exists, the expected losses and expected residual returns of the silo are not considered in the calculation of expected losses of the host entity for purposes of determining the sufficiency of the hosts equity investment at risk, even if that silo has no primary beneficiary (see Interpretative guidance and Questions in Chapter 9). Although this is a similar concept to the provisions of the Variable Interest Model related to variable interests in specified assets (see Interpretative guidance and Questions in Chapter 8), all of the expected losses and expected residual returns absorbed or received by the variable interests in the silo are excluded from the host entitys expected losses and expected residual returns.
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If it is determined that after excluding expected losses absorbed by variable interests in one or more silos (and specified assets, if applicable), the host entitys equity investment at risk is sufficient to absorb the remaining expected losses so that the entity is not a VIE (assuming the other criteria also have been met see the Interpretative guidance and Questions in Chapter 9), the entity as a whole would be considered a voting interest entity, and no variable interest holder should separately consolidate the silo. Conversely, a silo can be consolidated separately from the host entity when the host entity is a VIE. If the host entity is a VIE (VIE host), a silo should not be evaluated for consolidation by the VIE hosts variable interest holders. Without requiring a silo to be separated from the VIE host, the same assets and liabilities would be consolidated by two parties, which the FASB believes is an undesirable outcome. If it is determined that the host entity is a VIE, then each portion (i.e., the VIE host and the silo) should be evaluated separately for consolidation. In considering whether an enterprise should consolidate a silo, the variable interest holder should determine whether it has (1) the power to direct activities of a silo that most significantly impact the economic performance of the silo and (2) the obligation to absorb losses of the silo that could potentially be significant to the silo or the right to receive benefits from the silo that could potentially be significant to the silo. That party (if any) should consolidate the silo as its primary beneficiary. A silo is not required to have a primary beneficiary in order to be excluded from the VIE host entity.
When does a silo exist?

Question 7.1 When should a specified asset, or group of assets, and related liability, or liabilities, of a VIE be separated from the larger entity and evaluated separately for consolidation? The Variable Interest Model provides that an enterprise with a variable interest in specified assets of a VIE is to treat a portion of the entity as a separate VIE (known as a silo) if the specified assets (and related credit enhancements, if any) are essentially the only source of payment for specified liabilities or other specified variable interests. A silo is deemed to exist if essentially all of the assets, liabilities and equity of the deemed entity (i.e., the silo) are separate from the larger host entity and specifically identifiable. In other words, a silo exists when essentially none of the returns of the assets of the silo inure to holders of variable interests in the host entity, and essentially none of the liabilities of the silo are payable from the remaining assets attributable to variable interests in the host entity. Both of the preceding conditions must be present for a silo to exist. While the FASB did not provide further clarification with respect to the term essentially all, we understand from discussions with the FASB staff that the Board members were concerned about the complexities arising from accounting allocations when liabilities or other interests were not entirely specified to an asset. As a result the FASB included the essentially all language in the Variable Interest Model. In evaluating essentially all, we believe that the purpose and design of the entity should be considered along with the particular facts and circumstances of the entitys arrangements. We generally have interpreted essentially all to mean that 95% or more of the assets, liabilities and equity of the potential silo are specifically identifiable and economically separate from the host entitys remaining assets, liabilities and equity.
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For example, assume an asset is financed with nonrecourse debt representing 95% or more of the assets fair value, and the asset is leased to a lessee under a lease containing a fixed price purchase option (such that the lessee receives essentially all returns associated with increases in the value of the leased asset). In this example, we believe that asset would represent a silo. However, consider the same example (inclusive of the fixed price purchase option), except the asset is financed with nonrecourse debt representing 94% of the assets fair value. In that circumstance, we do not believe that essentially all of the leased asset and related obligations would be economically separate from the host entity. Therefore, no silo exists. A silo is present, and variable interest holders in the silo must consider if they should consolidate the silo as its primary beneficiary, only when the host entity (after all assets, liabilities and equity of the silo are excluded from the analysis) is determined to be a VIE. If only a shell entity remains after all silos are removed, then careful consideration of criteria for determining whether an entity is a VIE is required to determine whether the shell entity, exclusive of the activity in the silos, is a VIE. If the remaining entity is not a VIE, then neither the host entity nor the silo should be evaluated for potential consolidation pursuant to the Variable Interest Model. Illustration 7-1: Example 1 Facts Company A, Company B and Company C each lease separate buildings that are owned by an entity. Each lessee provides a first dollar risk of loss residual value guarantee on the building it leases, and the entity has debt that is cross-collateralized by the three buildings (i.e., all three of the buildings support repayment of the debt). Analysis In this example, no silos exist. Each asset is not essentially the only source of payment for the entitys debt (all three buildings are), and other variable interest holders (outside of Company A, Company B and Company C) of the entity will receive returns associated with increases in the value of the buildings. Example 2 Facts Assume a lessor entitys balance sheet is as follows (on a fair value basis):
Assets Cash Building A (leased to Company A) Building B (leased to Company B) Total assets $ $ 20 120 100 240 Liabilities and equity Debt (recourse only to Building A) Debt (recourse only to Building B) Equity Total liabilities and equity $ $ 120 50 70 240
Silo identification
Additionally, Company A has a fixed price purchase option that allows it to purchase Building A for $120. No such option exists for Building B.
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Analysis In this example, a silo exists for Building A. The building has been wholly financed with nonrecourse debt such that all losses associated with decreases in the value of the building are attributable to the lender (i.e., none of the liabilities of silo are payable from the assets of the remaining entity). Additionally, all returns created by an increase in the value of the building will inure to Company A through the exercise of the fixed price purchase option (i.e., if the building appreciates in value, Company A, and not the host lessor entitys variable interest holders, will receive this benefit). No silo exists for Building B because, although there is debt that is recourse only to the building, the debt constitutes only 50% of the buildings fair value, with the remaining fair value supported by equity that also supports the host entitys other assets. Additionally, the equity holders receive any returns resulting from an increase in the value of Building B. Example 3 Facts Assume a lessor entity owns three buildings. Each building is separately leased to an unrelated third party (Company A, Company B and Company C, respectively). Each lease contains a $100 fixed-price purchase option and provides a first dollar risk of loss residual value guarantee of $85 to the lessor. The lessors balance sheet looks as follows at the inception of the leasing arrangements (on a fair value basis):
Assets Building A (leased to Company A) Building B (leased to Company B) Building C (leased to Company C) Total assets $ $ 100 100 100 300 Equity Total liabilities and equity $ 10 300 Liabilities and equity Debt (Recourse to the Entity) $ 290
Analysis In this example, no silos exist. Although the lease agreements of Company A, Company B and Company C each contain a residual value guarantee and fixed price purchase option that result in losses being absorbed by, and returns received by, each lessee, each asset is not essentially the only source of payment for the VIEs debt (the debt is cross-collateralized by all three buildings). Accordingly, essentially all of the assets and liabilities of any potential silo are not economically separate from the host entity. Example 4 Facts Assume a lessor entity owns three buildings. Each building is separately leased to an unrelated third party (Company A, Company B and Company C, respectively). Each lease contains a $100 fixed price purchase option and provides a first dollar risk of loss residual value guarantee of $85 to the lessor. The lessors balance sheet is as follows at the inception of the leasing arrangements (on a fair value basis):
Assets Building A (leased to Company A) Building B (leased to Company B) Building C (leased to Company C) Total assets $ $ 100 100 100 300 Liabilities and equity Nonrecourse Debt Building A Nonrecourse Debt Building B Nonrecourse Debt Building C Equity (non-targeted) Total liabilities and equity $ $ 96 96 96 12 300
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Analysis In this example, three separate silos exist. Each silo consists of a building, its related nonrecourse debt and a pro rata allocation of the lessors equity because essentially all of each specified asset (the building) and its related specified liability (the nonrecourse debt) or other variable interests (the lessees residual value guarantees and fixed price purchase options) are economically separate from the remaining entity. Additionally, essentially none of the returns of each building can be used by the remaining entity and essentially none of each debt interest is payable from the assets of the remaining entity. Although the non-targeted equity has losses and returns from all three buildings and looks to all three assets for its return, the amount of the interest is not deemed significant enough to prevent the entity from being carved up into three separate silos. The same conclusion would be reached even if no equity existed and instead the $12 was financed with recourse debt. Example 5 Facts Assume a lessor entity owns three buildings. Each building is separately leased to an unrelated third party (Company A, Company B and Company C, respectively). Each lease contains a $100 fixed price purchase option and provides a first dollar risk of loss residual value guarantee of $85 to the lessor. Additionally, the lessee of Building A made a $6 pre-payment of rent at inception of the leasing arrangement. The lessors balance sheet looks as follows at the inception of the leasing arrangements (on a fair value basis):
Assets Cash Building A (leased to Company A) Building B (leased to Company B) Building C (leased to Company C) Total assets $ $ 6 100 100 100 306 Liabilities and equity Nonrecourse Debt Building A Nonrecourse Debt Building B Nonrecourse Debt Building C Deferred Revenue Building A Equity (non-targeted) Total liabilities and equity $ $ 94 94 94 6 18 306
Analysis In this example, no silo exists for Building B or Building C because less than essentially all of the fair value of the specified assets (the buildings) is economically separate from the remaining entity. Rather, each building has been financed partially on a nonrecourse basis, and a sufficient amount of losses inure to the entitys equity interest holder, whose interest is not targeted to specific assets of the entity (i.e., the specified liabilities for Building B and Building C are less than 95%). However, Company A would evaluate Building A as a separate silo. The $6 rent prepayment made by Company A represents a liability of the lessor entity that can be recovered by Company A only through the use of the leased asset. Accordingly, essentially all (nonrecourse debt holder that financed Building A and the deferred revenue relating to the rent prepayment) of the losses and returns of Building A relate to or inure to a specified liability or other variable interest of the lessor entity. In other words, none of the returns of Building A can be used by the remaining entity and essentially none of the nonrecourse debt and deferred revenue for Building A is payable from the assets of the remaining host entity). We believe structuring fees paid to the lessor entity or directly to the lessor entitys equity holder should be evaluated similarly to prepaid rent.
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Effect of silos on the host entitys expected losses and expected residual returns
Question 7.2 How does a silo affect the calculation of the larger host entitys expected losses and expected residual returns? All of the expected losses and expected residual returns attributable to variable interest holders in the silo should be excluded from the expected losses and expected residual returns of the host entity, even if that silo has no primary beneficiary. If it is determined that, after excluding expected losses from variable interests in specified assets (see the Interpretative guidance and Questions in Chapter 8) and silos, the host entitys equity investment at risk is sufficient to absorb the entitys remaining expected losses, and the entity is not otherwise a VIE, then a silo does need not to be evaluated separately for consolidation by a variable interest holder in the silo. A silo can be consolidated separately only when the host entity is a VIE. Illustration 7-2: Facts Lease Co.s balance sheet is as follows (on a fair value basis):
Assets Cash Building A (leased to Company A) Building B (leased to Company B) Total assets $ $ 5 120 100 225 Liabilities and equity Debt (recourse only to Building A) Debt (recourse only to Building B) Equity Total liabilities and equity $ $ 100 97 28 225
Effect of silos on the host entitys expected losses and expected residual returns
Building A is leased under an operating lease that does not include a residual value guarantee, fixed price purchase option or other features. Building Bs lease terms include a fixed price purchase option whereby Company B can acquire the building from Lease Co. for $100. Assume expected losses of the entity are $65. Further assume that expected losses relating to Building A are $20, of which $4 are absorbed by the lender and $16 by Lease Co.s equity holder. Expected losses relating to Building B are $45, of which $43 are absorbed by the lender and $2 are absorbed by Lease Co.s equity holder. Analysis Building A is not a silo because nonrecourse debt represents less than essentially all of Building As financing ($100 debt/$120 asset value = 83%, which is less than 95%), and its returns inure to Lease Co.s equity holder. That is, essentially all of Building A, its specified liabilities and its other specified interests are not economically separate from the overall entity. Building B is a silo because nonrecourse debt represents essentially all of Building Bs financing ($97 debt/$100 asset value = 97%, which is 95% or more), and all of the returns associated with the building inure to the lessee, Company B, due to the fixed-price purchase option in the lease. In other words, none of the returns of Building B can be used by the remaining entity and essentially none of the nonrecourse debt for Building B is payable from the assets of the remaining entity. The amount of Lease Co.s equity investment at-risk equity for purposes of determining if the entity is a VIE is $25. The amount of equity at risk excludes equity amounts relating to the Building B silo of $3. This amount is subtracted from the equity of the host entity to arrive at the amount of equity investment at risk.
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Expected losses of the entity for purposes of determining the sufficiency of Lease Co.s equity investment at risk are $20. This amount is derived from the total expected losses of the entity of $65. All expected losses relating to the Building B silo ($45) are subtracted from this amount. Accordingly, Lease Co.s equity investment at risk of $25 is sufficient.
Stand-alone financial statements and silos

Question 7.3 A VIE is determined to have one or more silos that are each consolidated by their respective primary beneficiaries. The enterprise that established the VIE is determined to be the primary beneficiary of the larger VIE and consolidates that VIEs assets, liabilities and noncontrolling interests, exclusive of the silos. The enterprise is required by a lender to issue GAAP financial statements of the VIE. Should the silos be included in the VIEs separate stand-alone financial statements? Yes. The silos should not be removed from the balance sheet of the VIEs stand-alone GAAP financial statements. ASC 810-10s Variable Interest Model provides consolidation guidance and does not affect the stand-alone financial statements of the VIE.
Effect of silos on determining variable interests in specified assets

Question 7.4 Can the presence of a silo affect the determination of whether an enterprise holding a variable interest in specified assets of the larger host VIE has a variable interest in the entity? Yes. If a silo exists in a larger host entity, we believe the fair value of the silos assets should first be deducted from the fair value of the host entitys total assets before determining whether an enterprise with a variable interest in specified assets of the entity has a variable interest in the host entity as a whole. Illustration 7-3: Facts Lease Co.s balance sheet is as follows (on a fair value basis):
Assets Cash Building A (leased to Company A) Building B (leased to Company B) Building C (leased to Company C) Total assets $ $ 5 120 100 100 325 Liabilities and equity Debt (recourse only to Building A) Debt (recourse only to Building B) Debt (recourse only to Building C) Equity Total liabilities and equity $ $ 100 100 97 28 325
Effect of silos on determining variable interests in specified assets
Company A has a fixed price purchase option to acquire Building A from Lease Co. for $120. Building Bs lease terms do not include a residual value guarantee, fixed price purchase option or other features. Building Cs lease terms include a fixed price purchase option whereby Company C can acquire the building from Lease Co. for $100.
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Analysis In this example, Building A is not a silo, because the specified assets and liabilities are not economically separate. To illustrate, even though all returns inure to Company A due to the fixed price purchase option in the lease, the building has been financed less than 95% with nonrecourse debt ($100 debt/$120 asset value = 83%). Additionally, Building B is not a silo even though it has been financed in its entirety with nonrecourse financing, because its returns inure to Lease Co.s equity holder. However, Building C does represent a silo, because it and its specified liabilities are economically separate from the remaining entitys assets, liabilities and equity. To illustrate, Building C has been financed with 97% nonrecourse financing ($97 debt divided by $100 asset value = 97%), and all of the returns associated with the building inure to the lessee, Company C, because of the fixed price purchase option in the lease. In other words, none of the returns of Building C can be used by the remaining entity and essentially none of the nonrecourse debt for Building C is payable from the assets of the remaining entity. Total assets of the entity, less the fair value of Building C (the silo asset), are $225 ($325 less the $100 fair value of Building C). As Building B represents less than half of these assets ($100 of $225), the Building B lender has a variable interest in Building B, only, and not a variable interest in the Lease Co. host entity as a whole. However, since Building A represents more than half of the fair value of the assets of the entity (excluding Building C), Company As and the lenders variable interests in Building A (based on the fixed price purchase option and the nonrecourse loan, respectively) are variable interests in the Lease Co. host entity as a whole. If Lease Co. is a VIE, each should consider whether it should consolidate the entity (exclusive of Building C, the related $97 nonrecourse debt and $3 of equity that comprise the silo) as the primary beneficiary.
Can silo assets be greater than 50% of the fair value of a VIEs total assets?
Question 7.5 Assume a variable interest in specified assets is a variable interest in the entity as a whole (because the fair value of the specified assets of a VIE are greater than 50% of the fair value of the entitys total assets). Can such assets also represent a silo? How should the provisions of the Variable Interest Model be applied in this example? When evaluating an entity to determine if it is a VIE, an enterprise first should determine whether any silos are present. If silos exist, these should be evaluated for consolidation separately from the host entity (if the host entity itself is determined to be a VIE), regardless of their size. A portion of a VIE should be treated as a silo if the specified assets (and related credit enhancements) are essentially the only source of payment for specified liabilities or other variable interests of the VIE, and essentially none of the returns of the assets are available to other variable interest holders in the entity (see Question 7.1). Because the Variable Interest Models provisions treat such assets (and the related liabilities and equity) as a separate entity distinct from the host entity, when such situations exist, it should be evaluated for consolidation as a silo even if the fair value of the silos assets exceed 50% of the fair value of the VIEs total assets.
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Silo asssets greater than 50% of the fair value of the VIEs total assets
Lease Co.s balance sheet is as follows (on a fair value basis):

Assets Cash Building A (leased to Company A) Building B (leased to Company B) Building C (leased to Company C) Total assets $ $ 5 120 100 400 625 Liabilities and equity Debt (recourse only to Building A) Debt (recourse only to Building B) Debt (recourse only to Building C) Equity Total liabilities and equity $ $ 100 100 388 37 625
Company A has a fixed price purchase option to acquire Building A from Lease Co. for $120. Building Bs lease terms do not include a residual value guarantee, fixed price purchase option or other features. Building Cs lease terms include a fixed price purchase option whereby Company C can acquire the building from Lease Co. for $400. Analysis A determination should be made first as to whether any silos exist in Lease Co. In this example, Building A is not a silo, because while all returns inure to Company A due to the fixed price purchase option in the lease, the building has been financed less than 95% with nonrecourse debt ($100 debt/$120 asset value = 83%). Additionally, Building B is not a silo even though it has been financed in its entirety with nonrecourse financing, because its returns inure to Lease Co.s equity holder. While Company C has a variable interest in specified assets that qualifies as a variable interest in Lease Co. (Building C represents approximately two-thirds of Lease Co.s assets), it is a silo because it has been financed with 97% nonrecourse financing ($388 debt divided by $400 asset value = 97%), and all of the returns associated with the building inure to the lessee, Company C, because of the fixed price purchase option in the lease. In other words, the specified assets and liabilities are economically separate as none of the returns of Building B can be used by the remaining entity and essentially none of the nonrecourse debt for Building B is payable from the assets of the remaining entity. A determination should then be made whether any variable interest holders with interests in specified assets have variable interests in the entity as a whole. The entitys total assets, less the fair value of Building C (because silos are excluded first), are $225 ($625 less the $400 fair value of Building C). As Building B represents less than half of these assets ($100 of $225), the Building B lender has a variable interest in Building B only, and not a variable interest in the Lease Co. host entity as a whole. However, because Building A represents more than half of the fair value of the assets of the entity (excluding Building C), Company As and the lenders variable interests in Building A (based on the fixed price purchase option and the nonrecourse loan, respectively) are variable interests in the Lease Co. host entity as a whole. If Lease Co. is a VIE, Company A, the lender with recourse only to Building A, and the equity holder each should consider whether it should consolidate the entity (exclusive of Building C, the related $388 nonrecourse debt and $12 of equity that comprise the silo) as the primary beneficiary. Additionally, if Lease Co. is a VIE, the Building C silo should be evaluated separately for consolidation by those parties holding variable interests in the silo (Company C, the related lender and the equity holder of Lease Co.).
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Silo not required to have a primary beneficiary to be excluded from host entity
Question 7.6 Must a silo have a primary beneficiary in order for the silos expected losses and expected residual returns to be excluded from the host entity in determining whether the host entity is a VIE? As background, ASC 810-10-25-57 states [i]f one reporting entity is required to consolidate a discrete portion of a VIE, other variable interest holders shall not consider that portion to be part of the larger VIE. That provision was included to preclude two parties from consolidating the same assets, liabilities and equity of a silo. We do not believe that ASC 810-10-25-57 indicates that in determining whether an entity is a VIE, a silo should be excluded from the entity only if the silo has a primary beneficiary. That is, once a silo is determined to exist, the assets, liabilities and equity of the silo and its corresponding expected losses and expected residual returns should be excluded from the larger host entity in applying the Variable Interest Model irrespective of whether there is a primary beneficiary of the silo. Illustration 7-5: Excluding a silos assets, liabilities and equity from the host entity
To illustrate this concept, assume that in addition to other assets it holds, an entity owns a building and leases it to Company A. Company As lease contains a $100 fixed price purchase option. The building leased to Company A was financed entirely through nonrecourse debt funded equally by Lender A and Lender B. Assume the entitys balance sheet at the inception of the leasing arrangement is as follows (on a fair value basis):
Assets Building (leased to Company A) Other assets $ 100 300 Liabilities and equity Nonrecourse Debt Lender A Nonrecourse Debt Lender B Other liabilities Equity Total assets $ 400 Total liabilities and equity $ $ 50 50 280 20 400
In this example, a silo exists because the losses and returns of the building leased to Company A inure to specified liabilities (the nonrecourse debt) or other variable interests (the lessees fixed price purchase option). In other words, the specified assets and liabilities are economically separate as none of the returns of the building can be used by the remaining entity and none of the nonrecourse debt for the building is payable from the assets of the remaining entity. Regardless of whether the silo has a primary beneficiary, the expected losses and expected residual returns related to the silo should be excluded from the larger entity in determining whether the entity is a VIE. If the entity is determined to be a VIE and that entity has a primary beneficiary, we do not believe that primary beneficiary is required to consolidate any silos in the entity (even if those silos do not have a primary beneficiary). Otherwise, the primary beneficiary of the entity would be required to consolidate assets and liabilities in which it may have no economic interest.
Determining the primary beneficiary of a silo

Question 7.7 How should an enterprise determine which party is the primary beneficiary of a silo? Under the Variable Interest Model, silos are to be treated as if they are separate VIEs. Therefore, the primary beneficiary of a silo is the party that has both (1) the power to direct activities of a silo that most significantly impact the silos economic performance and (2) the obligation to absorb losses of the silo that could potentially be significant to the silo or the right to receive benefits from the silo that could potentially be significant to the silo. See the Interpretative guidance and Questions in Chapter 14 for further discussion.
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Variable interests interests in specified assets

Consolidation Overall Recognition Variable Interest and Interests in Specific Assets of a VIE 810-10-25-55 A variable interest in specified assets of a VIE (such as a guarantee or subordinated residual interest) shall be deemed to be a variable interest in the VIE only if the fair value of the specified assets is more than half of the total fair value of the VIEs assets or if the holder has another variable interest in the VIE as a whole (except interests that are insignificant or have little or no variability). This exception is necessary to prevent a reporting entity that would otherwise be the primary beneficiary of a VIE from circumventing the requirement for consolidation simply by arranging for other parties with interests in certain assets to hold small or inconsequential interests in the VIE as a whole. The expected losses and expected residual returns applicable to variable interests in specified assets of a VIE shall be deemed to be expected losses and expected residual returns of the VIE only if that variable interest is deemed to be a variable interest in the VIE. 810-10-25-56 Expected losses related to variable interests in specified assets are not considered part of the expected losses of the legal entity for purposes of determining the adequacy of the equity at risk in the legal entity or for identifying the primary beneficiary unless the specified assets constitute a majority of the assets of the legal entity. For example, expected losses absorbed by a guarantor of the residual value of leased property are not considered expected losses of a VIE if the fair value of the leased property is not a majority of the fair value of the VIEs total assets.
8.1
Situations will exist in which an enterprise holds a variable interest, but the variable interest is related to a specific asset or group of assets of an entity (as opposed to a variable interest in all of the assets of the entity, which is characteristic of an equity holder), and does not have a variable interest in the entity as a whole. For example, assume a VIE has total assets of $1,000,000, $300,000 of which is a machine that is financed with debt. To protect itself against a decline in the value of the equipment, the entity obtains a residual value guarantee on the machine from Company ABC, which guarantees that the machine will be worth at least $200,000 when the debt is due. In this case, Company ABC has a variable interest in a specified asset of the entity, but not in the entity. The Variable Interest Model has special provisions to determine whether an enterprise with a variable interest in specified assets of an entity has a variable interest in the entity as a whole. This determination is important because if a variable interest in specified assets is not considered a variable interest in the entity as a whole, then expected losses related to the variable interests in these specified assets are not considered part of the expected losses of the entity for purposes of determining the adequacy of the equity investment at risk of the entity in the VIE analysis (i.e., any expected losses absorbed by an
8 Variable interests interests in specified assets
enterprise holding an interest only in specified assets of the entity do not have to be supported by the atrisk equity holders of the entity). If a party has only a variable interest in specified assets of a VIE but does not have a variable interest in the VIE as a whole, it cannot be required to consolidate the VIE. A variable interest in specified assets of an entity is a variable interest in the entity as a whole only if the fair value of the specified assets is more than half of the total fair value of the entitys assets, or if the holder has another variable interest in the entity as a whole. Using the previous example, Company ABC would not have a variable interest in the entity as a whole because it has an interest in a specified asset (i.e., the machine that has a value of $300,000) that is less than half of the total fair value of the VIEs assets ($1 million). With no variable interest in the VIE, Company ABC cannot be required to consolidate it. Additionally, expected losses and expected residual returns related to the variable interest in the machine should not be considered part of the expected losses and expected residual returns of the entity for purposes of determining the sufficiency of the equity investment at risk. We believe that in determining whether the asset with a specified interest in it is worth more or less than one-half of the assets in the entity, the entire fair value of the asset ($300,000) that the interest relates to, and not the amount of the specific exposure ($200,000), should be used in performing this calculation. ASC 810-10-15-14(a) refers to expected losses of an entity for purposes of determining the sufficiency of the equity investment at risk for the entire entity. The provisions of ASC 810-10-25-55 and 25-56 determine whether expected losses that will be absorbed by guarantees or other variable interests in specified assets of the entity are expected losses of the entity for purposes of determining whether an entity has sufficient equity investment at risk. The guidance in ASC 810-10-25-55 and 25-56, therefore, always should be applied before determining whether an entity has a sufficient at-risk equity investment. It should be noted that this provision of the Variable Interest Model is different from the provision relating to silos (see the Interpretative guidance and Questions in Chapter 7 for a discussion of silos). When a silo exists, all of the expected losses and the expected residual returns of the silo are excluded from the calculation of the entitys expected losses and expected residual returns. Additionally, if a silo exists in a larger host entity, we believe the fair value of the silos assets should first be deducted from the fair value of the host entitys total assets before determining whether an enterprise with a variable interest in specified assets of the entity has a variable interest in the host entity as a whole (see Question 7.4).
Interests in specified assets

Question 8.1 If an enterprise holds an interest that is limited to a specific asset or group of assets of an entity, does that enterprise have a variable interest in the entity as a whole? If the enterprise does not have a variable interest in the entity as a whole, does that affect the calculation of the entitys expected losses for purposes of determining the sufficiency of the entitys equity investment at risk as part of the VIE determination? For purposes of applying the provisions of the Variable Interest Model, a variable interest in specified assets of an entity is a variable interest in the entity as a whole only if the fair value of the specified assets is more than half of the total fair value of the entitys assets, or if the holder has another variable interest in the entity as a whole. The determination of whether an interest in specified assets is a variable interest in the entity as a whole is important because if the interest is not considered a variable interest in the entity, then expected losses related to the variable interests in the specified assets are not considered part of the expected losses of the entity for purposes of determining the adequacy of the entitys equity investment at risk (i.e., any expected losses absorbed by an enterprise holding an interest only in specified assets of the
entity do not have to be supported by the at-risk equity holders of the entity). If a party has only a variable interest in specified assets of an entity, but does not have a variable interest in the entity as a whole, it cannot be required to consolidate the entity under the Variable Interest Model. Illustration 8-1: Facts Assume that an entity with a $50 equity investment at risk acquires two assets, Asset A and Asset B, for use in its operations. The fair value of Asset A is $100. The fair value of Asset B is $300. The fair value of all of the entitys assets is $500. The entity finances the costs of Asset A and Asset B in their entirety with debt from Lender A and Lender B, respectively. The lenders have recourse only to the cash flows generated by Asset A and B, respectively, for payment of the loans and do not have access to the general credit of the entity (i.e., the borrowings are nonrecourse). The expected losses of the entity are $100. The expected losses associated with Asset A are $60. The expected losses associated with Asset B are $30. All expected losses associated with Asset A and Asset B will be absorbed by the lenders. Analysis In this example, Lender A does not have a variable interest in the entity, because the fair value of the asset (Asset A) in which it has a variable interest is less than half of the fair value of the total assets of the entity ($100/$500 = 20%). However, Lender B does have a variable interest in the entity because the fair value of the asset (Asset B) in which it has a variable interest is more than half of the fair value of the total assets of the entity ($300/$500 = 60%). The expected losses of the entity for purposes of evaluating the sufficiency of the entitys equity investment at risk equity are $40 ($100 expected losses of the entity as a whole, less expected losses of $60 relating to Asset A which will be absorbed by Lender A). Accordingly, this entity would have sufficient equity because its $50 equity investment at risk exceeds its expected losses of $40. When determining whether an asset with a specified interest in it is worth more or less than one-half of the total fair value of the entitys assets, the entire fair value of the asset should be used (and not the amount of the specific exposure) in performing this calculation. For example, if an enterprise guaranteed that an entitys asset with a fair value of $500,000 would be worth at least $250,000 at a future date, when determining if the guarantor has an interest in the entity as a whole, the entire fair value of the asset (i.e., $500,000) should be used and not the value of the guarantee. Additionally, we believe that it is appropriate for enterprises holding variable interests in an entitys assets to determine whether the variable interests represent a variable interest in the entity as a whole, or only in the specified assets, based on the aggregate value of the assets in which it holds a variable interest. For example, if a VIE holds four assets that are valued at a total of approximately $20 million and one enterprise has three separate interests in three of the four assets, the enterprise should aggregate those three assets for purposes of determining if the assets in which it holds variable interests comprise greater than half of the fair value of the entitys total assets. If the aggregate fair value of the three assets is less than $10 million, the enterprise would not have a variable interest in the entity. However, if the aggregate fair value of the three assets exceeds $10 million, the enterprise would be deemed to have a variable interest in the entity as a whole. Interests in specified assets
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The provisions of ASC 810-10-25-55 and 25-56 should be applied to determine whether expected losses that will be absorbed by variable interests in specified assets of the entity are expected losses of the entity for purposes of determining whether an entity has sufficient equity investment at risk. The guidance in ASC 810-10-25-55 and 25-56, therefore, should always be applied before evaluating whether an entity has a sufficient at-risk equity investment when determining whether the entity is a VIE.
Illustrative example
Question 8.2 Illustrative example The following illustrates how an interest in specified assets of an entity affects the calculation of an entitys expected losses: Illustration 8-2: Facts Company A guarantees the collection of $750 of a $1,000 receivable held by an entity. The entitys total assets are $2,200. Company A has a variable interest in a specified asset of the entity (the receivable), and that asset is less than half of the total fair value of the entitys assets. Because Company A has no other interests in the entity as a whole, the expected losses related to the guarantee are not considered part of the expected losses of the entity for purposes of determining the sufficiency of the equity at risk in the entity. The expected losses and expected residual returns on that $1,000 receivable are as follows (assume all amounts are at present value):
Possible outcome 1 2 3 Estimated cash flows (a) $ 1,000 800 400 Probability (b) 50% 35% 15% $ Expected cash flows (a)*(b)=c $ 500 280 60 840 $ Expected losses (((a)-$840)*b) $ 14 66 80 $ Expected residual returns (($840-a)*b) $ 80 80
Interest in specified assets and effect on calculation of entitys expected losses
Analysis In this example, the guarantee absorbs a portion of the expected loss generated by the potential outcome in which the cash flow to be received is less than $750 (assume that the guarantee absorbs $45 of the $66 expected loss when the outcome is $400). Expected losses from all possible outcomes and the difference between $45 (expected losses absorbed by the guarantor associated with possible outcome 3) and the risk that the guarantor does not perform when called upon should be included in the entitys expected losses. For example, if based on the guarantors credit risk, it was determined that the guarantor could absorb only $43 of the expected losses, only $43 would be excluded in computing the entitys expected losses (see Question 10.12). Assume that the expected losses on the other assets in the entity are $250. The determination of the adequacy of the equity investment at risk would be performed as follows:
Total entity expected losses Less: Expected losses on variable interest in specified asset Entitys expected losses $ $ 33016 43 287
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Expected losses on receivables ($80) plus expected losses assumed on other assets ($250). 117
If the equity investment at risk exceeds $287, the equity investment would be deemed sufficient and, assuming the other criteria are met, the entity would not be considered a VIE. Conversely, if the equity investment at risk is less than $287, the entity is a VIE. The expected losses actually absorbed by the guarantors variable interest should be computed based on its allocated cash flows and the fair value of its variable interest, and that amount should be excluded from the entitys total expected losses (see Interpretative guidance and Questions to Chapter 10). It should be noted that the provisions relating to interests in specified assets are different from the provisions relating to silos (see the Interpretative guidance and Questions to Chapter 7 for a discussion of silos). When a silo exists, all of the expected losses and the expected residual returns of the silo are excluded from the analysis of the entitys expected losses and expected residual returns.
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Determining whether an entity is a variable interest entity

Consolidation Overall Scope and Scope Exceptions 810-10-15-14 A legal entity shall be subject to consolidation under the guidance in the Variable Interest Entities Subsections if, by design, any of the following conditions exist (The phrase by design refers to legal entities that meet the conditions in this paragraph because of the way they are structured. For example, a legal entity under the control of its equity investors that originally was not a variable interest entity [VIE] does not become one because of operating losses. The design of the legal entity is important in the application of these provisions.): a. The total equity investment (equity investments in a legal entity are interests that are required to be reported as equity in that entitys financial statements) at risk is not sufficient to permit the legal entity to finance its activities without additional subordinated financial support provided by any parties, including equity holders. For this purpose, the total equity investment at risk has all of the following characteristics: 1. 2. 3. Includes only equity investments in the legal entity that participate significantly in profits and losses even if those investments do not carry voting rights Does not include equity interests that the legal entity issued in exchange for subordinated interests in other VIEs Does not include amounts provided to the equity investor directly or indirectly by the legal entity or by other parties involved with the legal entity (for example, by fees, charitable contributions, or other payments), unless the provider is a parent, subsidiary, or affiliate of the investor that is required to be included in the same set of consolidated financial statements as the investor Does not include amounts financed for the equity investor (for example, by loans or guarantees of loans) directly by the legal entity or by other parties involved with the legal entity, unless that party is a parent, subsidiary, or affiliate of the investor that is required to be included in the same set of consolidated financial statements as the investor.
4.
Paragraphs 810-10-25-45 through 25-47 discuss the amount of the total equity investment at risk that is necessary to permit a legal entity to finance its activities without additional subordinated financial support. b. As a group the holders of the equity investment at risk lack any one of the following three characteristics: 1. The power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impact the entitys economic performance. The investors do not have that power through voting rights or similar rights if no owners hold voting rights or similar rights (such as those of a common shareholder in a corporation or a general partner in a
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9 Determining whether an entity is a variable interest entity
partnership). Legal entities that are not controlled by the holder of a majority voting interest because of noncontrolling shareholder veto rights as discussed in paragraphs 810-10-25-2 through 25-14 are not VIEs if the shareholders as a group have the power to control the entity and the equity investment meets the other requirements of the Variable Interest Entities Subsections. Kick-out rights or participating rights held by the holders of the equity investment at risk shall not prevent interests other than the equity investment from having this characteristic unless a single equity holder (including its related parties and de facto agents) has the unilateral ability to exercise such rights. Alternatively, interests other than the equity investment at risk that provide the holders of those interests with kick-out rights or participating rights shall not prevent the equity holders from having this characteristic unless a single reporting entity (including its related parties and de facto agents) has the unilateral ability to exercise those rights. A decision maker also shall not prevent the equity holders from having this characteristic unless the fees paid to the decision maker represent a variable interest based on paragraphs 810-10-55-37 through 55-38. 2. The obligation to absorb the expected losses of the legal entity. The investor or investors do not have that obligation if they are directly or indirectly protected from the expected losses or are guaranteed a return by the legal entity itself or by other parties involved with the legal entity. See paragraphs 810-10-25-55 through 25-56 and Example 1 (see paragraph 81010-55-42) for a discussion of expected losses. The right to receive the expected residual returns of the legal entity. The investors do not have that right if their return is capped by the legal entitys governing documents or arrangements with other variable interest holders or the legal entity. For this purpose, the return to equity investors is not considered to be capped by the existence of outstanding stock options, convertible debt, or similar interests because if the options in those instruments are exercised, the holders will become additional equity investors.
3.
If interests other than the equity investment at risk provide the holders of that investment with these characteristics or if interests other than the equity investment at risk prevent the equity holders from having these characteristics, the entity is a VIE. c. The equity investors as a group also are considered to lack the characteristic in (b)(1) if both of the following conditions are present: 1. The voting rights of some investors are not proportional to their obligations to absorb the expected losses of the legal entity, their rights to receive the expected residual returns of the legal entity, or both. Substantially all of the legal entitys activities (for example, providing financing or buying assets) either involve or are conducted on behalf of an investor that has disproportionately few voting rights. This provision is necessary to prevent a primary beneficiary from avoiding consolidation of a VIE by organizing the legal entity with nonsubstantive voting interests. Activities that involve or are conducted on behalf of the related parties of an investor with disproportionately few voting rights shall be treated as if they involve or are conducted on behalf of that investor. The term related parties in this paragraph refers to all parties identified in paragraph 810-10-25-43, except for de facto agents under paragraph 810-10-25-43(d).
2.
For purposes of applying this requirement, reporting entities shall consider each partys obligations to absorb expected losses and rights to receive expected residual returns related to all of that partys interests in the legal entity and not only to its equity investment at risk.
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Enterprises should apply the Variable Interest Model to involvements with other entities to determine if they have a variable interest in an entity. (Refer to Chapters 5-8 for Interpretative guidance and Questions.) If so, the Variable Interest Model is applied to determine whether the entity with which it is involved is a VIE or a voting interest entity. The Variable Interest Model provides the criteria for determining whether an entity with which an enterprise is involved is a VIE. If an entity is a VIE, then an enterprise will evaluate the entity for consolidation using the provisions of the Variable Interest Model. If an enterprise does not have a variable interest in an entity, the enterprise should account for its interest in accordance with other literature.
9.1
Interpretative guidance Equity investment at risk (ASC 810-10-15-14(a))

A VIE often is created for a single specified purpose, for example, to facilitate securitization, leasing, real estate development or operation, hedging, research and development, insurance, reinsurance or other transactions or arrangements. A VIE may also be a business as that term is defined in ASC 805, if certain conditions are met, as described in Chapter 4. It is possible that an enterprise whose shares are publicly held could be a VIE. The Variable Interest Model distinguishes VIEs from other business enterprises based on the nature and amount of the equity investment in the entity and the rights and obligations of the equity investors. To be considered a voting interest entity, the entitys equity investment at risk must be sufficient to permit the entity to carry on its activities without additional subordinated financial support (even if that support has been provided by one or more holders of an at-risk equity investment). That is, the entity must have enough equity to induce lenders or other investors to provide the funds necessary for the entity to conduct its activities. The Variable Interest Model uses expected losses as the benchmark for determining the sufficiency of equity. The equity investment at risk can be demonstrated to be sufficient by an entity by any one of three ways: (1) by demonstrating the ability to finance its activities without additional subordinated financial support; (2) by having at least as much equity as a similar entity that finances its operations with no additional subordinated financial support or (3) by comparing the entitys investment at risk to its calculated expected losses. If the equity investment at risk is insufficient to absorb expected losses, the entity is a VIE. The determination of an entitys expected losses is discussed in more detail in the Interpretative guidance and Questions in Chapter 10. The methods that may be used in demonstrating the sufficiency of an entitys at-risk equity are discussed in more detail below. For purposes of this test, an equity investment in an entity is an interest that is required to be reported as GAAP equity in that entitys financial statements. Common stock is an example of an equity investment. Certain forms of preferred stock such as perpetual preferred stock also currently constitute an equity investment. However, ASC 480 requires mandatorily redeemable preferred stock to be classified as a liability. Accordingly, it will not constitute an equity investment. We believe preferred stock classified in temporary equity (e.g., because the preferred stock is redeemable upon the occurrence of an event that is not solely under the entitys control, such as a change in control) pursuant to ASR 268 also should be considered an equity investment when evaluating the provisions of the Variable Interest Model. A commitment to fund equity does not constitute an equity investment because that commitment would not be reported as GAAP equity in the entitys financial statements. For purposes of the test of sufficiency, an equity investment at risk must participate significantly in profits and losses. ASC 810-10 does not provide detailed implementation guidance on how to make this determination, but in general, we believe that this provision should be read literally and that the determination should be based on the individual facts and circumstances. For example, if evaluating preferred stock classified in equity, we generally believe that the preferred stock participates significantly in losses. To participate significantly in profits, we believe the coupon must be set at a level that allows the preferred stock to participate significantly in the entitys profits.
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While there may not be substantive economic differences between an entity that is capitalized with equity and an entity that is capitalized solely with subordinated debt (because in both situations the residual holder absorbs the first dollar risk of loss), the Variable Interest Model indicates the form of the instrument is determinative, and to be an equity investment, the interest must be recorded as GAAP equity in that entitys financial statements, even if all of the entitys expected losses will be absorbed by the equity holders through other instruments. For purposes of the sufficiency test, an equity investment at risk does not include amounts provided to the equity investor directly or indirectly by the entity or by other parties involved with the entity, unless the provider is a parent, subsidiary or affiliate of the investor that is required to be included in the same set of consolidated financial statements as the investor. An equity investment obtained directly or indirectly through fees or charitable contributions should not be included in the equity sufficiency test because it is not considered at risk. For example, in a lease transaction, fees paid by the lessee to the owners of an entity (e.g., structuring or administrative fees) are considered a return of the owners equity investment at risk for purposes of evaluating the sufficiency of equity in the entity. The application of this criteria could have a significant impact in determining whether an entity is a VIE. For example, assume Company C and Developer B form a partnership by contributing $80 and $20, respectively. Company C and Developer B have voting and economic interests of 80% and 20%, respectively. Further assume that Developer B receives a development fee of $25 from the partnership. Expected losses of the entity are determined to be $50. In this case, the developers equity investment at risk ($20) should be reduced by the fee ($25) it received and thus Developer B does not have an equity investment at risk. Determining whether a party to the transaction has an equity investment at risk directly impacts whether the entity is a VIE. Using the previous example, while the resulting equity investment at risk is greater than the entitys expected losses, we believe the entity likely will be a VIE. Although the entity has sufficient equity, the Variable Interest Model requires the holders of the equity investments at risk to absorb the expected losses of the entity. Those equity holders cannot be indirectly protected from absorbing the first dollar risk of loss in the entity. In this example, we believe Company C, the holder of the equity investment at risk, will not absorb all of the expected losses of the entity as they occur, because 20% of losses are allocable to Developer B, and for purposes of evaluating whether the entity is a VIE, Developer B is not a holder of an equity investment at risk because its capital account should be reduced by the development fee paid to it. As such, the entity is a VIE. The Variable Interest Model provides that the equity investment at risk cannot be financed for the equity investor directly by the entity or by parties involved with the entity, unless that party is a parent, subsidiary or affiliate of the investor that is required to be included in the same set of consolidated financial statements as the investor. We believe that, in general, an equity holder may finance its equity investment or enter into other risk management arrangements provided such arrangements are with parties that have no involvement with the entity. In these situations, however, the transactions structure should be evaluated to ensure the equity investor is not merely acting as an agent for another party (the principal lender, guarantor, etc.), in which case, the equity interest should be attributed to the principal.
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Consolidation Overall Recognition Sufficiency of Equity Investment at Risk 810-10-25-45 An equity investment at risk of less than 10 percent of the legal entitys total assets shall not be considered sufficient to permit the legal entity to finance its activities without subordinated financial support in addition to the equity investment unless the equity investment can be demonstrated to be sufficient. The demonstration that equity is sufficient may be based on either qualitative analysis or quantitative analysis or a combination of both. Qualitative assessments, including, but not limited to, the qualitative assessments described in (a) and (b), will in some cases be conclusive in determining that the legal entitys equity at risk is sufficient. If, after diligent effort, a reasonable conclusion about the sufficiency of the legal entitys equity at risk cannot be reached based solely on qualitative considerations, the quantitative analyses implied by (c) shall be made. In instances in which neither a qualitative assessment nor a quantitative assessment, taken alone, is conclusive, the determination of whether the equity at risk is sufficient shall be based on a combination of qualitative and quantitative analyses. a. b. The legal entity has demonstrated that it can finance its activities without additional subordinated financial support. The legal entity has at least as much equity invested as other entities that hold only similar assets of similar quality in similar amounts and operate with no additional subordinated financial support. The amount of equity invested in the legal entity exceeds the estimate of the legal entitys expected losses based on reasonable quantitative evidence.
c.
810-10-25-46 Some legal entities may require an equity investment at risk greater than 10 percent of their assets to finance their activities, especially if they engage in high-risk activities, hold high-risk assets, or have exposure to risks that are not reflected in the reported amounts of the legal entities assets or liabilities. The presumption in the preceding paragraph does not relieve a reporting entity of its responsibility to determine whether a particular legal entity with which the reporting entity is involved needs an equity investment at risk greater than 10 percent of its assets in order to finance its activities without subordinated financial support in addition to the equity investment. 810-10-25-47 The design of the legal entity (for example, its capital structure) and the apparent intentions of the parties that created the legal entity are important qualitative considerations, as are ratings of its outstanding debt (if any), the interest rates, and other terms of its financing arrangements. Often, no single factor will be conclusive and the determination will be based on the preponderance of evidence. For example, if a legal entity does not have a limited life and tightly constrained activities, if there are no unusual arrangements that appear designed to provide subordinated financial support, if its equity interests do not appear designed to require other subordinated financial support, and if the entity has been able to obtain commercial financing arrangements on customary terms, the equity would be expected to be sufficient. In contrast, if a legal entity has a very small equity investment relative to other entities with similar activities and has outstanding subordinated debt that obviously is effectively a replacement for an additional equity investment, the equity would not be expected to be sufficient.
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Because precisely estimating expected losses may be difficult, and an entity may need an equity investment at risk greater than its expected losses, the FASB established a presumption that an equity investment is insufficient to allow an entity to finance its activities unless the investment is equal to at least 10% of the fair value of the entitys total assets. We believe that the main reason for this presumption was to emphasize that the consolidation principles prior to the development of the Variable Interest Model, which focused on a 3% equity presumption, were superseded. Under the Variable Interest Model, an equity investment as small as 3% may be insufficient for many variable interest entities. The FASBs preferred methods of overcoming the 10% presumption are to demonstrate the sufficiency of the invested equity at risk by (a) obtaining financing without additional subordinated financial support or (b) referring to the equity invested in another similar entity with similar assets, liabilities and other interests that has financed itself without additional subordinated financial support. It may be difficult for any entity that does not have a relatively simple capital structure to objectively demonstrate that it can finance its activities without additional subordinated financial support. That is, an entity capitalized with multiple classes of debt having different priorities generally would not be able to demonstrate it can finance its activities without additional subordinated financial support because it generally would be unclear that the equity investment at risk is sufficient to absorb the entitys expected losses. Additionally, we believe that it generally will be difficult for most entities to find comparably sized entities that have similar assets, liabilities and other interests that have financed their operations without additional subordinated financial support, and thus meet the ASC 810-10-25-45(b) criterion, because in many cases enterprises will not have enough detailed information about other entities to assess comparability. Accordingly, we believe that many enterprises will default to assessing the sufficiency of at-risk equity through the ASC 810-10-25-45(c) quantitative analysis. To illustrate how an equity investment can be demonstrated to be sufficient, consider a real estate partnership that operates a property. The partnerships initial equity investment is 30% of the assets value. If the partnership was able to obtain market rate, nonrecourse financing for 70% of the propertys value, we believe that, in general, the entity would be able to demonstrate that it can finance its activities without additional financial support (and satisfy the ASC 810-10-25-45(a) criterion). If, however, the entity was able to obtain nonrecourse financing for only 60% of the propertys value, and the partnership obtained subordinated financing from a separate lender for 10% of the propertys value, we do not believe that the entity would have demonstrated that it has sufficient equity by showing that it can finance its activities without additional financial support. Because it was required to issue subordinated debt in order to obtain the senior financing that was used to carry out its principal activities, it is unclear whether the subordinated debt is absorbing expected losses. In that case, if it was unable to find a comparable entity that operates with no additional financial support (the criterion in ASC 810-10-25-45(b)), the partnerships expected losses could be calculated (see the Questions in Chapter 10 for a discussion of how to compute expected losses) based on reasonable quantitative evidence and compared to the amount of the equity investment at risk to demonstrate the equitys sufficiency (ASC 810-10-25-45(c) criterion). The FASB intends the 10% presumption to apply in one direction only. That is, an equity investment of less than 10% is presumed to be insufficient, but an equity investment of 10% or more is not presumed to be sufficient. Because less than a 10% equity investment at risk is presumed to be insufficient, and the Variable Interest model specifies that an equity investment of 10% or greater does not relieve an enterprise of its responsibility to determine whether it requires a greater equity investment, we do not believe that the 10% presumption is relevant. Rather, we believe that the sufficiency of an enterprises equity investment at risk must be demonstrated in all cases through one of the three methods specified in ASC 810-10-25-45.
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Forms of investments that qualify as an equity investment at risk

Question 9(a).1 What constitutes an equity investment at risk for purposes of determining whether the entity is a VIE? An equity investment at risk must be reported as equity in the GAAP balance sheet of the potential VIE and must satisfy the requirements of ASC 810-10-15-14(a). The following are common forms of investments that may be considered an equity investment at risk: Common stock Voting and nonvoting
Certain forms of perpetual preferred stock, if they significantly participate in the profits and losses of the entity Voting and nonvoting Participating and nonparticipating Convertible and nonconvertible
Preferred stock classified in temporary equity (e.g., because the preferred stock is redeemable upon the occurrence of an event that is not solely under the entitys control, such as a change in control provision) pursuant to ASR 268 Warrants to purchase equity interests LLC member interests General partnership interests Limited partnership interests Certain trust beneficial interests
Although all of the interests noted previously may be reported as equity in the GAAP equity section of the entitys balance sheet, the features of each equity interest must be carefully evaluated to ensure that that they do not include those features that may indicate the equity interest is not at risk, as described in ASC 810-10-15-14(a).
Sufficiency of equity investment at risk based on fair value

Question 9(a).2 For purposes of determining the sufficiency of the equity investment at risk, should sufficiency be measured based on: (1) the carrying value of the entitys equity, as reported in its GAAP balance sheet, or (2) the fair value of the equity interests? We believe the fair value (as defined by ASC 820) of the equity investment at risk as of the date the evaluation is performed should be used in evaluating the sufficiency of the equity investment at risk. At the date of formation, the fair value and carrying value of the equity investments often will be the same, exclusive of transaction costs. However, the fair value of the equity investment generally will differ from its carrying value at dates subsequent to the entitys formation, and that fair value should be used in the analysis if a VIE reconsideration event occurs.
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Determining the fair value of an entitys equity for purposes of assessing the sufficiency of its equity investment at risk may require the use of valuation techniques and the assistance of a valuation professional.
Commitments to fund losses, stock subscriptions

Question 9(a).3 May a stock subscription, a commitment to fund losses or an obligation to absorb losses be considered an equity investment at risk? Neither a commitment to fund losses nor an obligation to absorb losses is reported as equity in the GAAP balance sheet of the entity under evaluation. As a result, neither instrument can be considered an equity investment at risk for purposes of determining whether the entity has sufficient equity. However, such commitments generally would be variable interests in the entity (see the Interpretative guidance and Questions in Chapter 5). An equity investment is not considered to be at risk if the investment was financed for the equity investors directly by the entity or by other parties involved with the entity. Accordingly, a stock subscription receivable is not considered an equity investment at risk.
Significant participation in profits and losses

Question 9(a).4 How does an equity investment significantly participate in profits and losses? Only equity investments that participate significantly in profits and losses of the entity are considered to be equity investments at risk. This criterion is inclusive; if an equity investment significantly participates in profits but not losses, or vice versa, then this criterion has not been met. In general, we believe that if the equity investment participates in the profits and losses on a pro rata basis determined by its overall ownership interest in the entity, then the equity investment participates significantly in the profits and losses of the entity. For example, assume a general partner has a 1% interest in a limited partnership and participates in a pro rata basis in the limited partnerships profits and losses. Although the interest is only 1%, it participates on a pro rata basis and would be deemed to participate significantly in the partnerships profits and losses (see guidance on determining whether an entity investment at risk is substantive in Question 9(b)(1).6). Even if an equity investment does not participate in the entitys losses on a pro rata basis (e.g., preferred stock), it generally participates significantly in losses for purposes of this criterion if it is subject to total loss. An equity investment that is subject to only partial loss should be evaluated to determine whether the potential loss is significant, as compared with the initial investment. For example, Company A and Company B form a joint venture by each enterprise contributing assets in exchange for an equity investment in the venture. Company A has the right to sell its equity investment to Company B at a future date for an amount equal to the fair value of the equity investment at the date of the ventures formation. In this example, Company As equity investment does not participate significantly in the ventures losses because if such losses were to occur, Company A could put its interest to Company B at the price it paid for the instrument. (The fact that Company B may be unable to perform in accordance with its contractual commitment should not be considered in evaluating whether this criterion has been met.) Because this criterion is inclusive, even if it is concluded that an equity investment significantly participates in the entitys losses, a determination must also be made as to whether the equity investment at risk participates significantly in the entitys profits. We believe this determination should be made after considering the relative size of the investment and the potential for participation in profits. Using the previous example, assume instead that Company B has the right to call Company As equity investment in one year at a price equal to 105% of the price that Company A paid for the interest. In this example, Company As interest may not participate significantly in the ventures profits because it can be called by Company B at only 5% above what Company A paid for the interest.
Judgment will be required to determine whether a potential loss in value or participation in the entitys profits is significant. The determination should take into account all relevant facts and circumstances, including the nature of the instrument (e.g., preferred or common stock), the size of the potential losses relative to its fair value when acquired, and the nature of the entitys assets, among other items. Many entities are capitalized with preferred stock bearing a stated dividend rate. The stocks dividend rate should be evaluated to determine whether it permits significant participation in the entitys profits. Determining whether preferred stockholders significantly participate in profits will be based on the facts and circumstances and require the use of professional judgment, but if the fixed coupon of a preferred stock provides a debt-like return, then the preferred stock would not be considered an equity investment at risk. However, if the return is equity-like, then it would be considered to participate significantly in the entitys profits. For example, if the operations of the entity are anticipated to generate a return of 15% in total on amounts invested, and a preferred investor is entitled to a yield of 10% on its investment, that return generally would be deemed to participate significantly in profits. However, if the total return is anticipated to be 40% and a preferred investor is entitled to a yield of only 6% on its investment, that return generally would be more characteristic of a debt-like return, and the preferred stock would not be deemed to participate significantly in profits.
Other investments made by equity owners

Question 9(a).5 May other investments made by equity owners be considered an equity investment at risk for purposes of determining the sufficiency of an entitys equity at risk? ASC 810-10-15-14(a) states that the equity investment at risk must be an interest reported as equity in that entitys GAAP financial statements. Accordingly, we do not believe that investments made by an equity holder that are not reported as equity in the entitys financial statements can be considered equity at risk. Illustration 9-1: Facts Assume an entitys capital structure consists of subordinated debt, loaned by an equity holder, of $5 and an equity investment at risk of $7. Analysis If the expected losses were determined to be less than $7 based on reasonable quantitative evidence, the equity would be deemed to be sufficient to permit the entity to finance its activities without additional financial support. However, if expected losses are greater than $7, the equity investment at risk would be deemed to be insufficient, even though subordinated debt provided by an equity owner absorbs the next dollar risk of loss. The form of the instrument is determinative, and the equity investment at risk (to which expected losses will be compared) can include only interests reported as equity in the entitys GAAP financial statements, regardless of their source. Other investments made by equity owners as equity at risk
Source of the equity investment

Question 9(a).6 Does an evaluation of the source of an equity investment need to be performed in order to determine whether it is at risk? Yes. The source of an equity investment must be evaluated to determine that it does not violate the criteria of ASC 810-10-15-14(a). Under these provisions an equity interest is not at risk if: It has been issued in exchange for subordinated interests in other VIEs. This criterion is intended to prevent multiple VIEs from being capitalized with one investment.
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Equity investment exchanged for subordinated interest in another VIE
An enterprise makes an equity investment of $10 million in a VIE. It forms a second entity and contributes the investment in the first VIE in exchange for all of the second entitys equity interests. The second entitys expected losses are $8 million. Analysis In this example, the $10 million equity investment in the second entity is not at risk because it has been issued in exchange for a subordinated interest in a VIE. Accordingly, the second entity is a VIE because it has no equity investment at risk. The equity interest has been provided to the equity investor directly or indirectly by the entity or others involved with the entity (e.g., by fees, charitable contributions or other payments). This criterion is not violated, however, if the provider is a related party of the investor and is included in the same set of consolidated financial statements as the investor. Illustration 9-3: Facts Realco, a real estate developer, forms a limited partnership with Investco, a third party investment company. Realco contributes $5 million to the partnership in exchange for a 5% general partnership interest. Investco contributes $95 million in exchange for a 95% limited partnership interest. At its inception, the partnership acquires a plot of land for the development of commercial real estate for $95 million. Additionally, as compensation for certain efforts related to the identification and acquisition of the land and structuring of the partnership, Investco pays a $5 million fee to Realco. Analysis In this example, Realco does not have an equity investment at risk in the partnership because the fees received from Investco must be netted against its investment in the partnership. The equity interest has been financed (e.g., by loans or guarantees of loans) directly by the entity or others involved with the entity, unless financed by a related party included in the same set of consolidated financial statements as the equity investor. Illustration 9-4: Facts Parent forms an entity and capitalizes it with equity of $10 million, which is financed by a third party, Creditco, with debt that has recourse only to Parents investment in the entity. The entity borrows an additional $40 million from Bankco, which is not a related party of Creditco. Analysis Because Parents investment has been financed by a party not involved with the entity, its equity investment is considered at risk. Creditco does not have a variable interest in the entity because Parent was not acting as its agent. Equity investment financed by the entity or others involved with the entity Equity investment provided by the entity or others involved with the entity
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Effect of items reported in other comprehensive income

Question 9(a).7 Are amounts reported in other comprehensive income (e.g., amounts arising from hedge accounting pursuant to ASC 815 or relating to available-for-sale securities accounted for under ASC 320, etc.) considered in determining the amount of the equity investment at risk? In determining whether an entity is a VIE, the fair value of the equity investment at risk at the date of assessment should be used to assess whether the equity investment at risk is sufficient to absorb the entitys expected losses. Presumably, the fair value of the equity interests already will include the effects of items reported as a component of other comprehensive income or loss. Accordingly, these items, favorable or unfavorable, should be considered in determining the fair value of the equity investment at risk but should not be double-counted in the computation.
Do profitable entities have expected losses?

Question 9(a).8 Does an entity that has been profitable historically or is projected to generate future profits, have expected losses? Yes, we believe that even an entity that expects to be profitable will have expected losses. Expected losses are based on the variability in the fair value of the entitys net assets, exclusive of the variable interests, and not on the anticipated amount of variability of the net income or loss. Accordingly, even an entity that has a history of profitability and expects to remain profitable may be a VIE if its equity investment at risk is insufficient to absorb its expected losses (i.e., the probability-weighted potential unfavorable variability may be greater than the equity investment at risk).
Sweat equity
Question 9(a).9 Are equity interests provided in exchange for services provided or to be provided by an investor (commonly referred to as sweat equity) considered an equity investment at risk? We do not believe that equity interests provided in exchange for services may be considered an equity investment at risk because the entity has provided the investors equity investment through the fees paid in exchange for the services provided, which violates the criterion established in ASC 810-10-15-14. Illustration 9-5: Facts Two oil and gas exploration companies, Oilco and Gasco, form a venture and contribute certain unproven and proven producing oil and gas properties. The two companies agree to provide an interest in the venture to an oilfield services company, Drillco, in exchange for engineering and drilling services provided to the venture. At formation of the venture, the enterprises fair value is $100 million. The equity interests and related fair values of those interests at formation of the venture are as follows:
Ownership% Oilco Gasco Drillco 33.3% 33.3% 33.3% Fair value ($ millions) $ 33.3 33.3 33.3
Sweat equity
The expected losses of the entity are $70 million.
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Analysis In this example, the ventures equity investment at risk is $66.6 million (the sum of the equity investments of Oilco and Gasco). Drillcos equity investment is not at risk because it has been provided to Drillco in exchange for services provided to the partnership. Accordingly, the partnership is a VIE because its equity investment at risk ($66.6 million) is insufficient to absorb its expected losses ($70 million). We generally believe equity interests provided in exchange for the contribution of an intangible asset that meets the criteria for the recognition as an asset separate from goodwill pursuant to the provisions of ASC 805 may be considered an equity investment at risk. Illustration 9-6: Facts Two software companies form a partnership and contribute software that each has internally developed for licensing to third parties and cash of $2 million. The software products of each partner, which have complimentary functionality, will be integrated into one product for licensing to third parties. Each software product meets the criteria as an identified intangible asset that could be accounted for separately from goodwill in a purchase business combination pursuant to ASC 805. The carrying value of each partner in its respective software product is minimal. The fair value of each software product contributed is approximately $20 million. The expected losses of the partnership are $30 million. Analysis In this example, the partnerships equity investment at risk is $44 million (the sum of the cash contributed by the partners plus the fair value of the contributed software). Accordingly, the partnership has a sufficient equity investment at risk ($44 million) to absorb its expected losses ($30 million). Equity investment received from the contribution of an intangible asset
Effect of variable interests in specified assets and silos

Question 9(a).10 Expected losses absorbed by certain variable interests in specified assets or on assets in a silo should be excluded from the expected losses of the entity. Will these exclusions affect the determination of whether the potential VIEs equity investment at risk is sufficient to absorb the entitys expected losses? If variable interests in specified assets of a VIE are not considered interests in the entity, expected losses of the entity do not include the expected losses attributable to the excluded interests. Additionally, expected losses of the entity do not include the expected losses attributable to silos. Refer to Chapters 8 and 7 for additional discussion of interests in specified assets and silos, respectively. If an enterprise has an interest that is limited to a specific asset, or group of assets, of a potential VIE that represent less than one-half of the fair value of the entitys assets in total, the enterprise does not have a variable interest in the entity. Any expected losses absorbed by the enterprise holding an interest only in specified assets of the entity need not be supported by the at-risk equity holders of the entity. Accordingly, the expected losses absorbed by the holders of interests in specified assets of the entity are deducted from the total expected losses of the entity for purposes of determining the sufficiency of the at-risk equity. Refer to Question 8.1 for illustrative examples of this concept.
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Equity investment financed with nonrecourse debt

Question 9(a).11 If an equity investor financed its investment with nonrecourse debt, is the equity investment at risk? An equity holder may finance its equity investment or enter into other risk management arrangements relating to its equity investment in the potential VIE with parties that have no involvement with the entity. Illustration 9-7: Facts Leaseco forms an LLC to construct a $100 million commercial office building in a build-to-suit arrangement and leases it to Company A. Leaseco funds the LLC with equity of $20 million, and the LLC borrows an additional $80 million from Bank A. Leaseco wholly finances its equity investment in the LLC with Bank B, an independent third-party financier, with debt that has recourse only to the investment in the LLC and not the general credit of Leaseco. The expected losses of the LLC are $12 million. Analysis The $20 million equity investment in Leaseco is sufficient to absorb its expected losses of $12 million. In this example, the entity would not be a VIE, assuming none of the other VIE criteria are violated. Although Leaseco has financed its entire equity investment with nonrecourse debt, because it has done so with a third party not involved with the potential VIE, its equity investment is considered to be at risk. Although an equity investor may finance its equity investment outside of the potential VIE without disqualifying the investment as being at risk, if the equity investment has been financed by others involved with the entity (including their related parties), the provisions of ASC 810-10-15-14(a)(4) would be violated and the amount would not be at risk. Whenever the equity investment at risk is financed in a structured transaction, the arrangements terms should be evaluated carefully to ensure the equity investor is not merely acting as an agent for another party (the principal lender), in which case the equity interest should be attributed to the principal, not the investor. Illustration 9-8: Facts Assume the same facts as the example above, except that Leaseco finances $10 million of its equity investment in the LLC with Bank B and $10 million of its investment with an equity investee of Bank A, each on a nonrecourse basis. Analysis Because $10 million of Leasecos $20 million equity investment has been financed by a related party of Bank A, which is a variable interest holder in the LLC, that $10 million is not considered to be at risk. Accordingly, the LLC is a VIE because the equity investment at risk of $10 million is insufficient to absorb its expected losses of $12 million. Equity investment financed with nonrecourse debt by party involved with the entity Equity investment financed with nonrecourse debt by independent party
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Factors that may indicate that the equity investor is acting as an agent on behalf of another variable interest holder in the entity include: The investor has acted previously as an agent of the lender. Substantially all returns (both profits and losses) inuring to the equity investor are passed through the investor to the lender.
Fees received by an equity investor

Question 9(a).12 Should the investors equity interest be reduced by all fees received by that equity investor? We believe that all fees received by an equity investor at inception of an entity should reduce the equity investors equity interest for purposes of applying ASC 810-10-15-14(a). Additionally, we believe that any fees an equity investor is unconditionally entitled to receive at inception of the entity should also reduce the investors equity investment, even if those fees are received at a future date. In such cases, we believe the present value of the unconditionally receivable fees should be used to reduce the investors equity investment at risk. However, if receipt of the fees is contingent upon the achievement of certain performance targets by the entity, and these contingencies are substantive (i.e., introduce a substantial risk that the investor will not receive the additional fees), the fees should not reduce the investors equity interest. Determining if contingencies are substantive will be based on the applicable facts and circumstances and require the use of professional judgment. We believe fees received by an equity investor for services provided subsequent to the formation of an entity do not reduce the equity investors equity interest at risk provided that the fee is received in connection with the provision of a bona fide service, the fee is consistent with market rates and is commensurate with the service provided. Fees received for services in excess of market rates for those services represent a return of the investments equity interest. Determining whether fees are market based will be based on the applicable facts and circumstances and require the use of professional judgment. Illustration 9-9: Facts A real estate developer forms a limited partnership for the development of commercial real estate. Independent investors contribute at-risk equity of $950,000 in exchange for 95% limited partnership interests. The real estate developer contributes equity of $50,000 in exchange for a 5% general partnership interest. At formation of the limited partnership, the developer is paid a development fee of $20,000. Additionally, the developer is guaranteed to receive $10,500 at the first anniversary of formation of the entity. The developer also may receive an additional $30,000 fee if the entity realizes an IRR of greater than 15% over five years. It is not probable that the entity will be able to achieve such a return. The developer also will serve as the property manager for the real estate owned by the partnership. In this role, it will make decisions regarding the selection of tenants, negotiation of lease terms, setting of rental rates, capital expenditures and repairs and maintenance, among other things. For these services, it will receive fees of $150,000 per year, which are commensurate with market rates for such services. Fees received by an equity investor
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Analysis At inception of the entity, the developer has an equity investment at risk of $20,000 (the $50,000 it contributed, less the $20,000 received at inception of the entity and the $10,000 present value17 of the $10,500 to be received upon the first anniversary of the entity). The developers equity investment is not reduced by the additional $30,000 that it may receive if the entity realizes an IRR in excess of 15% over five years, because there is substantial uncertainty as to whether such returns will be realized. Additionally, the fees that the developer will receive as the property manager do not reduce its equity investment, because the fees are received in exchange for the provisions of substantive services and reflect a market rate for such services.
At-risk equity group for equity sufficiency test is used to determine if the at-risk equity group has power
Question 9(a).13 Are the investors identified as having an equity investment at risk for purposes of applying ASC 81010-15-14(a) the same equity investors that should be used for purposes of applying ASC 810-10-1514(b)? Yes. Holders of equity investments not determined to be at risk for the purposes of evaluating the sufficiency of equity should not be considered holders of an equity investment for purposes of determining if the equity holders have the power to direct the activities of the entity that most significantly impact the entitys economic performance. This could result in an entity being a VIE. Illustration 9-10: Facts A real estate developer forms a limited partnership for the development of commercial real estate. Independent investors contribute at-risk equity equal to 95% of the entitys capitalization in exchange for limited partnership interests. The real estate developer contributes equity equal to 5% of the entitys capitalization in exchange for the general partnership interest. At formation of the limited partnership, the developer is paid a development fee equal to 6% of the entitys total capitalization. The fee is netted against the developers equity investment, reducing it to zero. Accordingly, the developer does not have an equity investment at risk. Analysis Assuming that the remaining equity contributions of the limited partners are deemed to be at risk, it is likely that the partnership has a sufficient equity investment at risk to absorb its expected losses. However, the entity is a VIE because the holders of the equity investment at risk (i.e., the limited partners) lack the power to direct the activities of the entity that most significantly impact the entitys economic performance, violating the provisions of ASC 810-10-15-14(b)(1). That is, the general partner makes all substantive decisions for the partnership, and the general partner does not have an equity investment at risk. Accordingly, the partnership would be a VIE. At-risk equity group for equity sufficiency test and group for power test
17
Assumes a 5% discount rate. 133
Call option premiums received by an equity investor

Question 9(a).14 Assume a holder of an equity investment at risk writes a call option on that equity investment to another variable interest holder. Is the investors equity investment considered to be at risk? ASC 810-10-15-14(a)(3) states that an equity investment at risk [d]oes not include amounts provided to the equity investor directly or indirectly by the legal entity or by other parties involved with the legal entity (for example, by fees, charitable contributions, or other payments) We generally believe that if (1) the call options strike price is sufficiently out-of-the-money and (2) the options premium is at fair value, the option premium generally should not reduce the amount of the investors equity investment at risk. Both conditions must be met to conclude that the option premium should not reduce the investors equity investment at risk, because while an option premium may be at fair value, it could include a financing element. Consider the following two options:
Option 1 Asset value Options strike price Options fair value (assumed) $ $ $ 100 130 15 Option 2 $ $ $ 100 80 35
Although Option 2s premium is at fair value, it includes a financing element of $20, representing the amount that the option is in-the-money at its inception. Consequently, we believe the equity investor that wrote the call option should reduce its equity investment at risk by at least $20 (the facts and circumstances may indicate a higher amount may be warranted). A consequence of such a reduction is that the entity may be a VIE because a portion of the investors equity investment that is not at risk will absorb the entitys expected losses, thus violating the requirement that an entitys equity investment at risk absorb the first dollar risk of loss (see the Interpretative guidance and Questions regarding this concept later in this chapter). Additionally, such a reduction could affect the sufficiency of equity test. All of the relevant facts and circumstances should be considered in determining whether a portion of an investors equity investment is at risk, particularly when other transactions among the variable interest holders have occurred.
Entities used to invest in synthetic fuel tax credits

Question 9(a).15 How should the sufficiency of the equity investment at risk of an entity that produces coal-based synthetic fuel be evaluated? Certain sections18 of the Internal Revenue Code (such as Section 2919) provide for synthetic fuel tax credits. These credits are intended to reduce the United States dependence on imported oil by subsidizing ventures to produce alternative sources of energy that might otherwise be unattractive to investors. Generally, tax credits are available provided the facility qualifies under the relevant tax code and demonstrates that the production process results in a significant chemical change.20 In the example of Section 29 credits, the amount of the credit earned by the taxpayer is dependent on the energy content of the coal-based synthetic fuel produced and sold to third party purchasers. The facilities are subject to maximum production limits. The taxpayer also must demonstrate that it bears the risks associated with ownership of the facility that produces the synthetic fuel.
18
Although Section 29 credits also subsidize other alternative energy sources, this Question focuses on structures used to invest in tax credits arising from the production and sale of coal-based synthetic fuel. Section 29 credits are available for coal-based synthetic fuels produced and sold through 31 December 2007. Generally, this is demonstrated through testing performed by independent laboratories and chemists. 134
19 20
Investors in a synthetic fuel tax credit facility generally receive their returns from a combination of (1) realization of tax credits, (2) deductions for operating losses and (3) depreciation of the synthetic fuel production equipment. Structures used to facilitate investments in synthetic fuel tax credit facilities are usually established as limited partnerships or limited liability companies that pass the tax benefits associated with the entitys production of synthetic fuel directly to the investors. This structure enables a taxpayer to receive credits in proportion to its ownership in the facility while providing some limitation on liability, particularly if the taxpayer is a limited partner or a non-managing member of an LLC. Investors in a synthetic fuel facility may purchase an interest in the entity from a co-investor for a relatively small initial cash payment and contingent consideration based on the amount of tax credits generated by the facility (an earn-out). Operations of synthetic fuel production facilities usually result in operating losses that the investors must fund through ongoing capital contributions, regardless of their ability to utilize the tax credits. We believe that, qualitatively, a typical synthetic fuel structure will be a VIE because the investors generally fund operating losses through ongoing capital contributions. As discussed in the response to Question 9(a).3, a commitment to fund losses is not reported as equity in the GAAP balance sheet of the entity under evaluation. Consequently, the commitment to fund losses cannot be considered an equity investment at risk for purposes of determining whether the entity has sufficient equity. We believe that a synthetic fuel structure that has an insufficient amount of equity at the evaluation date to fund its future operating losses will be a VIE even if, quantitatively, the fair value of the entitys equity investment at risk exceeds the entitys expected losses (see Question 10.14 for our views on including the investors tax benefits in the calculation of expected losses). We understand the SEC staff shares this view.
Transactions outside the entity

Question 9(a).16 Should transactions that occur outside the entity be considered in determining whether the equity investment is at risk? We believe transactions that occur outside the entity should be considered not only in determining whether the equity investment is at risk, but also in identifying the parties holding variable interests in the entity and in the entitys primary beneficiary (if the entity is a VIE). In certain cases, the Variable Interest Model specifically prohibits an equity investment from being considered at risk. For example, an equity investment would not be considered at risk if it was financed by an unrelated third party that is also involved with the entity. Because the Variable Interest Model does not contemplate all potential types of structuring, the use of professional judgment (after considering all of the relevant facts and circumstances) will be required.
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Transactions outside the entity
Manufacturer X sells a product to Entity 1 for $100. Entity 1 was capitalized by issuing equity ($10) and debt ($90) to Equity Provider and Lender, respectively. Manufacturer X writes a put option so that Entity 1 may put the equity to Manufacturer X for $10 at a future date. The transaction is demonstrated pictorially as follows:
ManufacturerX Equity guarantee Saleof product
Equityprovider Equity $10 Loan
Lender
$90 Entity1
Analysis We believe the equity investment is not at risk because it does not participate significantly in losses of the entity. Accordingly, because there is no equity investment at risk, the entity would be a VIE. Additional Facts Further assume Manufacturer X entered into the same guarantee arrangement at inception of the arrangement with Equity Provider (instead of Entity 1) as follows:
ManufacturerX
Equity guarantee
Equityprovider Equity $10 $90 Entity1 Loan
Lender
Saleof product
Analysis
We believe the equity investment in this structure also would not be at risk (and the entity would be a VIE) because the substance of guarantee (provided by a party involved with Entity 1) prevents the Equity Provider from being exposed to potential losses of Entity 1. We do not believe that a transaction between two parties may be ignored merely because the entity under evaluation is not a direct party to the transaction. We believe all of the relevant facts and circumstances should be considered in applying the Variable Interest Model.
The SEC staff shares this view, as discussed in a December 2004 speech. Note that while this speech was intended to address accounting under FIN 46(R) (prior to the Statement 167 amendments), we believe that the concepts remain relevant to the Variable Interest Model in ASC 810-10.
Speech excerpts by Jane D. Poulin

2004 AICPA National Conference on SEC and PCAOB Developments Consolidation of Variable Interest Entities We have seen a number of questions about whether certain aspects of a relationship that a variable interest holder has with a variable interest entity (VIE) need to be considered when analyzing the application of FIN 46R. These aspects of a relationship are sometimes referred to as activities around the entity. It might be helpful to consider a simple example. Say a company (Investor A) made an equity investment in a potential VIE and Investor A separately made a loan with full recourse to another variable interest holder (Investor B). We have been asked whether the loan in this situation can be ignored when analyzing the application of FIN 46R. The short answer is no. First, FIN 46R specifically requires you to consider loans between investors as well as those between the entity and the enterprise in determining whether equity investments are at risk, and whether the at risk holders possess the characteristics of a controlling financial interest as defined in paragraph 5(b) of FIN 46R. It is often difficult to determine the substance of a lending relationship and its impact on a VIE analysis on its face. You need to evaluate the substance of the facts and circumstances. The presence of a loan between investors will bring into question, in this example, whether Investor Bs investment is at risk and depending on Bs ownership percentage and voting rights, will influence whether the at risk equity holders possess the characteristics of a controlling financial interest. Other activities around the entity that should be considered when applying FIN 46(R) include equity investments between investors, puts and calls between the enterprise and other investors and noninvestors, service arrangements with investors and non-investors, and derivatives such as total return swaps. There may be other activities around the entity that need to be considered which I have not specifically mentioned. These activities can impact the entire analysis under FIN 46(R) including the assessment of whether an entity is a VIE as well as who is the primary beneficiary. Refer to Question 5.18 for a discussion of how to identify implicit variable interests.
Determining sufficiency of equity through comparison with other entities

Question 9(a).17 What factors should an entity consider in comparing itself to another entity to demonstrate the sufficiency of its equity investment at risk (ASC 810-10-25-45(b))? We believe that an entity can demonstrate the sufficiency of its equity investment at risk only by reference to unaffiliated entities that have substantially similar operations and economic characteristics. Use of this approach would not be appropriate in situations in which the operations or activities of the unaffiliated entities are not of a comparable nature, scope or size to the entity that is being evaluated under the Variable Interest Model.
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The following are examples of characteristics that should be comparable between the entities (this list is not all-inclusive): Size and composition of assets Amount Exposure to interest rate risk Type and duration Concentration Credit quality Liquidity
Capitalization Type and amount of debt/equity Terms of instruments Priority and liquidation preferences Maturities of debt
Nature of operations Geographic area(s) Scale Product line(s) Service line(s) Cash flows
Other Derivatives Risk management contracts
Regulatory capital requirements

Question 9(a).18 May a bank or insurance company be assumed to have sufficient equity because it is required by regulation to maintain minimum levels of capital to operate? Sufficiency of equity may be established through comparison with other entities that hold similar assets of similar quality in similar amounts and operate with no additional subordinated financial support. We generally believe that the capital levels imposed on a regulated institution such as a bank or an insurance company may be used to assist in determining the sufficiency of the equity investment at risk. We understand that it was these types of institutions, which may operate at capital levels that are less than 10% of their total assets that, in part, caused the FASB not to require an equity investment of at least 10% of assets in all cases. The determination of the sufficiency of the equity investment at risk should be made after consideration of all relevant facts and circumstances.
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Illustrative examples Qualitative and quantitative analyses of sufficiency of equity at risk

Question 9(a).19 Illustrative examples Qualitative and quantitative analyses of sufficiency of equity at risk The following illustrates the application of the provisions of ASC 810-10-25-45 and 25-46. Assume that the business scope exception to the Variable Interest Model does not apply: Illustration 9-12: Example 1 Facts DAX Partners is a small business partnership formed by two brothers in the business of harvesting wheat and hauling hay for farmers in the Midwest. The balance sheet of DAX Partners at its formation is as follows:
Total assets Bank loan Other liabilities Partners capital $12.0 million 9.0 million 1.9 million 1.1 million
Qualitative and quantitative analyses of sufficiency of equity at risk
$7.5 million of the bank loan bears a fixed interest rate of 6%, is due in five years and is secured only by combines, hay hauling and other equipment and, therefore, has no recourse to the equity holders. The remaining $1.5 million of the bank loan is unsecured, bears a fixed interest rate of 8%, is guaranteed by the partners and is due in seven years. Older Brother contributed $600,000 and Younger Brother contributed $500,000 in exchange for equity interests. Although each brother has equal voting control, profits and losses are shared in accordance with the respective capital contributions. DAX Partners is unable to demonstrate the sufficiency of its equity investment at risk by comparison to another entity (i.e., through the ASC 810-10-25-45(b) method). Analysis In this example, the sufficiency of equity can be demonstrated only through the method specified in ASC 810-10-25-45(c) (i.e., an expected loss calculation would be required). DAX Partners has not reasonably demonstrated that it can finance its activities without additional subordinated financial support because the unsecured debt has recourse to the partners. Accordingly, an expected loss calculation would be required to demonstrate whether the partners capital exceeds expected losses. Note that the relative size of the equity investment compared with the entitys assets is not determinative (i.e., it cannot be presumed that the equity investment at risk is sufficient even if it were greater than 10% of assets). In this specific circumstance, if the unsecured debt was not guaranteed by the partners and bore a reasonable interest rate, then DAX Partners may be able to demonstrate that it has sufficient equity to finance its activities without additional subordinated financial support. Example 2 Facts Assume the same facts as assumed in Example 1, except the $1.5 million unsecured loan is not guaranteed by the partners, bears a fixed interest rate of 10%, is due in 10 years and is entitled to 30% of all GAAP profits above a stated threshold.
Analysis An expected loss calculation is required. The unsecured loan has characteristics of an equity-like return, calling into question the sufficiency of the partners capital. As a result of lacking the partners guarantee of repayment, the subordinate investor demanded a higher interest rate along with a significant participation in GAAP profits, indicating that DAX Partners may not have sufficient equity to support itself without additional subordinated financial support. Example 2.1 Facts Assume the same facts as Example 2, except that the entitys expected losses are computed to be $1 million. However, allocation of the entitys expected losses indicates that in certain possible outcomes of the entity, both the equity investment at risk and the subordinated debt will absorb expected losses. Analysis In this fact pattern, expected losses are less than the partners capital. Accordingly, the equity of the partnership would be considered sufficient even though there are certain scenarios that would show expected losses inuring to the subordinated debt holder. The Variable Interest Model requires only the amount of equity to exceed expected losses of the entity as a whole. It does not require the equity to be sufficient to bear all losses that could occur and not be absorbed by other variable interest holders. It should be noted, however, that if expected losses were calculated to be $1.1 million or higher, the equity of DAX Partners would not be sufficient. Example 3 Facts Assume the same facts as assumed in Example 1, except the unsecured debt is not guaranteed by the partners and the balance sheet of the entity, at its formation, is as follows:
Total assets Bank loan Partner loans Other liabilities Partners capital $12.0 million 6.0 million 3.6 million 1.9 million 0.5 million
Additional facts (different from Example 1): The $6 million bank loan bears a fixed interest rate of 6%, is due in five years and is secured only by combines, hay hauling and other equipment and therefore has no recourse to the equity holders. The partner loans (Big Brother, 60%, and Little Brother, 40%) bear a fixed coupon of 15% and are due in 10 years. Big Brother contributed $300,000 and Little Brother contributed $200,000 in exchange for an equity interest. DAX Partners believes that the entity has sufficient equity to carry on its activities without additional financial support because the total amount of partners capital and partner loans is $4.1 million (33% of total assets). An expected loss calculation shows that the entitys expected losses are $2 million.
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Analysis Subordinate loans made to the entity by the equity holders or commitments to fund future losses are not equity because an equity investment is defined as amounts that are included within equity in the entitys financial statements. Accordingly, the brothers are required to determine whether the entity has sufficient equity to support its activities without additional financial support. Because of the capital structure, it is not clear that the entity can operate without additional subordinated financial support. Accordingly, an expected loss calculation would need to be performed. DAX Partners does not have sufficient equity, because total partners capital is only $500,000. Although the partner loans could absorb the remaining $1.5 million of expected losses, because that investment is not an equity investment at risk, the entity has insufficient equity to absorb its expected losses. Accordingly, DAX Partners is a VIE.
Is an equity investment of 10% of the entitys total assets sufficient?

Question 9(a).20 Can it be assumed that an entity that has an equity investment at risk exceeding 10% of the fair value of its total assets has an equity investment at risk sufficient to absorb its expected losses? The sufficiency of an entitys equity investment at risk must be demonstrated through one of the three methods as discussed in ASC 810-10-25-45: The entity has demonstrated that it can finance its activities without additional subordinated financial support. The entity has at least as much equity invested as other entities that hold only similar assets of similar quality in similar amounts and operate with no additional subordinated financial support. The amount of equity invested in the entity exceeds the estimate of the entitys expected losses based on reasonable quantitative evidence.
It cannot be assumed that an equity investment at risk that is based on some percentage of the entitys total assets is either sufficient or insufficient. We believe the 10% presumption, for all intents and purposes, is irrelevant in determining the sufficiency of the equity investment at risk and should not be used in making this determination. That is, an equity investment of at least 10% of the fair value of an entitys total assets is not a safe harbor. Even an equity investment at that level, or higher, requires a demonstration that an enterprises equity investment at risk is sufficient.
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Illustrative examples Sufficiency of equity at risk

Question 9(a).21 Illustrative examples Sufficiency of equity at risk The following illustrates the application of the provisions of ASC 810-10-15-14(a): Illustration 9-13: Example 1 Facts ABC Enterprises and Investor XYZ form a limited partnership to buy and sell ownership interests in real estate. ABC Enterprises serves as general partner and contributes $100 million of existing subordinated investments in other real estate ventures that are VIEs to the partnership. Investor XYZ contributes $100 million in exchange for the sole limited partnership interest. The partnership has no debt. Expected losses of the partnership are $120 million. Partnership losses are shared on a pro rata basis, but to compensate ABC Enterprises for its duties as general partner, profits are shared pro rata until Investor XYZ has reached an internal rate of return on its investment of 15%. At that point, ABC Enterprises receives all of the profits. Investor XYZ participates in significant decisions (buying/selling of assets, incurring debt, approving the budget, etc.) but may remove the general partner only with cause. Example 1.1 Facts Assume the same facts as in Example 1, except that ABC Enterprises contributes $100 million of cash, and the real estate ownership interests are purchased in the open market from third parties. Also, assume that ABC Enterprises finances its investment on a nonrecourse basis with proceeds received from Bank A, which is not related to ABC Enterprises or Investor XYZ, nor is it involved with the limited partnership. Example 1.2 Facts Assume the same facts as in Example 1.1, except that Investor XYZ can put its limited partnership interest to ABC Enterprises for $100 million after five years. Sufficiency of equity at risk
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Analysis
At-risk factor 1. Do the equity holders significantly participate in profits and losses of the entity? Example 1 Example 1.1 Example 1.2 No. Investor XYZ does not participate significantly in the losses of the partnership due to the existence of the put option. The put option protects Investor XYZ from all future losses. Accordingly, the equity investment is not at risk. Possibly. As long as the See Example 1. 15% internal rate of return to Investor XYZ makes up a significant amount of the entitys expected GAAP profits, its equity interest would significantly participate in profits and losses of the entity. ABCs equity investment significantly participates in profits and losses. Yes. ABC Enterprises No. equity investment meets this criterion. Accordingly, its equity investment is not at risk No.
2. Does equity include equity interests issued in exchange for subordinated interests in other VIEs?
No.
3. Has any amount of No. equity been provided to the equity investor directly by the entity or by other parties involved with the entity? 4. Has any amount of No. equity been financed directly by the entity or by other parties involved with the entity?
No.
No. Although ABC See Example 1.1. Enterprises financed its equity investment on a nonrecourse basis with Bank A, Bank A has no involvement with the entity. However, it should be noted that if ABC Enterprises were acting in the capacity of an agent for Bank A, Bank A may need to evaluate the entity for consolidation. Yes. Assuming XYZs equity investment is at risk, the $200 million at-risk equity investment exceeds the expected losses of the partnership of $120 million. No. As XYZs equity investment is not at risk, the $100 million at-risk equity investment of ABC Enterprises does not exceed the expected losses of the partnership of $120 million.
5. Is the equity investment sufficient to permit the entity to finance its activities without additional subordinated financial support?
No. As ABC Enterprises equity investment is not at risk, the $100 million atrisk equity investment of XYZ does not exceed the expected losses of the partnership of $120 million.
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Example 2 Facts Assume Company A and Developer B form a partnership by contributing $80 and $20, respectively. Company A and Developer B have voting and economic interests of 80% and 20%, respectively. The partnership purchased undeveloped property costing $1,000 that was funded by partner contributions, $600 of nonrecourse debt and $325 of unsecured debt. Developer B receives a development fee of $25 from the partnership at inception of the entity. Company A and Developer B calculate expected losses to be $85 based on reasonable quantitative evidence. Analysis The partnership is a VIE because it does not have sufficient equity at risk to permit it to absorb its expected losses. Developer B does not have an equity investment at risk because the $25 of development fees it received at inception of the entity eliminates its equity investment of $20. Accordingly, the partnerships equity investment at risk ($80) is less than expected losses ($85). Example 3 Facts Assume Company B and Developer C form LandDevelopers, Inc. to buy undeveloped land, develop it and sell it to unrelated homebuilders. Each enterprise contributes $5 million in exchange for all of the common stock of the corporation. Profits, losses and decision making are shared pro rata. LandDevelopers, Inc., purchases undeveloped property costing $40 million that was funded by the equity contributions; $20 million of nonrecourse debt; and $12 million of non-voting cumulative preferred stock bearing a fixed coupon of 5% that is puttable at 95% of par in five years. Developer C receives $2 million in development fees at the entitys inception. Expected losses of the entity are $9 million. Analysis The total amount of equity at risk is $8 million ($5 million pertaining to Company Bs investment and $3 million pertaining to Developer Cs investment). Of the $5 million contributed by Developer C, $2 million does not meet the criteria to be considered at risk because it represents fees received from the entity. The preferred stock investment of $12 million would not be considered to participate significantly in profits and losses of the entity because of the put right held by the preferred investor, which prevents it from participating significantly in the entitys losses, and the 5% coupon does not significantly participate in profits. The entity is a VIE because its at-risk equity investment of $8 million is insufficient to absorb the entitys expected losses of $9 million.
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Example 3.1 Facts Assume the same facts as Example 3, except that instead of receiving a $2 million fee at inception, Developer C receives only $1 million at inception. However, Developer C is unconditionally entitled to receive an additional $1 million to be paid at the end of two years. Analysis The timing of receipt of the vested development fees does not affect the assessment as to whether the equity is at risk. Accordingly, the present value of the fee should reduce the equity investment at risk. Regardless of the discount rate reflected, the deduction of any amount resulting from the present value calculation would reduce the equity investment at risk below $9 million and, therefore, the entity is a VIE. If the development fees were contingent on the entitys performance or other meaningful factors such that Developer C was not vested in the fees at inception, then the deferred development fees may not reduce the Developers equity investment. The determination as to whether the contingency is substantive should be based on the applicable facts and circumstances. Example 3.2 Facts Assume the same facts as Example 3, except that the preferred stock is not puttable or cumulative, bears a fixed coupon of 12% and expected losses of the entity are $15 million. Analysis In this example, the provisions of ASC 810-10-15-14(a) are not violated because the at-risk equity is sufficient to absorb the entitys expected losses. In this fact pattern, at-risk equity is $20 million ($5 million for Company Bs investment, $3 million for Developer Cs investment and $12 million for the preferred stock investment). The $12 million of preferred stock is included as an at-risk equity investment as it will likely participate significantly in the profits of the entity because of the relatively higher rate of return (assuming that the 12% return is a significant portion of the entitys GAAP profits), and, without the put, a significant portion of the investment could be lost if the entity were to incur losses.
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9.2
Interpretative guidance Power (ASC 810-10-15-14(b)(1))

Note: The FASB currently has a project on its agenda that would modify the Variable Interest Models provisions for evaluating an enterprise as a principal or an agent (see Chapter 6) and the provisions for evaluating the substance of kick-out rights and participating rights (see this Chapter and Chapter 14), among other things. Readers should monitor developments in this area closely. For an entity not to be a VIE, the Variable Interest Model requires that, as a group, the holders of the equity investment at risk must have the power, through voting rights or similar rights held through their equity interests, to direct the activities of an entity that most significantly impact the entitys economic performance. The owners of the equity investment at risk should be able to make decisions that significantly affect the economic results of the entity in order for it not to be a VIE because, as the decisions to be made by the equity holders become less significant in nature, a model that bases consolidation on ownership of voting interests becomes less relevant. The determination of whether, as a group, the holders of an entitys at-risk equity investment have the power to direct the activities of an entity that most significantly impact the entitys economic performance should take into account the extent to which parties other than the at-risk equity holders have the ability to make decisions about an entitys activities. In situations in which parties other than the at-risk equity holders have the right to make or participate in decisions about an entitys activities, emphasis should be placed on the ability of the equity group to make decisions that most significantly impact the entitys economic performance. Determining whether an entity is a VIE because it has a decision maker or other party with substantive participating rights that does not have an equity investment at risk should be based on the applicable facts and circumstances. Other interests held by holders of an equity investment at risk may not be considered in determining whether those equity holders have the power to direct the activities that most significantly impact the entitys economic performance. In the FASBs view, the Variable Interest Model would not be effective in identifying a VIE if the equity holders treated the rights and obligations provided by their other interests in the entity as if those rights and obligations were derived from the equity investment. Additionally, the extent to which the equity group absorbs expected losses and receives expected residual returns of the entity should be considered in determining whether the at-risk equity holders lack the ability to make decisions about an entitys activities. Presumably, the ability to make decisions that have a significant impact on the success of the entity becomes increasingly important to the equity group as the amount of their investment increases. The greater the equity as compared to the expected losses of the entity, the less likely it is that the equity group would be willing to give up the ability to make decisions consistent with their interest or permit others to make decisions counter to their interests. Subsequent to the adoption of Statement 167s amendments to ASC 810-10, kick-out rights (see Chapter 14 for definition) should not be considered in determining whether the at-risk equity investors lack the power to direct the activities of an entity that most significantly impact the entitys economic performance unless a single enterprise (including its related parties and de facto agents) has the unilateral ability to exercise those rights. This amendment to the criteria for determining whether an entity is a VIE is consistent with the amendments to the primary beneficiary determination, which are discussed in detail in the Interpretative guidance in Chapter 14. Prior to Statement 167, practice generally considered substantive kick-out rights in the evaluation of whether an entity was a VIE even if the kick-out rights could not be exercised by a single party.
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This change may result in entities becoming VIEs upon the adoption of Statement 167 in certain circumstances. For example, if decision making ability is held by a non-equity holder, an enterprise previously may have concluded that the entity was not a VIE by giving consideration to substantive kickout rights held by the equity holders as a group (as opposed to a single equity holder). This is often a consideration for partnerships or LLCs in which the general partner or managing member does not have a substantive equity investment at risk but can be removed by a majority of the LP or member interests. Thus, the amendments to the determination of whether an entity is a VIE may result in more partnerships and LLCs becoming VIEs. Upon adoption of Statement 167s amendments, limited partnerships that are VIEs likely will be consolidated by the general partner. Alternatively, interests other than the equity investment at risk that provide the holders of those interests with kick-out rights or participating rights do not prevent the equity holders from having power unless a single enterprise (including its related parties and de facto agents) has the unilateral ability to exercise such rights. However, few structures provide for non-equity interests to hold unilateral kick-out rights or participating rights. If an interest other than the equity investment at risk provides the holder of that interest with decisionmaking ability, but the interest does not represent a variable interest based on the guidance in ASC 81010-55-37 and 55-38, that interest does not make the entity a VIE. The FASB reasoned that such a decision maker would never be the primary beneficiary of the VIE because it would not hold a variable interest. Additionally, such an interest typically would indicate that the decision maker was acting as a fiduciary, and the FASB observed that this fact alone should not lead to a conclusion that entity is a VIE. The FASB observed that this guidance was intended to prevent many traditional voting interest entities and certain investment funds from becoming VIEs. For example, if a property manager that is considered to have power over the entity concludes that it does not have a variable interest in the entity after evaluating ASC 810-10-55-37 and 55-38, the property managers decision-making does not make the entity a VIE under the Variable Interest Model. In this instance, the property manager is acting as an agent on behalf of the equity holders, which does not indicate that the entity is a VIE. The determination of whether the holders of an entitys equity investment at risk have the power to direct the activities of an entity that most significantly impact the entitys economic performance should be made after considering all of the facts and circumstances and will often require the use of professional judgment. Refer to the Interpretative guidance in Chapter 14 for additional considerations as to what would constitute power to direct the activities of an entity that most significantly impact the entitys economic performance.
Holders of the equity investment at risk must make substantive decisions

Question 9(b)(1).1 What types of decisions should the holders of the equity investment at risk have the ability to make through their voting rights to satisfy ASC 810-10-15-14(b)(1)? For an entity to be a voting interest entity, the holders of the equity investment at risk, as a group, must have the power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entitys economic performance (power). We believe the power held by the holders of the equity investment at risk, as a group, cannot be limited to administrative functions. Rather, those powers must enable the equity holders to make substantive decisions.
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Decisions are substantive when they most significantly affect the economic performance of the entity (e.g., revenues, expenses, gains and losses or financial position of the entity). Examples of substantive decisions that affect economic performance may include the ability to purchase or sell significant assets, enter into new lines of business, incur significant additional indebtedness, etc. We believe that the assessment of power in evaluating whether an entity is a VIE generally should be consistent with the assessment of power when determining the primary beneficiary of a VIE. That is, we believe that the identified activities that most significantly impact an entitys economic performance would be the same for the purposes of the VIE determination (ASC 810-10-15-14(b)(1)) and the determination of the primary beneficiary. Additionally, when considering all facts and circumstances, enterprises should consider the extent to which the holders of an entitys at-risk equity investment absorb expected losses and receive expected residual returns of the entity. Generally, the ability to make decisions that have a significant impact on the success of the entity becomes increasingly important to the at-risk equity group as the amount of their investment increases. The greater the amount of the at-risk equity investment as compared to the expected losses of the entity, the less likely it is that the holders of the investment would be willing to give up the ability to make decisions consistent with their interests or permit others to make decisions counter to their interests. Determining whether, as a group, the holders of the equity investment at risk have the power will be based on the applicable facts and circumstances and will require the use of professional judgment.
Must all equity holders participate in decision making?

Question 9(b)(1).2 Does each holder of an equity investment at risk have to participate in decisions about the entitys activities in order for the entity not to be a VIE? No. Because this test is applied to the holders of the equity investment at risk as a group, if any member, or collection of members, of the group that holds a substantive equity investment has the power, through its equity position, to direct the activities of an entity that most significantly impact the entitys economic performance (power), generally we believe that the criterion in ASC 810-10-15-14(b)(1) is met. Determining whether an enterprise has a substantive equity investment in an entity should be made based upon all of the relevant facts and circumstances and should consider the absolute size of the investment and its relationship to (1) the total equity investment at risk and (2) the entitys total assets (see Question 9(b)(1).6 for further considerations). It is not necessary for all holders of an equity investment at risk to participate in decision making, as long as power is held by a member(s) of the at-risk equity group. However, if significant decisions about the entitys activities are made by a holder of an equity investment that is not at risk (see the Interpretative guidance and Questions to ASC 810-10-15-14(a)), the entity may be a VIE (see Question 9(b)(1).3). Illustration 9-14: Facts A limited partnership is formed to develop commercial real estate. The general partner acquires a 1% interest in the partnership, and its investment is considered an equity investment at risk. The 99% limited partner interests are also considered substantive at-risk equity. As is customary in a limited partnership, the general partner makes day-to-day decisions, and the limited partners have only protective rights (as that term is defined in the ASC) in the decision making about the entitys activities. There are no other variable interest holders in the partnership (e.g., a lender) that have participating rights. Evaluation of whether power is held by the equity holders as a group
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Analysis Because the general partner holds a substantive equity investment at risk, and the equity holders, as a group, have the power, the provisions of ASC 810-10-15-14(b)(1) are not violated. It is not necessary for the 99% limited partner interests to have participating rights for the criterion of ASC 810-10-15-14(b)(1) to be met. It is important to note that any time the voting rights of an equity investor are not proportional to its obligation to absorb the expected losses of the entity, to receive the expected residual returns of the entity, or both, the anti-abuse provision in ASC 810-10-15-14(c) should be evaluated (see further discussion of the anti-abuse provision below).
Participation in decision making by holders of interests that are not equity investments at risk
Question 9(b)(1).3 Is an entity a VIE pursuant to ASC 810-10-15-14(b)(1) if a holder of a variable interest that is not an equity investment at risk substantively participates in decision-making? Yes. The requirement for the equity investors, as a group, to have the ability to make decisions would not be met if a party (including its related parties and de facto agents) other than a holder of an equity investment at risk has participating rights (as defined in the ASC). In situations in which a single party other than at-risk equity holders has the right to make or participate in decisions, emphasis should be placed on the ability of the participating party to block the actions through which at-risk equity holders may exercise power. ASC 810-10-15-14(b)(1) may not be violated, however, if the participating rights are held collectively by multiple, unrelated parties that are not at-risk equity holders. Refer to Question 9(b)(1).7 for further discussion of participating rights. A holder of an interest that is not an equity investment at risk may hold protective rights (such as a lender through debt covenants) without ASC 810-10-15-14(b)(1) being violated. Illustration 9-15: Example 1 Facts Assume that three unrelated enterprises (Enterprises A, B and C) form an LLC. Enterprise A has a 60% equity ownership in the venture, and Enterprises B and C each hold a 20% equity ownership. However, Enterprises B and C can both put their equity interests to Enterprise A at the end of five years for an amount equal to their original equity investment. Enterprise A makes all decisions. However, Enterprise B has the ability to block Enterprise As decisions. Analysis In this fact pattern, Enterprises B and C are not holders of an equity investment at risk because their ability to put their interests to Enterprise A at the end of five years protects them from having to significantly participate in the losses of the LLC. Enterprise A cannot unilaterally make decisions about the entitys activities because Enterprise B has participating rights. Because Enterprise B (holder of an equity investment that is not at risk) has the unilateral ability to exercise the participating rights, the entity is a VIE. Participating rights held by holders of interests that are not equity investments at risk
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Example 2 Facts Assume the same facts as Example 1. However, in order to block Enterprise As decisions, Enterprises B and C must both agree to do so. Analysis Because two parties must agree to exercise the participating rights, the entity is not a VIE pursuant to ASC 810-10-15-14(b)(1).
Effect of decision makers or service providers when evaluating power under ASC 810-10-15-14(b)(1)
Question 9(b)(1).4 If a decision maker or service provider holds a variable interest in an entity separate from an equity investment at risk, do the holders of the equity investment at risk have the power to direct the activities of the entity that most significantly impact the entitys economic performance (power)? What if the holders of the equity investment at risk have kick-out rights or other rights that allow them to make decisions affecting the entity? Determining whether an entity is a VIE because it has a decision maker or service provider with power or participating rights through an interest separate from an equity investment at risk should be based on the applicable facts and circumstances. In particular, it is important to determine whether the decision maker or service provider has a variable interest based upon an evaluation of the criteria in ASC 810-10-55-37. This analysis focuses on whether the decision maker or service provider is acting in a fiduciary capacity (i.e., as an agent of the equity holders) or as a principal to the transaction. The Variable Interest Model indicates if an interest other than an equity investment at risk provides the holder of that interest with decision-making ability, but the interest does not represent a variable interest (e.g., the decision makers or service providers fee does not constitute a variable interest based on the guidance in ASC 810-10-55-37), then the criterion in ASC 810-10-15-14(b)(1) is not violated. The FASB believed that such a decision maker or service provider could never be the primary beneficiary of a VIE as it does not hold a variable interest. Often in the circumstances in which it is determined that a decision maker has a variable interest, the entity will be a VIE as a result of the decision maker receiving power or participating rights through their fee arrangements (rather than through an equity investment at risk). In making this determination, the nature of the rights held by the holders of the equity investment at risk (i.e., kick-out rights or liquidation rights) should be considered when a single enterprise (including its related parties and de facto agents) has the unilateral ability to exercise those rights. Refer to Question 9(b)(1).7 for further discussion on kick-out rights and liquidation rights.
Can interests other than equity investment at risk be considered for purposes of evaluating power under ASC 810-10-15-14(b)(1)?
Question 9(b)(1).5 Does the power to direct the activities of an entity that most significantly impact the entitys economic performance (power) have to be demonstrated through the ability to vote an equity investment at risk? Yes. Other interests held by holders of an equity investment at risk may not be combined with equity interests in determining whether power is held by the holders of an entitys equity investment at risk. The FASB believes that ASC 810-10-15-14(b) describes the characteristics of a controlling financial interest, and if the rights and obligations provided by the total equity investment at risk lack any of those characteristics, then the ownership of a majority of the equity investment would not be an appropriate basis for determining consolidation of the entity.
Illustration 9-16: Example 1 Facts
Power through interests other than equity investments at risk
Assume a partnership is created to develop commercial real estate. None of the partnership interests have voting rights, but one partner, a real estate developer, makes all significant decisions for the partnership under the terms of a service agreement entered into at inception of the entity. The developer is required to have a substantive equity investment at risk as long as it provides services pursuant to the service agreement. Assume the service agreement is a variable interest. Analysis In this example, the power rests with the real estate developer by virtue of the service agreement rather than through its equity interest. Therefore, the entity would be a VIE because there is no decision making for the entity embodied in the equity interests. Example 2 Facts In contrast to the structure above, assume the entity is instead formed as a limited partnership with the real estate developer as the general partner, who makes all significant decisions for the entity. The equity holders agree to a disproportionate sharing of profits within the equity group to compensate the general partner for service performed as the general partner. Analysis Although economically the rights and obligations of the equity holders of both entities are the same, the form of the instrument through which decisions are made for the entity is determinative as to whether the entity is or is not in violation of ASC 810-10-15-14(b)(1). Accordingly, in this case, because the decision making for the entity is embodied in an equity interest, the entity is not a VIE (assuming that none of the other criteria are violated).
Determining whether a general partners at-risk equity investment is substantive

Question 9(b)(1).6 Should the amount of the general partners equity investment at risk in a limited partnership be considered in evaluating whether the conditions in ASC 810-10-15-14(b)(1) have been met? How should other interests held by a general partner be considered in this evaluation? We believe that in order to conclude that the group of at-risk equity investors in a limited partnership have the power to direct the activities of the entity that most significantly impact the entitys economic performance (power) pursuant to the conditions in ASC 810-10-15-14(b)(1), either (1) the general partner must have a substantive equity investment at risk, or (2) a single limited partner (and its related parties and de facto agents) must be able to unilaterally exercise kick-out rights over the general partner or liquidation rights of the partnership. The determination of whether a general partners equity investment is substantive should be made after consideration of all of the relevant facts and circumstances. Generally, we believe there is a rebuttable presumption that a general partners equity investment is substantive if it is at least 1% or more of the partnerships assets (or alternatively the partnerships equity). Additionally, an investment of less than 1% may be substantive depending on the facts and circumstances. We believe that the use of the partnerships assets or equity in the denominator of this computation is an accounting policy election and should be applied consistently to all entities evaluated as potential VIEs. (Although the general partners interest may be substantive, the entity must have sufficient equity to absorb its expected losses, along with other conditions, in order for the entity not to be a VIE.)
In evaluating whether a general partners equity investment is substantive, generally we believe that the general partners other equity (but not debt) investments at risk should be considered. A general partners non-equity investments or equity investments that are not at risk should not be considered in making this determination. A party that is related to the general partner may make an equity investment in the partnership, and that investment may be attributed to the general partner in certain situations in determining whether the condition in ASC 810-10-15-14(b)(1) is met. The nature of the related party relationship should be evaluated based on the individual facts and circumstances to determine whether the related partys equity investment at risk should be attributed to the general partner. We believe that the substance of the entire arrangement even if different from the legal form should be considered in evaluating whether the general partner has a substantive equity investment at risk. For example, if a general and a limited partner are under common control or the general partner controls the limited partner, the limited partners equity investment may be attributed to the general partner in certain situations. However, if the limited partner and the general partner are not under common control, attribution of the limited partners investment to the general partner may not be appropriate. In addition, the Variable Interest Models anti-abuse provisions should be considered where applicable. The SEC staff has indicated that it shares this view, as highlighted in the speech below. Note that the references to FIN 46(R) in the following speech equate to the Variable Interest Model in the ASC. Also note that the discussion of the primary beneficiary determination in the excerpt below has been superseded by the current application of the Variable Interest Model. Refer to the Interpretative guidance and Questions to Chapter 14 for further discussion of the primary beneficiary determination.
Speech excerpts by Mark Mahar

2006 AICPA National Conference on Current SEC and PCAOB Developments We understand that certain general partner (GP)/limited partner (LP) arrangements have become common in which the partnership might be considered a VIE. These circumstances include a GP that makes no or only a non-substantive investment in the entity. Further the LPs have no kick-out rights, however, at least one of the LPs are related parties of the GP. When the GP considers its relationship with the entity in isolation, it comes to the conclusion that the entity is a VIE because the holders of the equity investment at risk as a group (that is, the LPs) do not have the ability to make decisions about the entitys activities that have a significant effect on its success. A subsequent primary beneficiary determination could conclude that the GP does not absorb greater than 50% of the expected gains and losses and therefore the GP does not consolidate the VIE. However, a view that analyzes the GP and the entity in isolation seems to be incomplete because of the relationships with certain of the LP investors. Depending on the significance of those relationships, I believe the GP and LPs may be so closely associated that it is most appropriate to consider their interests in the aggregate. This analysis depends heavily on the particular facts and circumstances, thus a degree of reasonable judgment is necessary. If the GP and LP are considered as a group, the FIN 46R analysis could yield different results. If the GP and certain LP equity interests are combined, then the entity, all other things being equal, would likely pass the paragraph 5(b)(1) test. That is, the equity holders as a group, inclusive of the GP rights, would have the ability to make decisions about the entitys activities that affect its success. The result would be the entity is not a VIE and the accounting consideration would revert to the voting interest model with the GP consolidating.
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Illustration 9-17: Example 1 Facts
Determining whether a general partners at-risk equity investment is substantive
A general partner and group of limited partners invest $1,000 and $1 million, respectively, to form a partnership. The partnership does not issue debt. The general partner may be removed only for cause, and there is no individual limited partner that possesses kick-out rights, as that term is defined in the ASC. Analysis The partnership is a VIE because the group of holders of the equity investment at risk lack the power, as the general partners investment ($1,000, or .1%) is not substantive, and there is no individual limited partner that can remove the general partner. Example 2 Facts Assume the same facts as Example 1, except the general partner also has a limited partnership interest of $100,000. Analysis The group of holders of the equity investment at risk has the power as the general partners aggregate equity investment is considered substantive. (The general partners aggregate at-risk equity investment is at least 1% of the partnerships assets, and there is no evidence to rebut the presumption that it is substantive.) Example 3 Facts Assume the same facts as Example 1, except the limited partnership issued debt of $100,000 to the general partner. Analysis The partnership is a VIE because the group of holders of the equity investment at risk lack the power, as the general partners equity investment at-risk is not substantive, and there is no individual limited partner that can remove the general partner. While the general partner has another investment in the partnership, because that investment is not at-risk equity (it is debt), it cannot be considered in determining whether the general partners equity investment is substantive.
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Consideration of kick-out rights and participating rights

Question 9(b)(1).7 How should an enterprise consider kick-out rights and participating rights when evaluating the provisions of ASC 810-10-15-14(b)(1)? When evaluating ASC 810-10-15-14(b)(1), kick-out rights21 and participating rights should not be considered in determining whether the at-risk equity investors lack the power to direct the activities of an entity that most significantly impact the entitys economic performance unless a single enterprise (including its related parties and de facto agents) has the unilateral ability to exercise those rights. For voting interest entities, kick-out rights and participating rights are considered in the circumstances in which those rights can be exercised by a simple majority of the equity holders (as opposed to one party) and are otherwise substantive. The FASB has acknowledged the inconsistency between the Variable Interest Model and the guidance for voting interest entities. In arriving at its conclusion, the FASB was concerned with potential structuring opportunities and ultimately reasoned that kick-out rights rarely are exercised in practice. Therefore, these rights should not be considered in determining whether an entity is a VIE and, if so, which enterprise, if any, is the primary beneficiary, unless held by one party. With respect to participating rights, the FASB affirmed that it believes that participating rights are substantively similar to kick-out rights and, thus, should be subject to the same restrictions as kick-out rights. That is, the FASB decided that the VIE determination should not be affected by participating rights unless a single party (including its related parties and de facto agents) has the unilateral ability to exercise such participating rights. While the Variable Interest Model defines kick-out rights, we believe that enterprises should consider the provisions of ASC 810-20 when evaluating whether kick-out rights held by a single enterprise are substantive. The following barriers to exercise may indicate that the kick-out rights held by a single enterprise are not substantive: Kick-out rights are subject to conditions that make it unlikely they will be exercisable (e.g., conditions that narrowly limit the timing of the exercise) Financial penalties or operational barriers associated with replacing the decision maker would act as a significant disincentive for removal The absence of an adequate number of qualified replacement decision makers or inadequate compensation to attract a qualified replacement The absence of an explicit, reasonable mechanism in the arrangement by which the party that possesses the kick-out rights can exercise them
Refer to the Interpretative guidance and Questions in Chapter 14 for additional guidance on kick-out and participating rights.
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Consistent with the guidance in ASC 810-20, we believe that, for the purpose of applying the provisions of Statement 167, kickout rights encompass liquidation rights. Refer to Question 14.22 for further discussion on liquidation rights. 154
Franchise arrangements
Question 9(b)(1).8 Franchise arrangements generally stipulate many specific business practices that the franchisee must follow. Do franchise agreements result in a violation of ASC 810-10-15-14(b)(1)? A typical franchise agreement has as its purpose the distribution of a product, service or establishment of an entire business concept within a particular market area. Both the franchisor and the investors in the franchise contribute resources for establishing and maintaining the franchise. The franchisors contribution may be a trademark, a company reputation, products, procedures, manpower, equipment or a process. The franchisees investors usually contribute operating capital as well as the managerial and other resources required to open and operate the franchise. The franchise agreement generally describes the specific marketing practices to be followed, specifies the contribution of each party to the operation of the business, and sets forth certain operating procedures that both parties agree to comply with. The franchise agreement may establish certain protocols relating to the management or operating policies of the franchises by, among other items: (1) specifying goods and services produced and sold by the franchise, (2) providing training of the franchises employees, (3) establishing standards for the appearance of the franchises place of business and (4) requiring that the franchises purchase raw materials or goods directly from the franchisor. Although many of these decisions are important to the success of the franchise, the fact that certain of these decisions may be stipulated by the franchisor does not necessarily result in the entity being a VIE. By entering into a franchise agreement, at-risk equity investors in a franchise have decided to operate the business in a specific location under a common trademark and system and comply with the franchisors business standards. A key consideration is whether the decisions stipulated through the franchise agreement are meant to protect the franchisors brand, or allow the franchisor to participate in ongoing substantive decision making relating to the franchises operations. The ability of the franchisor to enforce business standards that protect the value of its brand, and the value of other investors franchise entities, does not result in an entity being a VIE. To be considered a voting interest entity, the at-risk equity investor(s) in the franchisee, as a group, should have the power to direct the activities of the franchise that most significantly impact the franchises economic performance through voting or similar rights. The decisions must be substantive (i.e., decisions that may significantly affect the revenues, expenses, gains and losses or financial position of the entity) and not ministerial, in nature. In addition, the equity investors must have the ability to make whatever decisions are not pre-determined through the franchise agreement. These typically would include control over the day-to-day operations of the franchise, including, but not limited to, hiring, firing and supervising of management and employees, establishing what prices to charge for products or services and making capital decisions of the franchise. Also, control over such fundamental decisions as the form (corporate, LLC, LLP, partnership, etc.) of the franchise entity, its charter and how it is capitalized may be important to the success of the franchise. In some situations a franchisor may invest directly in the franchise through an equity position, loan or other means of subordinated financial support. In such cases, or if the franchise investors obligation to absorb expected losses or receive expected residual returns of the franchise is otherwise limited by the franchisor, holding the power to direct the activities of the franchise that most significantly impact the franchises economic performance becomes increasingly important to the franchisor because of the additional risk borne by the franchisor. Although the amount of equity investment as compared to expected losses may mitigate the franchisors risk, in some instances the franchisor will require the franchisee to provide the franchisor with the power to direct the activities of the franchise that most significantly impact the franchises economic performance. In those instances, the equity group would lack the characteristic in ASC 810-10-15-14(b)(1), and, as a result, the franchise would be considered a VIE. In other situations, the franchisor may require the franchisee to relinquish some, but not all, of its
power to direct the activities of the franchise that most significantly impact the franchises economic performance. Determining whether, as a group, the holders of a franchises equity investment at risk have the ability to make substantive decisions about the entitys activities will be based on the applicable facts and circumstances and will require the use of professional judgment. Additionally, the extent to which the franchisees at-risk equity investors absorb expected losses and receive expected residual returns of the entity should be considered in determining whether, as a group, such holders lack the ability to make decisions about its activities. The greater the amount of their at-risk equity investment as compared to the expected losses of the entity, the less likely it is that the investors would be willing to give up the ability to make decisions consistent with their interests or permit others to make decisions counter to their interests. It should be noted that Statement 167 nullified FSP FIN 46(R)3. FSP FIN 46(R)-3 provided Interpretative guidance on the application of ASC 810-10-15-14(b)(1), including its application to franchise arrangements. Under FSP FIN 46(R)-3, the rights of a franchisor in a franchise arrangement generally were considered protective rights. By including the rights of a franchisor as an example of a protective right in the amendments to the Variable Interest Model, the FASB believes that the same objectives are achieved. Therefore, the FASB does not expect or intend for the nullification of FSP FIN 46(R)-3 to result in a significant change in practice to franchisors evaluations of the criteria in ASC 810-10-15-14(b)(1).
Illustrative examples
Question 9(b)(1).9 Illustrative examples The following examples illustrate the application of the provisions of ASC 810-10-15-14(b)(1) that require the holders of the equity investment at risk, as a group, to have the power to direct the activities of an entity that most significantly impact the entitys economic performance through voting rights or similar rights: Illustration 9-18: Application of the provisions of ASC 810-10-15-14(b)(1) Example 1 Facts High-Tech Enterprises, Investor ABC and Investor XYZ form a joint venture. The venture is formed to acquire a division of High-Tech Enterprises. High-Tech Enterprises will retain a 40% equity ownership in the venture. The fair value of the divisions net assets and liabilities is $300 million. Investor ABC and Investor XYZ each contribute $90 million to the venture in exchange for equity interests. Investor XYZ can put its interest to High-Tech Enterprises for $90 million in Year 5. The corporate charter of the JV provides that decisions will be determined based on a voting majority. The votes are shared as follows:
Voting Allocation High-Tech Enterprises Investor ABC Investor XYZ 40% 30% 30%
Example 1.1 Facts Assume the same facts assumed in Example 1, except that Investor XYZ can vote only on decisions that are determined to be insignificant. Investor XYZs rights are consistent with protective rights as defined in the Variable Interest Model (see ASC Master Glossary or guidance in Chapter 14).
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Example 1.2 Facts Assume the same facts assumed in Example 1, except that Investor XYZ cannot put its investment to High-Tech Enterprises, but High-Tech Enterprises has the right to call Investor ABCs equity interest for $110 million in Year 5. Analysis
Question Do the holders of the equity investment at risk, as group, have the power to direct the activities of an entity that most significantly impact the entitys economic performance? Example 1 Example 1.1 Yes. In this scenario, Investor XYZ does not have participating rights in the entitys decision making. Unlike Example 1, Investor XYZ does not have the same voting rights as the other equity investors, and because those rights provide Investor XYZ with protective rights as defined in the Variable Interest Model (see ASC Master Glossary or guidance in Chapter 14), the holders of the equity investment at risk, as a group, have the power to direct the activities of an entity that most significantly impact the entitys economic performance. Example 1.2 Possibly. If the call option is determined to prevent Investor ABC from significantly participating in the profits of the entity, then Investor ABC would not be considered a holder of an equity investment at risk. In that case, the answer would be the same as in Example 1, except that it would be Investor ABC who would have participating rights in the entitys decision maker as an investor holding an interest other than an equity investment at risk. If the call option were determined not to keep Investor ABC from participating significantly in profits of the entity, then the holders of the equity investment at risk, as a group, would control the entity. It depends on whether Investor ABC participates significantly in the profits of the entity. Assuming that it does not, the entity is a VIE because Investor ABCs equity investment would not be considered to be at risk. However, if it were considered to participate significantly in the profits of the entity, then the entity has not violated the provisions of ASC 810-10-15-14(b)(1). No. Only High-Tech Enterprises and Investor ABC hold equity investments at risk. Investor XYZ does not significantly participate in the losses of the entity due to the put option, and, therefore, its equity investment is not considered to be at risk. High-Tech and Investor ABC cannot unilaterally make decisions about the entitys activities because Investor XYZ has 30% of the voting rights, and if the at-risk equity holders do not agree about an action, Investor XYZ is the tiebreaker, giving an investor other than the holder of an equity investment at risk significant participating rights in the entitys decision making. Has the design of the entity Yes. The entity is a VIE violated the provisions of because the holder of an ASC 810-10-15-14(b)(1)? interest (Investor XYZ) other than an equity investment at risk has the ability to participate in the activities of an entity that most significantly impact the entitys economic performance.
No. The entity has not violated the provisions of ASC 810-10-1514(b)(1) because the holders of the equity investment at risk, as a group (Investor ABC and High-Tech Enterprises), have the power to direct the activities of an entity that most significantly impact the entitys economic performance.
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Example 2 Facts Assume that a transferor transfers $80 of marketable debt securities and $20 of passive equity investments to a special purpose vehicle (SPV). The SPV funds the acquisition of the financial assets by issuing $40 of senior certificates to Company A, $40 of subordinate certificates to Company B, a $10 residual equity interest to Company C and a $10 residual equity interest to the transferor. The residual equity interests purchased by Company C and retained by the transferor are pari passu and are subordinate to the certificates issued to Company A and Company B. SPV has hired an unrelated investment manager (Asset Management, Inc.) to manage its activities. Under the arrangement, Asset Management, Inc. is paid a fee equal to 15% of the residual profits. The agreements specify that any one of the holders of the residual equity interests has the ability to remove Asset Management, Inc. for cause (which is defined as illegal acts, fraud, etc.). Example 2.1 Facts Assume the same facts assumed in Example 2, except that upon majority approval by the holders of the residual equity interests, Asset Management, Inc. can be removed at any time without cause. Example 2.2 Facts Assume the same facts assumed in Example 2.1, except that any one of the holders of the residual equity interests has the ability to remove Asset Management, Inc. at any time without cause. Analysis
Question Do the equity holders, as a group, have the power to direct the activities of an entity that most significantly impact the entitys economic performance? Example 2 No. We believe that the holders of the equity investment at risk do not have substantive kick-out rights providing the ability to remove the asset manager. As the asset manager is not a holder of an equity investment at risk, the equity holders, as a group, do not have the power to direct the activities of an entity that most significantly impact the entitys economic performance. Yes. Example 2.1 No. No party has the unilateral ability to exercise the kick-out rights as exercise can only occur with majority approval by the holders of the residual equity interests. As the asset manager is not a holder of an equity investment at risk, the equity holders, as a group, do not have the power to direct the activities of an entity that most significantly impact the entitys economic performance. Yes. Example 2.2 Yes. One of the holders of the residual equity has the ability to exercise the kick-out rights. Therefore, the equity holders, as a group, have the power to direct the activities of an entity that most significantly impact the entitys economic performance.
Has the design of the entity violated the provisions of ASC 81010-15-14(b)(1)?
No.
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Affordable housing projects

Question 9(b)(1).10 Are typical affordable housing projects VIEs? Many financial institutions and real estate enterprises have investments in affordable housing projects that are considered variable interests. Accordingly, these enterprises apply the provisions of the Variable Interest Model to reach consolidation conclusions. Summary of the tax credit The affordable housing tax credit is addressed in Section 42 of the Internal Revenue Code. The credit, created by the Tax Reform Act of 1986, expired 30 June 1992 and was subsequently reestablished indefinitely as part of the Omnibus Budget Reconciliation Act of 1993. The credit is allocated on a stateby-state basis for investments in qualifying affordable housing projects. The credit rate, which is set by the Internal Revenue Service, is generally in the range of 8-9% of the projects basis and is earned at such rate (or the credit allocated by the state, if lower) by the projects owner(s) for each of the first 10 years of operations. The project must continue to qualify as an affordable housing project for an additional five years (for a total of 15 years) or until recapture of a portion of the credit occurs. In order to obtain a credit allocation from the state, the project must be subject to an extended use agreement. The agreement requires that the project is dedicated to affordable housing for at least 30 years. However, foreclosure, at any time, or sale, with at least one year notice to the state on or after 14 years, is a permitted exception to the 30-year dedication requirement. Summary of the investment In order to facilitate an investment in these projects, the projects are usually established as limited partnerships that pass the tax benefits directly to the investors. A general partner builds or renovates the housing project, issues the partnership interests, maintains and operates the project. The general partner typically holds a very small percentage of the equity investment in the partnership (the general partnership interest can be as little as 0.01%), and the limited partners hold the remaining interests. In one common form of the arrangement, the investors acquire a direct limited partnership interest in each housing project. More complex arrangements may be used, which include the use of two or three tiers of limited partnerships. In this form, the investors contribute capital to the upper-tier partnership (Investment Partnership) as limited partners. The Investment Partnership, in turn, invests as a limited partner in one or more lower-tier partnerships (Operating Partnerships) that own housing projects. The general partner of the Investment Partnership may serve as a co-general partner in each Operating Partnership in order to exercise certain decision-making rights on behalf of the Investment Partnership. In a typical structure, the general partner cannot liquidate the partnership without the consent of the limited partners. Additionally, the limited partners may or may not have the ability to remove the general partner for reasons other than for cause. Limited partners often consist of individuals or entities that are able to utilize the tax benefits and, in most cases, derive no economic benefit from the investment other than the expected tax benefits. In other cases, in addition to the return on investment from the tax credits and tax benefits (which are obtained because the limited partners are allocated operating losses from the partnership that are deductible), the eventual disposition of the property is expected to provide a modest level of proceeds to the limited partners. The price paid to acquire an interest in the project is primarily a function of the estimated tax benefits to be earned. It is anticipated that the partnership will generate housing credits and tax losses, including depreciation and interest expense, over the life of the project, which will be allocated proportionately to the partners. In addition, most of these partnerships are designed to allocate any excess cash flow of the
partnership to the general partners, except for excess cash flow generated on the sale of the property. Cash flows from the sale of property, which are generally not expected to be significant, may be allocated partially to the limited partners. In summary, the limited partners receive their investment return through tax credits and tax benefits from allocated losses of the partnership and also may receive a modest level of proceeds from the eventual disposition of the property. The general partner (or in some cases, a related party of the general partner) may make certain guarantees to the limited partners, which could include: Construction guaranty the general partner guarantees that it will fund any amounts necessary to complete the projects construction if the partnership does not have sufficient funds to do so Guaranty against operating deficits the general partner guarantees that it will advance the partnership funds, typically structured as loans, to pay any operating deficits of the partnership for a period of years (commonly three to five years) Guaranty against reduction of credit amount the general partner guarantees that if the amount of the actual tax credits allocated to investors is less than the projected tax credits, the general partner will pay to the partnership for distribution to the limited partners an amount equal to the credit adjustment grossed up by any resulting tax liability of the limited partner
VIE considerations Amounts provided to an equity investor directly, or indirectly, through fees are not considered an equity investment (see Question 9(a).6 for additional discussion). Often the general partners investment is de minimus (it can be as low as 0.01%), and when the fees that the general partner earns are deducted from its contributed capital, the general partner typically will not be considered to have an equity investment at risk in the partnership. Even if the general partner has an equity investment at risk, that investment may not be considered substantive (see Question 9(b)(1).6). In the circumstances in which the general partner does not have an equity investment at risk (or substantive investment), the general partner is excluded from the group of equity holders in evaluating whether the equity holders as a group have power to direct the activities of an entity that most significantly affect the economic performance of the entity (e.g., sale of the property, financing decisions and day-to-day property operating decisions). Limited partners may have protective rights with respect to these significant activities but they usually do not have the unilateral ability to make decisions over such activities. Additionally, an individual limited partner may not have the ability to remove the general partner for reasons other than for cause. Because the general partner typically can make significant decisions and does not have an equity investment at risk (or substantive investment), the limited partners that hold the equity investment at risk do not have the power to direct the activities of an entity that most significantly affect the entitys economic performance. Accordingly, an affordable housing partnership with the terms described above will be a VIE. Furthermore, when the general partner is not considered to have an equity investment at risk but provides one or more of the guarantees described above, the partnership may be a VIE if the guarantee(s) protect the at-risk equity investors (i.e., the limited partners) from the first dollar risk of loss. Thus, the at-risk equity investors do not have the obligation to absorb the expected losses of the entity (see ASC 810-10-15-14(b)(2) and Question 9(b)(2).6 for additional discussion). The affordable housing partnership also should be evaluated pursuant to the anti-abuse test to determine if it is a VIE (see Section 9.5). In the circumstance where the limited partner has up to 99.99% of the affordable housing partnerships economics and no significant voting rights, it initially may appear that substantially all of the entitys activities are conducted on behalf of the limited partner (i.e., because it has up to a 99.99% investment in the partnership) resulting in the partnership being a VIE. However, we
do not believe the size of the investment alone is determinative in assessing whether substantially all of the entitys activities are conducted on behalf of the investor with disproportionately few voting rights. Instead, we believe the nature of the activities being performed by the entity also should be compared to the activities performed by the investor as part of its ongoing operations to make this determination. In this case, because the partnership is providing affordable housing, and in typical affordable housing partnerships, the limited partners generally are not engaged in that same activity, we do not believe that substantially all of the entitys activities are conducted on behalf of the limited partner. Conversely, if the limited partner is engaged in developing or providing housing, then its activities would be similar to that of the entity, and the entity generally would be considered a VIE pursuant to the Variable Interest Models anti-abuse clause. In evaluating whether the affordable housing partnership has sufficient equity in accordance with ASC 810-10-15-14(a), we believe that the tax benefits provided to the limited partners of an affordable housing partnership should be included in the evaluation of the partnerships expected losses and expected residual returns (see Question 10.14 for additional discussion). The accounting analysis discussed above is of a typical affordable housing partnership. The terms of each entity should be evaluated carefully against the Variable Interest Models VIE criteria before making that determination. Primary beneficiary considerations An enterprise with a variable interest in a VIE is required to consolidate that VIE if it has both power and benefits (see Chapter 14 for additional discussion). As discussed above, typically the general partner has the power to direct the most significant activities of the entity. The general partner typically also receives benefits from the development and operating fees it earns. Therefore, in these typical affordable housing partnerships, the general partner would be identified as the primary beneficiary. However, the terms of each entity should be evaluated carefully against the Variable Interest Models primary beneficiary provisions before making that determination. A structure may provide for a kick-out right that can be exercised unilaterally (without cause) by a single limited partner (inclusive of its related parties and de facto agents). In this case, the general partner would not be the primary beneficiary, and the limited partner should evaluate whether it is the primary beneficiary.
9.3
Interpretative guidance Obligation to absorb expected losses (ASC 810-10-15-14(b)(2))

To be considered a voting interest entity, the equity owners, as a group, must have the obligation to absorb the expected losses of the entity through the equity investments they hold. In addition, an entity is subject to the Variable Interest Model if the equity owners are directly or indirectly protected from expected losses by the entity itself or by other parties involved with the entity. We believe this means that, by design, the holders of the equity investment at risk cannot be shielded from the risk of loss on any portion of their investment by the entity itself, or by others that are involved with the entity. However, guarantees and other arrangements that protect lenders to, or other variable interest holders in, the entity after the holders of the equity investment at risk have suffered a total loss of their investment do not violate this condition. For example, assume a partnership issues $96 of debt and $4 of equity, and uses those proceeds to purchase a share of common stock. To protect the holders of the equity investment at risk against a decline in the value of the stock, the entity purchases a put option that gives it the ability to sell the stock to the counterparty for $100. In this case, the equity holders are not subject to risk of loss because all downside risk has been transferred to the put option writer, and thus, the entity is a VIE. In other words, the equity holders will never lose their investment unless the
counterparty fails to perform and there is insufficient collateral. If, however, the put options exercise price was set at $96, the equity holders, as a group, would absorb the first dollar risk of loss of the entity, and the put option would protect only the lenders after the holders of the equity investment at risk suffered a total loss of their investment. Because the holders of the equity investment at risk must bear the exposure to the first dollar risk of loss in the entity, we believe that by design, sharing exposure with non-equity holders or with instruments other than equity investments at risk (e.g., put options or guarantees held or written by a member of the at-risk equity group) is not permitted. Certain arrangements including total return swaps, which pay the total return (i.e., interest, dividends, fees and capital gains/losses) in exchange for floating rate interest payments, by design, may cause an entity to be a VIE. For example, assume an entity issues debt ($90) and common stock ($10), and that amount of equity is determined to be sufficient. The entity initially holds a fixed income instrument with a fair value of $100. Further assume the entity enters into a 90% total return swap with Investment Bank A, pursuant to which the entity will pay 90% of the total return of that fixed income instrument in exchange for a LIBOR-based return. In this situation, the holders of the equity investment at risk are protected from 90% of the assets losses. That is, as the fixed income instruments value declines by $1, the Investment Bank pays the entity $.90 and, in effect, shields the holders of the equity investment at risk from $.90 of the assets losses. Consequently, the equity investment, by design, does not absorb all of the first dollar risk of loss in the entity and, thus, the entity is a VIE. Guarantees on a portion of an entitys assets may be permitted. As discussed in the Interpretative guidance and Questions in Chapter 8, when a variable interest holder has a variable interest in a specific asset, and that asset is less than half of the total fair value of the entitys assets, that variable interest is not a variable interest in the entity. Additionally, guarantees of the values of assets in silos (see the Interpretative guidance and Questions in Chapter 7) are not variable interests in the entity as a whole, as silos are treated as separate entities when applying the Variable Interest Model. If it is not a variable interest in the entity, that variable interest should not be considered in evaluating whether the equity holders in the entity have the obligation to absorb expected losses. Because the holders of the equity investment at risk, as a group, must absorb the entitys expected losses, we believe a disproportionate allocation of losses among the equity owners through their equity interests would not violate this criterion as long as the holders of the equity investment at risk, as a group, are exposed to the first dollar risk of loss in the entity. For example, we believe that allocation formulae that distribute losses among the equity holders (through the equity instruments) generally are consistent with this requirement. However, in situations in which the allocation of profits and losses to the equity holders are disproportionate to their voting interests, the Variable Interest Models anti-abuse provisions (see the Interpretative guidance and Questions later in this Chapter) should be evaluated carefully.
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Do customary business arrangements violate ASC 810-10-15-14(b)(2)?

Question 9(b)(2).1 ASC 810-10-15-14(b)(2) requires that investors not be protected directly or indirectly from the expected losses of an entity. Entities commonly enter into normal and customary business arrangements to protect equity holders from the risk of loss (e.g., property and casualty insurance, hedging arrangements, etc.). Do these arrangements result in an entity becoming a VIE? The criterion in ASC 810-10-15-14(b)(2) is meant to identify structures that, by design, protect the equity investors from losses arising from the primary economic risks of the entity. The criterion is designed to identify structures in which the equity interests lack economic substance. While certain normal and customary business arrangements, such as obtaining property and casualty insurance and business interruption insurance, among others, protect the equity holders from risk of loss, we believe they do not result in the entity, by design, being a VIE. A structures terms should be evaluated carefully to ensure protection from first dollar risk of loss is not afforded to the holders of the equity investment at risk. Any derivative contract that serves to transfer all or substantially all of the entitys variability to the counterparty is generally not a normal and customary hedging arrangement.
Common arrangements that may violate ASC 810-10-15-14(b)(2)

Question 9(b)(2).2 What are some common examples of arrangements that may protect holders of the equity investment at risk from first dollar risk of loss? The following arrangements generally would result in protection from first dollar risk of loss and the entity being a VIE: A variable interest holder who reimburses the entity or the holders of the entitys equity investment at risk for losses or has made arrangements for another party to do so (e.g., a guarantee of certain of an entitys receivables that, by design, protects the equity holders). The allocation of the entitys cash flows effectively removes the risk of loss from the holders of the entitys equity investment at risk. A variable interest holder provides credit enhancements for assets of the entity, guarantees its debt or has arranged for another party to do so. (Guarantees and other arrangements that protect lenders to the entity after the holders of the equity investment at risk have suffered a total loss of their investment do not prsevent the equity holders from absorbing first dollar risk of loss but may raise a question as to the sufficiency of the equity as discussed earlier in this chapter.) A variable interest holder guarantees residual values of assets comprising more than half of the fair value of the entitys total assets or agrees to future purchases of such assets at predetermined prices that protect the equity holders from risk of loss or has made arrangements for another party to do so. Contractual arrangements for a purchaser to acquire the majority of an entitys goods or services at a price based on the actual costs incurred to produce the good or service plus a specified margin (a cost-plus arrangement). That is, if the cost to acquire the goods or services could be in excess of their fair values, the acquirer may be providing a form of subordinated financial support, which may result in the entity being a VIE. The terms of the cost-plus arrangement should be evaluated carefully to determine whether it protects holders of the equity investment from first dollar risk of loss.
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Disproportionate sharing of losses

Question 9(b)(2).3 May the holders of an entitys equity investment at risk agree to share losses through their equity instruments in a manner that is disproportionate to their respective ownership percentages without violating ASC 810-10-15-14(b)(2)? Yes. Because the criterion of ASC 810-10-15-14(b)(2) is applied to the holders of the entitys equity investment at risk as a group, the holders of the equity interests may agree to share losses in a manner that is disproportionate to their respective ownership interests in the entity without the entitys being a VIE. Allocation formulae that distribute losses among the equity holders also generally are consistent with this requirement. Illustration 9-19: Facts A general partner manages the activities of a limited partnership while the limited partners contribute capital and share in the profits but take no part in running the business. The general partner is liable for partnership debts while the limited partners incur no liability with respect to partnership obligations beyond their capital contributions. Analysis While the limited partners participate in the expected losses of the entity disproportionally with the general partner, since the criterion in ASC 810-10-15-14(b)(2) is to be applied to the equity holders as a class, this criterion is not violated. Additionally, it should be noted that it is not a requirement for an equity holder to absorb losses beyond its initial contribution for an entity not to be a VIE under the Variable Interest Model. Although ASC 810-10-15-14 (b)(2) is applied to the holders of the entitys at-risk equity investment as a group, arrangements should be carefully evaluated to ensure that each investors equity interest participates significantly in the losses of the entity to be considered an equity investment at risk. Additionally, the Variable Interest Models anti-abuse provisions (see Interpretative guidance and Questions relating to ASC 810-10-15-14(c)) should be carefully evaluated any time the obligation of a variable interest holder to absorb losses is disproportionate to its voting interests. If an at-risk equity holder agrees to protect other equity holders from the risk of loss through an instrument other than an equity instrument, ASC 810-10-15-14(b)(2) is violated and the entity is a VIE (see Question 9(b)(2).4). Disproportionate sharing of losses
Absorption of expected losses by an equity holder through other than an equity investment
Question 9(b)(2).4 Is an entity a VIE if certain equity holders are protected from risk of loss by instruments other than equity instruments held or issued by other equity holders? Yes. The obligation of variable interests other than equity interests to absorb expected losses of an entity may not be considered in determining if the entitys at-risk equity holders have the obligation to absorb the entitys expected losses, even if the other variable interests are held or issued by an equity investor.
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Absorption of expected losses by an equity holder through other than an equity investment
A partnership is formed by three investors: A, B, and C. Each partner funds $1 million into the partnership for an equal partnership interest (all considered at risk). The partnership uses the funds to acquire an office building for $1.8 million. Additionally, Investor A agrees to guarantee that the value of the building will be at least $1.8 million if sold during the 10 years following its purchase by the partnership, in exchange for a premium of $200,000. The partnership agreement requires that the partnership liquidate no later than the tenth anniversary of its formation. Analysis In this example, an equity holder is obligated to absorb any expected losses of the partnership upon the disposal of the building for less than $1.8 million because of the guarantee. However, because the obligation to absorb expected losses is embodied in an instrument other than an at-risk equity instrument, the partnership is a VIE.
May other variable interest holders be shielded from risk of loss?

Question 9(b)(2).5 Would the requirements in ASC 810-10-15-14(b)(2) be met if other variable interest holders in an entity are shielded from loss by guarantees and other arrangements that do not protect the holders of the entitys equity investment at risk? Yes. The holders of an entitys equity investment at risk, as a group, cannot be shielded from the risk of loss on any portion of their investment by the entity itself or others that are involved with the entity. However, guarantees and other arrangements that protect lenders to, or other variable interest holders in, the entity after the holders of the equity investment at risk have suffered a total loss of their investment do not violate this condition. Illustration 9-21: Facts An LLC issues $190 of debt and $10 of equity. Using the proceeds from these issuances, it acquires an asset for $200 and leases it to a third party under a ten year lease. The debt matures in 10 years and does not amortize prior to maturity (i.e., it has a bullet maturity at the end of 10 years). The lender has recourse only to the leased asset and does not have recourse to the general credit of the LLC. The lessee has guaranteed that the residual value of the asset will be at least $200 at the end of the lease term. Analysis In this case, the LLC is a VIE because the residual value guarantee provided by the lessee protects both the equity holders and the lender from risk of loss associated with potential decreases in the value of the leased asset. If, however, the lessee guarantees that the residual value of the asset will be at least $190 at the end of the lease term, the equity holders, as a group, would absorb the first dollar risk of loss of the entity, and the residual value guarantee would protect the lender only after the at-risk equity holders suffered a total loss of their investment. Other variable interest holders shielded from risk of loss
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Sharing first dollar risk of loss

Question 9(b)(2).6 May holders of an entitys equity investment at risk share the first dollar risk of loss with other variable interest holders in the entity without the entity becoming a VIE? No. Because the holders of the equity investments at risk must bear the exposure to the first dollar risk of loss in the entity, sharing that exposure with non-equity holders is not permitted. Certain arrangements, including total return swaps, which pay the total return (i.e., interest, dividends, fees and capital gains/losses) in exchange for floating rate interest payments, by design, may cause an entity to be a VIE. Illustration 9-22: Facts Assume an entity issues debt ($90) and common stock ($10). The equity is determined to be at risk and sufficient to absorb the entitys expected losses. The entity initially holds a fixed income instrument with a fair value of $100. The entity enters into a 90% total return swap with Investment Bank A, pursuant to which the entity will pay 90% of the total return of that fixed income instrument in exchange for a LIBOR-based return. Analysis In this situation, the holders of the equity investment at risk are protected from 90% of the assets losses. That is, as the fixed income instruments value declines by $1, the Investment Bank pays the entity $.90 and, in effect, shields the at-risk equity holder from $.90 of the assets first dollar of loss. Consequently, the equity investment, by design, does not absorb all of the first dollar risk of loss in the entity, and thus, the entity is a VIE. Sharing first dollar risk of loss
Variable interests in specified assets

Question 9(b)(2).7 May a variable interest in specified assets of an entity protect the holders of the entitys equity investment at risk from losses without causing the entity to become a VIE? Guarantees on a portion of an entitys assets may not automatically result in an entitys becoming a VIE. As discussed in the Interpretative guidance and Questions in Chapter 8, when a variable interest holder has a variable interest in a specified asset, and that asset is less than half of the total fair value of the entitys assets, that variable interest is not a variable interest in the entity. Additionally, variable interests in silos of a host entity are not variable interests in the host entity (see the Interpretative guidance and Questions in Chapter 7). If it is not a variable interest in the entity, that variable interest should not be considered in evaluating whether the entitys at-risk equity holders have the obligation to absorb expected losses. Illustration 9-23: Facts A joint venture LLC is formed to acquire and operate two office buildings and to sell the buildings at the end of five years. The LLC issues debt of $90 million and equity of $10 million. Two buildings are acquired, one for $60 million and one for $40 million (Building One and Building Two, respectively). The two buildings are leased to separate third party tenants. The tenant of Building Two provides a guarantee that the value of the building will be at least $40 million at the end of five years. Interests in specified assets
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Analysis Although the guarantee may shield the holders of the equity investment at risk from risk of loss relating to Building Two, because the fair value of the building is less than half of the total fair value of the entitys assets, the residual value guarantee is not considered a variable interest in the entity. As such, expected losses of Building Two absorbed by the tenant are not considered in evaluating whether the equity holders as a group have the obligation to absorb losses. Accordingly, ASC 810-10-15-14(b)(2) is not violated. However, if the guarantee were for $60 million on Building One instead of Building Two, then the guarantee would be a variable interest in the entity because Building One comprises more than onehalf of the fair value of the entitys assets. The tenant of Building One would have a variable interest in the entity. Because that variable interest would protect the equity holders from risk of loss, the entity would be a VIE. We believe the variability created by each building, as well as the overall design and purpose of the structure, should be evaluated in determining whether the entity is a VIE.
Question 9(b)(2).8 Illustrative examples The following illustrates the evaluation of whether the holders of an entitys equity investment at risk, as a group, are protected directly or indirectly from expected losses or are guaranteed a return by the entity itself or by other parties involved with the entity (other than an equity holder): Illustration 9-24: Example 1 Facts Lessor XYZ operates a building to be leased by Company ABC. The building is financed with 80% debt ($400 million), with all of the principal due at maturity, and 20% equity ($100 million). The lease term is 10 years. The equity holders are not constrained from selling their interest in Lessor XYZ, make all decisions about the operations of the building and may at any time expand the building and lease space to other lessees. Lessor XYZ has the right to put the building to Company ABC at the end of 10 years for 90% of the buildings fair value at inception or $450 million. Analysis In this example, the put option limits the losses that will be absorbed by the equity holders resulting from decreases in the fair value of the building to $50 million, or from $500 million to $450 million. Because the holders of the entitys equity investment at risk are protected from risk of loss of their investment through the existence of the put option, the entity is a VIE. Obligation to absorb expected losses
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Example 2 Facts Assume the same facts as in Example 1, except that the put option does not exist. Instead, Company ABC guarantees that at the end of 10 years, the building will be worth at least 10% of its fair value at inception, or $50 million. Analysis In this example, the guarantee does not protect the equity investors from risk of loss but rather prevents the lenders from losing more than $350 million if Lessor XYZ defaults on the loan and the building is worth less than $50 million upon foreclosure. If Company ABC is called upon to perform pursuant to the guarantee, the value of the building will have decreased by at least $450 million, and the equity investors will have suffered a complete loss of their investment. Accordingly, the provisions of ASC 810-10-15-14(b)(2) are not violated. Example 3 Facts Assume the same facts as in Example 2, except that instead of guaranteeing the value of the building, Company ABC writes an option giving the debt holders the ability to put the building to it for $250 million at the end of 10 years if the debt holders foreclose on the building. Analysis Similar to Example 2, the put option provided by Company ABC provides protection only to the lenders. The fixed price put option provided to the debt holders would be effective only when the equity investment at risk has been eliminated. As the holder of the entitys equity investment at risk absorbs 100% of the first dollar of expected losses, the provisions of ASC 810-10-15-14(b)(2) are not violated. Example 4 Facts Fortune 500 Company owns and operates ten crude oil refineries in the United States and has been operating in the crude oil refining and marketing business since it first went public in 1956. To manage certain of its business risks, Fortune 500 Company purchases business interruption insurance, and property and casualty insurance, and locks in the difference between the cost of crude and the sales price of refined products on 60% of its future expected processing runs using total return swaps and other derivative financial instruments. Analysis In this example, Fortune 500 Company is not a VIE simply because of the existence of risk management programs. The criterion in ASC 810-10-15-14(b)(2) is meant to identify entities that, by design, protect the holders of the entitys equity investment at risk from losses arising from the primary economic risks of the entity. While certain normal and customary business practices, such as the acquisition of insurance or hedging activities, protect the equity holders from risk of loss, they do not result in the entitys being a VIE. Judgment is required to determine whether, by design, the holders of the equity investment at risk are protected from first dollar risk of loss.
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9.4
Interpretative guidance Right to receive expected residual returns (ASC 810-10-15-14(b)(3))

The Variable Interest Model requires the equity holders, as a group, to have the right to receive the entitys expected residual returns. The equity investors, as a group, cannot have their return capped through arrangements with the entity, through the rights provided through variable interests other than equity interests (even if those rights are held by equity holders) or by the entitys governing documents. We believe that, for example, an entity that writes a call option on an asset that, by design, explicitly caps the return of the equity holders is a VIE. We believe one result of this provision is that a lessor entity that, by design, has a single asset that is leased under an operating lease with a fixed price purchase option will be a VIE. For example, assume an entity has a building ($100) that was financed with debt ($90) and equity ($10). The building is leased to Company Y in an operating lease. At the lease termination date, Company Y has an option to buy the building for a fixed price, for example $100. In this case, if the building were to have a value higher than $100 at the lease termination, the lessee would exercise the option and directly cap the equity investors return. Because the equity investors rights to receive the expected residual returns are capped, we believe the entity is a VIE. Judgment will be required in determining whether, by design, a call option caps the returns of the holders of the equity investment at risk. Because ASC 810-10-15-14(b)(3) requires that, as a group, the holders of the equity investment at risk must have the right to receive the expected residual returns of the entity, we believe that profit sharing arrangements among the holders of the equity investment at risk through rights and obligations embodied in the equity interests would not violate this criterion. For example, assume a joint venture is created by Strategic Co. (25% of equity) and Financial Co. (75% of equity). The joint venture agreement states that profits are to be allocated based on each partys relative ownership until Financial Co. achieves an internal rate of return of 15% on its investment, at which point profits are then to be distributed to Strategic Co. and Financial Co. at a rate of 75% and 25%, respectively. While this profit distribution may indirectly cap Financial Co.s return, we believe ASC 810-10-15-14(b)(3) would not be violated because the holders of the equity investment at risk, as a group, receive the expected residual returns of the entity. In situations in which the allocation of profits and losses to the equity holders are disproportionate to their voting interests, however, the Variable Interest Models anti-abuse provisions (see the Interpretative guidance Questions later in this Chapter) should be evaluated carefully.
Examples of situations that violate the conditions of ASC 810-10-15-14(b)(3)

Question 9(b)(3).1 What are examples of situations that would cap the returns to the equity holders and thus result in an entity becoming a VIE? Examples of arrangements that would cause an entity not to meet the condition in ASC 810-10-15-14(b)(3) include: A fixed price call option on assets in an entity that, by design, caps the returns of the holders of the equity investment at risk (e.g., held by a lessee in an operating lease in an entity that holds only the asset under lease). In that circumstance, the equity holders return is explicitly capped. However, if that call option is on an asset whose fair value is less than half of the total fair value of the entitys assets, the expected residual returns attributable to that interest should not be considered in this analysis. See Question 9(b)(3).5 for more details. Judgment will be required in determining whether, by design, the call option caps the returns of the holders of the equity investment at risk.
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Predetermined distribution arrangements that limit the residual returns of the entity inuring to the equity holders to either a nominal portion of the entitys net cash flows or an amount that lacks significant variability. Illustration 9-25: Example 1 Facts Lessor XYZ operates a building to be leased by Company ABC. The building was financed with 80% debt ($400 million) and 20% equity ($100 million). The lease term is 10 years. At the end of Year 10, the lessee has an option to buy the building for a fixed price (assume $500 million). The equity holder is not constrained from selling its interest in Lessor XYZ, makes all decisions about the operations of the building and may at any time expand the building and lease space to other lessees. Analysis In this example, the entity is a VIE because the fixed price purchase option caps the expected residual returns of the at-risk equity holders. Example 2 Facts Fortune 500 Company owns and operates ten crude oil refineries in the United States and has been operating in the crude oil refining and marketing business since it first went public in 1956. Fortune 500 Company also has a profit sharing plan that provides its employees with up to 10% of its annual operating profit. Analysis In this example, the provisions of ASC 810-10-15-14(b)(3) are not violated simply because of the existence of the employee profit sharing plan. Sharing of an entitys profits with parties other than holders of the equity investment at risk is permitted as long as that sharing does not cap the at-risk equity holders returns. Judgment is required to determine whether, by design, the at-risk equity holders returns are capped. Example 3 Facts A transferor transfers $80 of marketable debt securities and $20 of passive equity investments to a special purpose vehicle (SPV). SPV funds the acquisition of the financial assets by issuing $40 of senior certificates to Company A, $40 of subordinate certificates to Company B, a $10 residual equity interest to Company C and a $10 residual equity interest to the transferor. Both the residual equity interests purchased by Company C and retained by the transferor are pari passu and subordinate to the certificates issued to Company A and Company B. SPV hires C Management Fund (CMF) to be the asset manager. The asset management agreement provides CMF with the ability to buy and sell securities for profit and stipulates that CMF will receive a fixed fee of $5,000 per month, plus any residual profits after the residual equity interest holders receive a 15% IRR. Analysis In this example, the return to the at-risk equity holders is capped at a 15% IRR. Because the return to the residual equity interest holders is capped, the SPV is a VIE. Right to receive expected residual returns
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Equity holder receives expected residual returns through other than an equity interest
Question 9(b)(3).2 Would the provisions of ASC 810-10-15-14(b)(3) be violated if the right to receive an entitys expected residual returns is provided to an equity holder through an instrument other than an equity interest? The right to receive expected residual returns embodied in a variable interest other than an equity interest held by an at-risk equity holder may not be considered when determining whether the entitys atrisk equity holders have the right to receive the entitys expected residual returns. Illustration 9-26: Facts A partnership is formed by three investors: A, B and C. Each partner funds $1 million into the partnership in exchange for a 33% ownership interest. The partnership uses the funds to acquire an office building for $3 million. Additionally, the partnership writes a call option allowing Investor A to purchase the office building from the partnership for $3.5 million upon the fifth anniversary of the partnerships formation. Analysis In this example, the expected residual returns associated with the building will inure to the at-risk equity holders. However, because the call option caps the return provided to the equity holders through their equity interests, the provisions of ASC 810-10-15-14(b)(3) are violated, and the partnership is a VIE (even though the call option merely reallocates the partnerships returns between the partners). Equity holder receives expected residual returns through other than an equity interest
Participation of other variable interest holders in expected residual returns

Question 9(b)(3).3 Does ASC 810-10-15-14(b)(3) require the holders of an entitys equity investment at risk to receive all of the entitys expected residual returns? May other variable interest holders share in the expected residual returns of an entity and the entity still not be a VIE? The equity holders may share a portion of the residual returns of an entity with other variable interest holders provided that the sharing arrangement does not explicitly or implicitly cap the returns that inure to the equity holders, as a group. Illustration 9-27: Facts Four companies form a partnership for the purpose of investing in commercial real estate. Each company holds a 25% interest in the partnership, and each equity investment is deemed to be at risk. The partnership acquires a newly constructed office building, partially financing the acquisition with debt from a senior secured lender. The partnership engages the developer of the office building to act as the property manager. In this role, the developer will make decisions regarding the selection of tenants, negotiation of lease terms, setting of rental rates, capital expenditures and repairs and maintenance, among other things. The developer will receive a fee of $250,000 per annum for acting as the property manager. In addition, the partners agree that the developer will receive 50% of all returns of the partnership once an IRR of 15% has been achieved.
Participation of other variable interest holders in expected residual returns
Analysis In this example, the returns to the holders of the entitys equity investment at risk are not capped, because they will continue to receive one-half of all amounts exceeding a 15% IRR. Accordingly, the provisions of ASC 810-10-15-14(b)(3) are not violated.
Disproportionate sharing of profits

Question 9(b)(3).4 May the equity holders of an entity agree to share residual returns of an entity through their equity interests in a manner that is disproportionate to their respective ownership percentages without violating ASC 810-10-15-14(b)(3)? Yes. Because the criterion is applied to the holders of the entitys equity investment at risk, as a group, the holders may agree to share profits through their equity interests in a manner that is disproportionate to their respective ownership interests in the entity without the entitys being a VIE. Allocation formulae that distribute profits among the equity holders are generally consistent with this requirement. Illustration 9-28: Facts Two oil and gas exploration companies, Oilco and Gasco, form a limited partnership and contribute certain unproven and proven producing oil and gas properties in exchange for equal partnership interests. The partners agree that, in exchange for acting as the general partner, Oilco will receive all profits until a cumulative 10% IRR is achieved. Gasco will then receive all profits until a cumulative 20% IRR is achieved. All profits in excess of a cumulative 20% IRR are then allocated to Oilco. Analysis While this profit distribution caps Gascos return, Oilcos return is not capped. Because the holders of the equity investment at risk, as a group, receive the expected residual returns of the entity, the provisions of ASC 810-10-15-14(b)(3) are not violated. Although this criterion is to be applied to the holders of the entitys at-risk equity investment, as a group, profit sharing arrangements should be evaluated carefully to ensure that each investors equity interest participates significantly in the profits of the entity (as discussed in the Interpretative guidance to ASC 810-10-15-14(a) above). Additionally, the Variable Interest Models anti-abuse provisions (see Interpretative guidance and Questions relating to ASC 810-10-15-14(c)) should be evaluated carefully any time the rights of a variable interest holder to receive the entitys expected residual returns are disproportionate to its voting interests. Disproportionate sharing of profits
Variable interests in specified assets

Question 9(b)(3).5 Does a cap on the return of any asset in an entity automatically result in the entitys being a VIE? No. As discussed in the Interpretative guidance and Questions in Chapter 8, when a variable interest holder has a variable interest in a specific asset, and that asset is less than half of the total fair value of the entitys assets, that variable interest is not a variable interest in the entity. Additionally, variable interests in silos of a host entity are not variable interests in the host entity (see the Interpretative guidance and Questions in Chapter 7). If a variable interest is not deemed to be a variable interest in the entity, it should not be considered in evaluating whether the equity holders have the right to receive the entitys expected residual returns.
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Even if a cap on the return of an asset is considered to be a variable interest in the entity as a whole, judgment should be applied based on the facts and circumstances to determine whether the cap, by design, caps the returns of the group of at-risk equity investors. Illustration 9-29: Facts An LLC is formed and issues debt of $90 million and equity of $10 million. The LLC acquires Building One for $60 million and Building Two for $40 million. Each building is leased to separate third party tenants. The lease terms for Building Two allow the tenant to purchase the building for $40 million at the end of five years. Analysis Although the fixed price purchase option caps the returns to the equity holders for Building Two, because the fair value of the building is less than half of the total fair value of the entitys assets, the purchase option is not considered a variable interest in the entity and the expected residual returns allocable to it should not be considered in evaluating whether the return to the equity holders as a group is capped. Conversely, if the lease terms for Building One allowed the tenant to purchase that building at the end of five years for $60 million, the purchase option would give the tenant a variable interest in the entity because Building One comprises more than one-half of the total fair value of the entitys assets. Because the purchase option would cap the returns inuring to the equity holders from Building One, further analysis would be required to determine whether, by design, the equity investors returns are capped. We believe the variability created by each building, as well as the overall design and purpose of the structure, should be evaluated in determining whether the entity is a VIE. Interests in specified assets
Impact of call options on an entitys assets or its equity

Question 9(b)(3).6 How should ASC 810-10-15-14(b)(3) be applied when an entity or its equity holders write call options on the entitys assets or equity? ASC 810-10-15-14(b)(3) states that if, by design, the rights of the holders of the equity investment at risk to receive the entitys expected residual returns are capped, the entity is a VIE. We believe the term cap means that the holders of the equity investment at risk have no right to receive or participate in the entitys expected residual returns above a certain point. We believe there is a distinction between capping and reducing or diluting the entitys expected residual returns. Provisions that limit the returns to the entitys at-risk equity holders should be evaluated to determine whether they are, in essence, a cap. ASC 810-10-15-14(b)(3) indicates that convertible stock or stock options do not cap the returns of the equity holders because, upon conversion, the instrument holders would be equity holders. This could be read to indicate that call options written on the entitys stock do not, by design, cap the group of equity holders returns because the option holder would, upon exercise of the option, become an equity holder. Pursuant to that reading, an entity would not be determined to be a VIE in a structure in which a third party has a fixed price call option on all of the entitys outstanding voting securities because the option holder would become an equity holder if the option were to be exercised. We believe that the instruments cited in ASC 810-10-15-14(b)(3) dilute, rather than cap, the expected residual returns of the group of the at-risk equity investors. As such, we do not believe that those instruments, in and of themselves, would result in an entity being classified as a VIE. However, we believe the terms of call options on the entitys stock or its assets should be evaluated carefully because they may, by design, cap the at-risk equity investors returns, as illustrated in the examples to this Question.
We believe the provisions of ASC 810-10-15-14(b) should also be considered in determining whether the group of the at-risk equity investors have the necessary characteristics of a controlling financial interest. ASC 810-10-15-14(b) indicates that if interests other than the equity investment at risk prevent the equity holders from having the characteristics in ASC 810-10-15-14(b), the entity is a VIE. We believe a determination also should be made about whether the call options are part of the entitys design. We do not believe the Variable Interest Model requires each of an entitys variable interest holders to perform an exhaustive analysis to determine all of the other holders rights and obligations. Instead, we believe an interest holder should assess whether the call option is a key element of the overall structure and design of the entity of which the holders are aware (or should be through the transaction documents themselves or inquiry). Illustration 9-30: Effect of call options on an entitys assets or its equity
Example 1 Call option to acquire 100% of entitys assets Facts Assume an entity owns Asset 1 and Asset 2, which have fair values of $51 and $49, respectively. The entity has equity of $100, contributed by a limited number of stockholders. The entity has written a call option to an unrelated party to acquire both assets for $110 at a future date. Analysis We believe the entity is a VIE because the expected residual returns to the holders of the equity investment at risk are capped through the call option on all of the entitys assets. Further, the entity is a VIE because the call option (i.e., an instrument other than the equity investment at risk) prevents the holders of the equity investment from having the characteristics of a controlling financial interest. Example 2 Call option to acquire 100% of entitys outstanding stock Facts Same facts as Example 1, but the stockholders, by design, have written a call option to an unrelated party to acquire 100% of the entitys outstanding voting stock for $110 at a future date. Analysis We believe the entity is a VIE. The substance of Example 1 and Example 2 are identical. In each case, the returns of the current group of the holders of the at-risk equity investment are capped. For the entity to be a voting interest entity, no interests can prevent the equity holders from having the necessary characteristics described in ASC 810-10-15-14(b). The call option is a separate instrument that caps the returns of the current group of equity holders. Thus, the entity is a VIE. Example 3 Call option to acquire a percentage of entitys assets Facts Same facts as Example 1, but the entity has written a call option to an unrelated party to acquire Asset 1 (51% of the entitys assets) for $55 at a future date.
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Analysis We believe the classification of the entity as a VIE is dependent on the facts and circumstances. Although the entity has written an option to buy a majority of the entitys assets at a fixed price, the stockholders returns are not capped as they continue to have a right to the entitys residual rewards on its remaining assets (49% of the total). By design, the equity holders returns are not capped. Rather, the equity holders have diluted their interest in the entitys returns and limited their upside but have not capped their returns. Indeed, they participate fully in the returns on 49% of the assets, which could be significantly more volatile than the majority of its assets. We believe the variability of the respective assets should be determined and compared, and then the design and purpose for which the entity was created should be evaluated, to determine whether the call option on the majority of the entitys assets results in the entitys classification as a VIE pursuant to ASC 810-10-15-14(b).
9.5
Interpretative guidance Anti-abuse clause (when the economics do not follow the votes) (ASC 810-10-15-14(c))
To prevent an entity from avoiding consolidation of a VIE by structuring it with non-substantive voting rights, the Variable Interest Model provides that an entity is a VIE when (1) the voting rights of some investors are not proportional to their obligations to absorb the expected losses of the entity, their rights to receive the expected residual returns of the entity, or both and (2) substantially all of the entitys activities (e.g., providing financing or buying assets) either involve or are conducted on behalf of an investor (including the investors related parties (as defined in ASC 810-10-25-43), except its de facto agents under ASC 810-10-25-43(d)) that has disproportionately few voting rights (which could be indicated in some circumstances by disproportional representation on the board of directors). The intent of this provision is to prevent an equity interest from being analyzed under the voting interests model in those instances in which the features of the entitys structure, or the contractual arrangements among the entitys investors, indicate the voting arrangements are not useful in identifying who truly controls the entity. To illustrate how this provision should be applied, assume Company A, a manufacturer, and Company B, a financier, establish a joint venture. The joint venture agreement states that the venture may purchase only Company As products. Company As and Company Bs economic interests are 70% and 30%, respectively. Further assume that Company B has 51% of the outstanding voting rights. In this case, we believe that the entity is a VIE because substantially all of the entitys activities (i.e., buying Company As products) are conducted on behalf of Company A, which has disproportionately few voting rights as compared with its economic interest. The Variable Interest Model does not provide guidance to determine what constitutes substantially all of an entitys activities. We believe this determination will be based on the individual facts and circumstances and will require the use of professional judgment. We do not believe that the holders of the equity interests of an entity that meets the criterion of ASC 81010-15-14(c) should be presumed to have non-substantive voting rights. As such, determining the primary beneficiary of an entity that is a VIE pursuant to ASC 810-10-15-14(c) will require a careful examination of the facts and circumstances. In particular, the provisions of ASC 810-10-25-38G addressing situations in which a reporting entitys economic interest in a VIE, including its obligation to absorb losses or its right to receive benefits, is disproportionately greater than its stated power to direct the activities of a VIE should be carefully considered. Additionally, the provisions of ASC 810-10-15-13A and 15-13B addressing substantive terms, transactions and arrangements should be considered carefully.
Under the Variable Interest Model prior to Statement 167s amendments, the primary beneficiary of an entity that was a VIE as a result of ASC 810-10-15-14(c)s provisions was often the party with disproportionally few voting rights. This outcome was due to the previous Variable Interest Models quantitative approach for assessing which party was the primary beneficiary. Subsequent to the amendments, the primary beneficiary of a VIE is the party that has (1) the power to direct activities of a VIE that most significantly impact the entitys economic performance and (2) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE. Therefore, the party with disproportionally few voting rights may or may not be the primary beneficiary.
Evaluating the substantially all requirement

Question 9(c).1 In part (2) of ASC 810-10-15-14(c) (the anti-abuse clause), which factors should be considered to determine whether substantially all of a potential VIEs activities involve or are conducted on behalf of an investor (including the investors related parties, except its de facto agents under ASC 810-2543(d)) with disproportionately few voting rights? The assessment of whether substantially all of the entitys activities either involve or are conducted on behalf of an investor (including the investors related parties, except its de facto agents under ASC 81010-25-43(d)) will be a judgmental determination, based on a qualitative assessment of the applicable facts and circumstances. Although the amount of the entitys economics attributable to the investor with the disproportionately few voting rights is a factor that should be considered, applicability of the antiabuse clause is not based primarily on a quantitative analysis. We believe the activities of the potential VIE should be compared with those of the variable interest holders in the entity. The nature of the entitys activities, the nature of each variable interest holders activities exclusive of their investment in the entity, the rights and obligations of each variable interest holder and the role that each variable interest holder has in the entitys operations, among other pertinent factors, should be considered. If the activities of the entity involve or are conducted on behalf of the investor that holds the disproportionately few voting rights (or the investors related parties, except its de facto agents under ASC 810-10-25-43(d)), then the entity is a VIE. Factors that should be considered in determining whether the activities involve or are conducted on behalf of with the investor22 having disproportionately few voting rights include: Are the entitys operations substantially similar in nature to the activities of the investor with disproportionately few voting rights? Are the entitys operations more important to the investor with disproportionately few voting rights than the other variable interest holders? What decisions does the investor with disproportionately few voting rights participate in and to what extent? Are the majority of the entitys products or services bought from or sold to the investor with disproportionately few voting rights?
22
For purposes of evaluating the factors listed, the term investor should be read to include the investor and the investors related parties, except its de facto agents under ASC 810-10-25-43(d). 176
Were substantially all of the entitys assets acquired from the investor with disproportionately few voting rights? Are employees of the investor with disproportionately few voting rights actively involved in managing the operations of the entity? What roles do the variable interest holders play in conducting the entitys operations? Do employees of the entity receive compensation tied to the stock or operating results of the investor with disproportionately few voting rights? Is the investor with disproportionately few voting rights obligated to fund operating losses of the entity, or is the entity economically dependent on the investor? Has the investor with disproportionately few voting rights outsourced certain of its activities to the entity, or vice versa? If the entity conducts research and development activities, does the investor with disproportionately few voting rights have the right to purchase any products or intangible assets resulting from the entitys activities? Has a significant portion of the entitys assets been leased to or from the investor with disproportionately few voting rights? Does the investor with disproportionately few voting rights have a call option to purchase the interests of the other investors in the entity? Fixed price and in the money call options likely are stronger indicators than fair value call options. Do the other investors in the entity have an option to put their interests to the investor with disproportionately few voting rights? Fixed price and in the money put options likely are stronger indicators than fair value put options.
Not all of these conditions must be present to conclude that the activities of the entity are conducted principally on behalf of the investor with disproportionately few voting rights. Determining whether substantially all of a potential VIEs activities involve or are conducted on behalf of an investor (including the investors related parties, except its de facto agents under ASC 810-10-25-43(d)) with disproportionately few voting rights requires the use of professional judgment after considering all of the relevant facts and circumstances.
Variable interests to be considered when applying the anti-abuse clause

Question 9(c).2 In determining whether an investor has disproportionately few voting rights as compared to its obligation to absorb expected losses or receive expected residual returns of the entity, should the comparison be based only on the rights and obligations of equity investments, or should all variable interests held by an investor be considered? The FASB intended that the anti-abuse clause be applied broadly to all interests held in a potential VIE to determine if an investor has disproportionately few voting rights as compared with its obligations to absorb expected losses or rights to receive expected residual returns. Accordingly, all variable interests held by an investor should be considered in determining whether the investor has disproportionately few voting rights in the entity.
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Variable interests to be considered when applying the anti-abuse clause
An enterprise holds a 10% equity ownership interest in an entity and also has provided subordinated debt financing to the entity such that, in the aggregate, it has provided 70% of the entitys total capitalization. The enterprises voting rights in the entity are proportionate to its 10% equity ownership interest. Substantially all of the entitys activities are conducted on behalf of the enterprise. Analysis Because the enterprise has an overall economic position in the entity equal to 70% of its capitalization (based on the aggregate of its combined debt and equity position), but has only a 10% voting interest, its obligation to absorb expected losses is disproportionate to its voting interest. As substantially all of the entitys activities are conducted on behalf of the enterprise, the provisions of the anti-abuse clause are applicable, and the entity is a VIE.
Limited partnerships
Question 9(c).3 A limited partnership may have a general partner that maintains a relatively minor partnership interest. If the limited partners have protective voting rights (as that term is defined in the Variable Interest Model) in the partnership and the general partner has all of the substantive decision making ability, will such an entity always be a VIE as a result of the Variable Interest Models anti-abuse clause? We do not believe all limited partnerships will be VIEs due to the anti-abuse clause. Although the limited partners have disproportionately few voting rights, the anti-abuse clause is applicable only if substantially all of the entitys activities are conducted on behalf of the limited partner (or the limited partners related parties except its de facto agents under ASC 810-10-25-43(d)). The factors discussed in Question 9(c).1 should be considered to determine if the anti-abuse clause is applicable. Illustration 9-32: Facts A limited partnership is formed to develop multi-family residential housing projects. A real estate development company identifies the site for the housing project, does pre-construction development work, syndicates the partnership interests and serves as the general partner. As general partner, the developer is responsible for constructing the housing project and maintaining and operating the project once constructed. The general partner holds a 1% interest in the partnership, and one limited partner holds the remaining 99% limited partnership interest. The limited partner is not actively involved in real estate development or the provision of residential housing and holds its interest for investment purposes. Analysis It could be viewed that the entity is a VIE because (1) the voting rights of the limited partner are not proportional to its obligations to absorb the expected losses of the entity or receive its expected residual returns (i.e., the limited partner has up to 99% of the partnerships economics and no significant voting rights) and (2) substantially all of the entitys activities are conducted on behalf of the limited partner (i.e., because it has up to a 99% investment in the partnership). However, we do not believe the size of the investment alone is determinative in assessing whether substantially all of the entitys activities are conducted on behalf of the investor with disproportionately few voting rights. Instead, the nature of the activities being performed by the entity should also be considered and compared to the activities performed by the investor as part of its ongoing operations to make this determination. In this case, because the partnership is providing residential housing, and the limited partner is not engaged in that
Limited partnerships
same activity outside of the partnership, substantially all of the activities of the partnership are not being conducted on behalf of the limited partner with disproportionately few voting rights. Accordingly, the entity is not a VIE pursuant to the Variable Interest Models anti-abuse clause.
Related parties
Question 9(c).4 In part (1) of the first sentence of ASC 810-10-15-14(c) (i.e., voting rights of some investors not proportional to their economics), does the term investors denote a group of related parties, or an investor individually? In part (2) of the anti-abuse clause (i.e., substantially all of the entitys activities conducted on behalf of the investor with disproportionally few voting rights), does the term investor denote a group of related parties, or an investor individually? The term investors in part (1) denotes an individual investor, even if related parties hold variable interests in a potential VIE. In part (2), the term investor denotes the individual investor and its related parties, as defined in ASC 850, and de facto agents as defined by ASC 810-10-25-43 (but excluding de facto agents identified under ASC 810-10-25-43(d) see Question 9(c).5). The anti-abuse clause was designed to prevent an enterprise from avoiding consolidation of a VIE by organizing the entity with nonsubstantive voting interests. In applying the anti-abuse clause, the FASB intended that an individual investor with disproportionately few voting rights (without regard to interests held by its related parties) treat activities of the entity that involve or are conducted on behalf of the investors related parties as if they involve or are conducted on behalf of the investor. Illustration 9-33: Facts Oilco, an oil and gas exploration and production company, Refineco, a crude oil refining company and related party of Oilco, and Investco, an investment company, form an LLC to buy and sell chemical feedstocks commonly used in the refining of crude oil into various petroleum products. Oilco, Refineco and Investco receive economic interests in the LLC of 40%, 20% and 40%, respectively. Voting rights are shared equally between the three parties. The equity investment is deemed to be at risk and is sufficient to absorb the entitys expected losses. The LLC enters into a long-term contract to supply chemicals to Refineco. At inception of the entity, it is anticipated that sales to Refineco will constitute approximately two-thirds of the LLCs revenues. Analysis In this example, because Oilco shares voting rights equally with Investco and Refineco, its voting rights are disproportionate to its obligation to absorb expected losses or receive expected residual returns of the LLC through its equity ownership. If the voting rights held by Oilcos related party, Refineco, were aggregated with its interest, the related party group would not have disproportionately few votes in comparison to their combined economic interest. However, the equity ownership and related voting rights held by Refineco are ignored for purposes of determining if Oilco has disproportionately few voting rights. Although the activities of the entity buying and selling chemical feedstocks commonly used in crude oil refining are not substantially similar in nature to Oilcos own operations as an oil and gas exploration and production company, they are substantially similar to Refinecos operations. As a crude oil refiner, Refineco commonly acquires chemical feedstocks for use in its refining operations. Because sales of chemical feedstocks to Refinceco will constitute approximately two-thirds of the LLCs revenues, the activities of the LLC are deemed to be substantially on behalf of a related party of the investor (Oilco) with disproportionately few voting rights. Accordingly, the entity is a VIE. Related parties
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Do related parties include de facto agents?

Question 9(c).5 In applying the anti-abuse clause, should an investors related parties include de facto agents, as identified under ASC 810-10-25-43? For purposes of applying the anti-abuse clause, an investors related parties include de facto agents, as that term is defined in ASC 810-10-25-43, except for de facto agents identified by ASC 810-10-2543(d). See Question 9(c).4 for how interests held by related parties affect application of the anti-abuse clause. Pursuant to ASC 810-10-25-43(d), a party is a de facto agent of an enterprise if that party has an agreement that it cannot sell, transfer or encumber its interests in a entity without the prior approval of the enterprise because the agreement constrains the party from being able to manage the economic risks or realize the economic rewards of its interests in the entity. However, a de facto agency relationship does not exist if both the enterprise and the party have right of prior approval and the rights are based on mutually agreed terms by willing, independent parties. The anti-abuse clause was designed to prevent an enterprise from avoiding consolidation of a VIE by organizing the entity with nonsubstantive voting interests. The anti-abuse clause could identify certain entities as VIEs that the FASB did not intend to be VIEs if the investor were to aggregate its interests in the entity with certain de facto agents. The attribution of a de facto agents interests to an investor with disproportionate voting rights due to a provision that constrains another party from being able to manage the economic risks or realize the economic rewards of its interests in the entity may result in an inappropriate conclusion that the activities of the entity are being conducted on behalf of the party with the disproportionately few voting rights. Illustration 9-34: Facts A limited partnership is formed to develop commercial real estate. A real estate development company, Restco, identifies the site for the project, does pre-construction development work, syndicates the partnership interests and serves as the general partner. As general partner, Restco is responsible for completing construction of the project and maintaining and operating the project once constructed. Restco holds a 20% interest in the partnership, and Investco holds the remaining 80% limited partnership interest. Investco is not actively involved in real estate development and holds its interest for investment purposes only. Under the terms of the partnership agreement, Restco is constrained from being able to realize the economic benefits of its interest in the partnership by sale, transfer or encumbrance without the prior approval of Investco. Investco does not have a similar restriction. Investco sought this provision to ensure that a qualified, reputable real estate developer will always be the general partner of the partnership. However, assume that pursuant to the provisions of ASC 810-10-25-43(d), Restco is deemed to be a de facto agent of Investco. As is common in a limited partnership, Investco is restricted to protective voting rights (as that term is defined in the Variable Interest Model) in the partnership. Consideration of de facto agents
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Analysis In this example, the first condition of the anti-abuse clause is met because Investco has disproportionately few voting rights in comparison with its 80% limited partnership interest. If Investco was required to include Restcos interest with its own because of the de facto agent relationship, the second condition also would be met because the activities of the partnership (the development of commercial real estate) are substantially similar to the activities of Restco. However, because an investor is not required to aggregate its interest with those of its de facto agents (as identified under ASC 810-10-25-43(d)) for purposes of evaluating the applicability of the second condition of the anti-abuse clause, the second condition is not met in this example, and the entity is not a VIE due to the anti-abuse clause.
Determining whether voting rights are proportionate to economic rights

Question 9(c).6 Does any difference between an investors voting rights and its obligation to absorb the entitys expected losses or receive its expected residual returns require a determination as to whether substantially all of the entitys activities either involve or are conducted on behalf of that investor (including the investors related parties, except its de facto agents under ASC 810-10-25-43(d))? Generally, yes. We believe that any disproportionality between an investors voting rights and its obligation to absorb the entitys expected losses or receive its expected residual returns requires a determination of whether the conditions in part (2) of ASC 810-10-15-14(c) have been met. An investors voting percentage may not be clear. As a result, the entitys underlying documents should be reviewed. In a limited partnership, a general partner typically will have 100% of the vote, and each limited partner will have 0% of the vote. In other entities, both parties must agree to decisions before certain major actions are undertaken (e.g., approval of operating budgets or issuance or refinancing of debt). In these situations, we generally believe each venture partner has 50% of the vote for purposes of evaluating part (1) of ASC 810-10-15-14(c). Many entities will have an investor that has disproportionately few voting rights as compared to its economic interest because of the entitys profit or loss sharing formulae, or an investor may have a variable interest (e.g., a call option, loan, etc.) other than its voting equity interest. However, an entity will not be a VIE solely because only part (1) of ASC 810-10-15-14(c) has been met. To be a VIE, substantially all of the entitys activities must either involve or be conducted on behalf of the investor (including the investors related parties, except its de facto agents under ASC 810-10-25-43(d)) with disproportionately few voting rights. Refer to Question 9(c).1 for further Interpretative guidance. Illustration 9-35: Example 1 Facts Partner A and Partner B contribute $66 and $34, respectively, in exchange for equity interests in a newly-formed joint venture. Each party must approve major operating activities before those activities are undertaken. Profits and losses are allocated in proportion to each partners capital balance. Analysis Partner A has disproportionately few voting rights. Partner A has 50% of the ventures voting rights but is entitled to 66% of its underlying economics. Part (2) of the anti-abuse clause must be evaluated to determine whether the venture is a VIE. Determining whether voting rights are proportionate to economic rights
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Example 2 Facts Assume the same facts as Example 1, except that Partner B makes a loan to the joint venture, which increases its obligation to absorb the entitys expected losses to 54%. Analysis Partner B has disproportionately few voting rights. Partner B has 50% of the ventures voting rights but is obligated to absorb 54% of the ventures expected losses. Part (2) of the anti- abuse clause must be evaluated to determine whether the venture is a VIE.
Question 9(c).7 The following examples illustrate the application of the anti-abuse clause: Illustration 9-36: Example 1 Facts Automobile Manufacturing Corp. (AMC) established an entity with Investor Big Bucks (IBB). The sole purpose of the entity is to purchase automobiles manufactured by AMC and to sell the automobiles to various car dealerships in New York, New Jersey and Connecticut. AMC contributed automobiles with a fair value of $200 million to the JV, and IBB contributed $100 million in exchange for a 50% share of the venture. The $100 million was distributed to AMC at inception. AMC and IBB share 50/50 in all decision making activities. Any major decisions (as defined in the operating agreement) that cannot be made because the parties cannot agree are to be submitted to binding arbitration. Profits and losses are shared pro rata until the investors achieve an IRR on their investments of 12%, at which point AMC receives 60% of the entitys profits. It is expected that the entity will generate profits to activate this allocation. Analysis In this example, AMC has disproportionately few voting rights compared with its right to receive expected residual returns. However, it is possible that AMC could conclude that substantially all of the entitys activities are not being conducted on its behalf because the entity has the ability to sell automobiles to entities other than AMC dealerships. Under that view, the entity is not a VIE. However, careful consideration of the facts and circumstances regarding the design and business purpose of the entity is necessary, which could result in a different conclusion. Example 2 Facts Assume the same facts as assumed in Example 1, except that the entity is required to sell all of its automobiles to AMC-owned automobile dealerships. Analysis As in Example 1, AMC has disproportionately few voting rights compared with its right to receive expected residual returns. Because the entity is limited to purchasing all of its automobiles from AMC and is limited to selling them to AMC dealerships, all of its activities involve or are conducted on behalf of AMC. Accordingly, both conditions of the anti-abuse clause are met, and the entity is a VIE. Anti-abuse clause
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Example 3 Facts Assume the same facts as assumed in Example 1, except that (1) AMC contributed $100 million for its share of the entity, (2) the entity initially purchased automobiles from Detroit Auto, an unrelated third party and (3) the entity is not limited to purchasing automobiles from AMC on an ongoing basis. Analysis AMC still has disproportionately few voting rights compared with its right to receive expected residual returns. However, because the entity is not limited to buying or selling automobiles directly with AMC, substantially all of its activities are not involving or conducted on behalf of AMC. As the second condition of the anti-abuse clause is not met, the anti-abuse clause is not violated. Example 4 Facts Assume the same facts as assumed in Example 1, except that certain decisions (as defined in the operating agreement) that constitute elements of power are to be made solely by AMC. Analysis In this example, IBB has disproportionately few voting rights on significant decisions to be made by the entity as compared with its obligation to absorb expected losses and right to receive expected residual returns of the entity. However, as the entitys activities are not substantially on behalf of IBB, the second condition of the anti-abuse clause is not met, and the anti-abuse clause is not violated.
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Expected losses and expected residual returns

Excerpt from Accounting Standards Codification Master Glossary
Consolidation Overall Glossary 810-10-20 Expected Losses A legal entity that has no history of net losses and expects to continue to be profitable in the foreseeable future can be a variable interest entity (VIE). A legal entity that expects to be profitable will have expected losses. A VIEs expected losses are the expected negative variability in the fair value of its net assets exclusive of variable interests and not the anticipated amount or variability of the net income or loss. Expected Residual Returns A variable interest entitys (VIEs) expected residual returns are the expected positive variability in the fair value of its net assets exclusive of variable interests. Expected Variability Expected variability is the sum of the absolute values of the expected residual return and the expected loss. Expected variability in the fair value of net assets includes expected variability resulting from the operating results of the legal entity.
10.1
The concepts of expected losses and expected residual returns are difficult aspects of the Variable Interest Model to understand and to apply. This difficulty arises primarily because expected losses and expected residual returns are not GAAP or economic losses that are expected to be incurred by the entity or GAAP or economic income that is expected to be earned by the entity. Instead, expected losses and expected residual returns are defined as amounts derived using the techniques described in CON 7. CON 7 requires expected cash flows to be derived by projecting multiple possible outcomes and assigning each possible scenario a probability weight. The multiple outcomes should be based on projections of how different assumptions regarding the factors most likely to significantly affect the entitys results of operations or the fair value of its assets would change the returns available to the entitys variable interest holders. Pursuant to the Variable Interest Model, expected losses and expected residual returns represent the potential for variability in a distribution of possible outcomes of the value of an entitys assets from the expected (or mean) outcome. Scenarios in the distribution in which projected outcomes exceed the expected outcome give rise to expected residual returns (overperformance or positive variability), while possible outcomes that are less than the amount of the expected outcome give rise to expected losses (underperformance or negative variability). The Variable Interest Model also provides that expected losses and expected residual returns represent amounts discounted and otherwise adjusted for market
10 Expected losses and expected residual returns
factors and assumptions rather than undiscounted cash flow estimates. Because expected losses and expected residual returns represent the potential variability from the expected cash flows of an entity, all entities will have expected losses even those entities that have a history of profitable operations and are projected to be profitable in the future. ASC 810-10 does not provide guidance on which of the various methods should be used to compute expected losses and expected residual returns (e.g., Fair Value, Cash Flow or Cash Flow Prime), each of which are described below. Instead, various methods have emerged in practice, and ASC 810-10-25-22 and ASC 810-10-25-23 require the entitys design to be the basis for applying the Variable Interest Models provisions. Judgment will be required to determine what variability the entity was designed to create and distribute to its interest holders. Variable interests, in turn, are identified based on whether they absorb the variability the entity was designed to create and distribute. ASC 810-10-25-35 and ASC 810-10-25-36 contain special provisions for certain market-based derivatives in that, notwithstanding that a derivative instrument may economically absorb the variability the entity was designed to create and distribute, it is to be considered a creator of variability (and thus not a variable interest) when certain conditions are met. Refer to Chapter 5 for further guidance on these concepts. Expected losses and expected residual returns are calculated after it is determined which variability the entity is designed to create and the instruments that absorb that variability. We are aware of three primary methods to measure variability: Fair Value, Cash Flow and Cash Flow Prime. Fair Value Method The Fair Value Method considers only fair value variability in determining whether an interest is a variable interest. In making this determination, a reporting enterprise considers only if the interest absorbs variability in the fair value of an entitys net assets (exclusive of variable interests). This view initially was developed based on the provisions of the Variable Interest Model that a VIEs expected losses and expected residual returns are based on the expected variability in the fair value of its net assets, exclusive of the effects of variable interests. Under the Fair Value Method, expected losses and residual returns are computed by projecting multiple possible cash flow outcomes under different interest rate environments and assigning each possible scenario a probability weight. Those possible cash flows are discounted to present value using the yield curve that was used in deriving the cash flows under the corresponding scenario. The Fair Value Method seeks to measure variability based on the relative value of cash flows. Interim changes in value are not considered in applying the Fair Value Method only distributable cash is used to measure variability. (As described in the next section, the same cash flows are used in computing variability under the Fair Value Method and Cash Flow Method, except that the Cash Flow Method discounts those cash flows using one constant yield curve, the yield curve that exists as of the evaluation date.) Cash Flow Method The Cash Flow Method computes expected losses and residual returns by projecting multiple possible cash flow outcomes under different interest rate environments and assigning each possible scenario a probability weight. The weighted multiple possible outcomes are discounted at the forward risk-free interest rate curve that exists at the time of the evaluation in computing expected losses and expected residual returns. Interim changes in value are not considered in applying the Cash Flow Method only distributable cash is used to measure variability.
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The Fair Value Method and the Cash Flow Method differ solely in the yield curves used to discount projected cash flow outcomes. The Fair Value Method uses multiple yield curves, representing the possible interest rate environments at the time the cash is distributable, while the Cash Flow Method uses only the yield curve at the evaluation date. There are no differences in the projected cash flows used under the Fair Value and Cash Flow Methods. Cash Flow Prime Method A variation of the Cash Flow Method also has been used in practice, which we refer to as the Cash Flow Prime Method. This approach assumes interest rate risk associated with the variability in periodic interest cash flows is not included in the calculation of expected losses and expected residual returns. That is, unlike the Cash Flow Method, in which numerous cash flow outcomes are projected under varying interest rate environments and then discounted using a static yield curve, the Cash Flow Prime Method projects periodic interest cash flows from variable rate instruments and discounts those cash flows at the same, static interest rate curve. That is, the cash flows are projected and discounted using the same yield curve. Mathematically, this results in the creation of no variability on periodic interest receipts from variable-rate instruments due to interest rate risk (both cash flow methods result in no variability due to interest rate risk for fixed-rate instruments). The Cash Flow Prime Methods cash flows differ from those used in the Fair Value and Cash Flow Methods because the Fair Value and Cash Flow Methods project multiple possible cash flow outcomes under different interest rate environments while the Cash Flow Prime Method projects future cash flows using only one interest rate environment the yield curve that is also used to discount those same cash flows. We generally expect the Cash Flow Prime Method will be used frequently in applying the Variable Interest Models provisions because: Many entities that hold primarily financial assets will not be designed to create and pass along interest rate risk because that risk is typically hedged through the use of interest rate swaps or other agreements and the entities often are not designed to create and distribute variability resulting from periodic interest receipts/payments (the Fair Value and Cash Flow Methods measure that variability), and The most practical way to measure variability for entities that are businesses or primarily hold or operate real estate or nonfinancial assets is based on variability in cash flow.
Appendix F includes a comprehensive example of the Cash Flow Prime Method for an entity holding real estate. Prior to Statement 167s amendments, expected losses and expected residual returns were used to determine the primary beneficiary of a VIE, which required an assessment of which party absorbed a majority of the entitys expected losses, received a majority of the entitys expected residual returns, or both. However, as a result of the amendments to the Variable Interest Model, the primary beneficiary is based upon a qualitative analysis. (See Interpretative guidance and Questions in Chapter 14 of this publication.) Therefore, FIN 46(R)s quantitative assessment for determining the primary beneficiary is no longer relevant after Statement 167s amendments to the Variable Interest Model. However, the Variable Interest Model continues to utilize the concepts of expected losses and expected residual returns for certain provisions. Namely, the concepts of expected losses and expected residual returns are still applicable in the following situations, among others: Determining whether the total equity investment at risk is sufficient to permit an entity to finance its activities without additional subordinated financial support and thus, whether an entity is a VIE
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Determining whether an enterprise has a variable interest (Chapters 5 and 6) Determining whether (1) the voting rights of some investors are not proportional to their obligations to absorb the expected losses of the entity, their rights to receive the expected residual returns of the entity, or both and (2) substantially all of the entitys activities either involve or are conducted on behalf of the investor that has disproportionately few voting rights and thus, whether an entity is a VIE
Thus, the Variable Interest Model still will require an enterprise to perform a quantitative analysis in certain scenarios.
Profitable entities have expected losses

Question 10.1 Do all entities have expected losses? Do entities with a history of profitable operations and that are expected to remain profitable have expected losses? Yes. Because expected losses and expected residual returns represent the potential variability from the fair value of the net assets of an entity (excluding variable interests), all entities that have the potential for multiple possible outcomes will have expected losses. Accordingly, even entities that have a history of profitable operations and are projected to be profitable in the future have expected losses. To illustrate this concept, assume an entity has generated net income between $10 million and $13 million in each year of its 10 years of operation. At 31 December 2009, the entity is expected to generate average profits of $14 million over the next few years. Although the entity is expected to remain profitable, its future net income is an estimate that has variability associated with it. The variability is the source of expected losses. In developing its estimate of average future net income, assume the entity believes its net income could vary between $12 million and $16 million as follows:
$16million
Expectednetincome
$14million
$12million
} }
Expectedresidualreturns
Expectedlosses
Although the entity has been profitable historically and is expected to remain profitable, it has expected losses because there is variability around its mean, or expected outcome, of $14 million. Any possible outcome with net income of less than $14 million gives rise to expected losses. Conversely, any possible outcome that produces more than $14 million of net income gives rise to expected residual returns.
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Expected losses and expected residual returns are based on design of entity
Question 10.2 Are expected losses and expected residual returns based on variability in an entitys cash flows, based on variability in the fair value of an entitys net assets, or both? The provisions of the Variable Interest Model are to be applied based on the variability the entity was designed to create and distribute to its interest holders. Refer to Chapter 5 for further guidance on determining the design of the entity and identifying variable interests and the Interpretative guidance section of this chapter for information on the various methods to compute expected losses and expected residual returns.
Calculation of expected losses and expected residual returns

Question 10.3 How are expected losses and expected residual returns calculated? The fair value of an asset traditionally has been determined by discounting the assets contractual cash flows at a rate that reflects the uncertainty in the amount and timing of their collection. Expected losses and expected residual returns are derived using techniques described in CON 7. CON 7 provides general principles that govern the use of present value and introduces the expected cash flow approach. The FASB believes this approach is a better measurement tool than the traditional approach for complex asset measurements. The expected cash flow approach of CON 7 differs from the traditional approach as described above by projecting a distribution of multiple possible cash flow outcomes based on explicit assumptions about the factors most likely to significantly affect the entitys results of operations or the fair value of its assets and assigning a judgmental estimate of the likelihood of occurrence to each outcome. To determine the present value of projected cash flows under a CON 7 approach, each possible cash flow outcome is multiplied by its related judgmentally determined probability of occurrence. These products are then discounted using the interest rate on the appropriate default risk-free investment (the risk-free rate) corresponding to the time horizon of the projected cash flows. The risk-free rate is used because all significant risks relating to the cash flows, and how those risks might impact the amount and timing of the cash flows, are explicitly considered in estimating the possible cash flow outcomes and assigning a related probability factor to each. The FASB believes the expected cash flow approach is preferable because the explicit assumptions about possible returns can be examined and questioned individually, which cannot be done under the traditional approach where uncertainty is reflected implicitly through its use of a single cash flow estimate and a risk-adjusted interest rate. This method also results in projections that demonstrate how differing assumptions change the timing and amount of cash flows available to the entitys variable interest holders, allowing quantification of the potential variability in the entitys returns. To compute expected losses and expected residual returns, possible outcomes should be based on the entitys projected net cash flows and changes in fair value of its assets arising from sources other than the variable interests in the entity (i.e., cash inflows such as revenues, investment maturities, asset sales, etc., from all sources other than variable interest holders, net of cash outflows such as operating expenses, commissions on asset sales, etc. to all sources other than variable interest holders). Cash flows and changes in the fair value of assets from or to variable interest holders are not included in developing the outcomes because it is these cash flows that serve as the basis for allocating the entitys expected losses and expected residual returns to the variable interest holders.
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Calculation of expected losses and expected residual returns
Assume an entity is capitalized with debt and equity and uses the proceeds to purchase a building. The entity enters into a contract with a management company to manage the day-to-day operations of the building. Assume it is determined that the management contract is not a variable interest. In developing the first years possible outcomes, the following should be considered:
Cash inflows from building (rent, etc.) Cash outflows to non-variable interest holders Cash available to variable interest holders used in computing expected losses and expected residual returns $ $ 1,000 (200) 800
Analysis The interest on the debt and any payments to the equity holders should not be deducted in determining the entitys expected losses and expected residual returns. The $800 should be used to determine the VIEs expected losses and expected residual returns, which should then be allocated to the entitys variable interest holders pursuant to the contractual arrangements that exist among the parties. For taxable entities (e.g., corporations but not partnerships), after-tax cash flow outcomes should be used. Except in certain circumstances (e.g., tax motivated structures such as affordable income housing partnerships), we believe that tax expense or benefit borne by or inuring to variable interest holders outside an entity should not be included in the cash flow outcomes used to determine if the entity is a VIE. Under the CON 7 approach, fair value (expected outcome) is the mean of a distribution of possible outcomes. Accordingly, the sum of the products of (1) each possible outcome of the entity and (2) the related probability for such outcome, when discounted using the risk-free rate, should derive the fair value of the entity. That is, the mean of the probability weighted, discounted outcomes of the entity under evaluation should equal its fair value. To illustrate the CON 7 expected outcome approach, assume a cash flow of $1,000 may be received in one year, two years or three years with probabilities of 10%, 60% and 30%, respectively.
Estimated outcome Year 1 Year 2 Year 3 $ 1,000 $ 1,000 $ 1,000 Probability 10% 60% 30% 100%
Expected outcome $ 100 600 300 $ $
Fair value23 95.24 544.22 259.15 898.61
23
Discounted at the interest rate on default risk-free investments (assumed to be 5.00% for all years). 189
In this example, the timing of the cash flows associated with the three outcomes is uncertain. Under CON 7s expected outcome approach, each estimated outcome is assigned a probability of being realized. That probability is multiplied by the estimated outcome to arrive at the expected outcome. Each expected outcome is then discounted to present value using the interest rate on the corresponding default risk-free investment, because the uncertainty about timing of collection is already reflected in the probabilities assigned. While any combination of outcomes and interest rates can be used to compute a present value, the CON 7 expected outcome approach should be used in performing the computations required by the Variable Interest Model. To illustrate how expected losses and expected residual returns are calculated, in the previous example, there were three different scenarios in which the $1,000 could be collected. Each was assigned a probability based on the estimate of that scenario occurring, and the expected outcome was computed. The expected outcome for each scenario was then discounted to obtain the expected outcome (which equals the fair value) of the instrument. The following table illustrates how expected losses and expected residual returns for the instrument are computed based on the expected outcome.
Expected Estimated outcome Year 1 Year 2 Year 3 $ 1,000 $ 1,000 $ 1,000 Discounted outcomes24 (a) $ 952.38 907.02 863.84 Fair value (b) $ 898.61 898.61 898.61 Expected probability (c) 10% 60% 30% 100%
Expected losses ((b-a)*c) $ 10.43 $ 10.43
residual returns ((a-b)*c) $ 5.38 5.05 $ 10.43
Expected losses and expected residual returns are computed by subtracting the present value of each possible outcome from the fair value of the instrument and multiplying the difference by the probability associated with the possible outcome. An expected loss arises when the present value of the possible outcome is less than the fair value of the instrument. Conversely, if the present value of the possible outcome is more than the fair value of the instrument, an expected residual return results. Because expected losses and expected residual returns are computed based on the variability from the expected outcome (i.e., fair value), the absolute values of expected losses and expected residual returns will be equal. This simple example illustrates how expected losses and expected residual returns are calculated for an entity that is to realize a $1,000 cash flow on one of three dates. In practice, entities will have multiple assets, cash flows and fair values that could vary significantly among a large number of possible outcomes.
24
Discounted at the interest rate on default risk-free investments (assumed to be 5.00% for all years). 190
Approaches to calculating expected losses and expected residual returns

Question 10.4 What are common approaches to calculating expected losses and expected residual returns? Is one approach preferable to another? In our experience, there are two general approaches that are commonly used to calculate expected losses and expected residual returns. One basic approach is to project and discount possible outcomes, which starts with a base outcome that is believed to be the most likely to occur. Multiple possible outcomes are then projected based on a determination of how changes to the assumptions used in the base outcome affect the projection. Probabilities are assigned to each outcome and used to calculate the entitys expected losses and expected residual returns. A second and more complex approach is to calculate expected losses and expected residual returns using a Monte Carlo simulation. Monte Carlo methods randomly select values from defined ranges of the primary factors that cause variability in an entitys returns. The range selected is based on the conditions surrounding that variable. Points within the ranges of each factor are randomly selected and an outcome resulting from the combination of the randomly selected point estimate of each factor is computed. The random selection process is repeated many times to create multiple outcome projections. It is not uncommon for a Monte Carlo simulation to result in thousands of outcome projections. These projections are then used to compute the potential variability in the entitys returns. Use of the Monte Carlo method generally requires the involvement of valuation or other professionals skilled in the preparation and interpretation of Monte Carlo models. The first approach described is simpler than the Monte Carlo approach and generally results in far fewer outcome projections than are included in the calculation prepared using the Monte Carlo approach. One approach is not preferable over the other. Additionally, while these two approaches have been the most prevalent in our experience, there may be other approaches, or derivations of the approaches discussed above, that also may be acceptable. Regardless of the approach selected, the outcomes used in the calculation must be based on reasonable judgments and assumptions, and the results of the calculation must satisfy the reasonableness checks (see Question 10.8).
Use of the risk-free rate for discounting

Question 10.5 In calculating expected losses and expected residual returns, must amounts be discounted using a risk-free rate rather than a risk-adjusted rate? Yes. Traditionally, fair value has been computed by determining the most likely projected outcome for the asset or entity and discounting that outcome at a risk adjusted interest rate that reflects the risks associated with the potential variability in the timing and amount of cash flows of that outcome. Expected losses and expected residual returns are derived using an expected outcome approach as described in CON 7. CON 7 provides general principles that govern the use of present value and introduces the expected cash flow approach. The FASB believes this approach is a better measurement tool than the traditional approach for complex asset measurements. The expected cash flow approach of CON 7 differs from the traditional approach as described above by projecting a distribution of multiple possible estimated outcomes based on explicit assumptions about the factors most likely to significantly affect the entitys results of operations or the fair value of its assets and assigning a judgmental estimate of the likelihood of occurrence to each outcome.
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To determine the present value of projected outcomes, each possible cash flow outcome is multiplied by its related judgmentally determined probability of occurrence. These products are then discounted using the interest rate on the appropriate default risk-free investment (the risk-free rate). The risk-free rate is used because all significant risks relating to the outcomes, and how those risks might impact the amount and timing of the outcomes, are explicitly considered when projecting multiple outcomes using differing assumptions about the factors that could significantly affect the entitys results of operations or the fair value of its assets and in judgmentally weighting the likelihood of occurrence of each outcome. Because this method results in projections that demonstrate how differing assumptions change the timing and amount of an entitys returns, it allows quantification of the potential variability in the returns available to the entitys variable interest holders. This quantification of potential variability is key in determining if an entity has sufficient equity to absorb its expected losses (if this cannot be determined qualitatively see the Interpretative guidance and Questions in Chapter 9) and may be relevant for evaluating other provisions of the Variable Interest Model as noted above. Use of a risk adjusted interest rate for discounting instead of the risk-free rate may disguise a portion of an entitys potential variability and could result in an inappropriate conclusion as to whether an entity is a VIE, even if multiple outcomes are projected for an entity.
Allocation of a VIEs expected losses and expected residual returns

Question 10.6 How should a VIEs expected losses and expected residual returns be allocated to its variable interest holders? In evaluating the Variable Interest Model, there may be scenarios in which expected losses and residual returns should be allocated to an entitys interest holders. For example, an enterprise may find this allocation to be necessary to assess whether an entity is a VIE pursuant to the anti-abuse clause of the VIE analysis in ASC 810-10-15-14(c). Thus, it may be necessary to allocate the entitys expected outcomes to its variable interest holders pursuant to the contractual arrangements among the parties. The contractual arrangements will determine how the entitys outcomes are to be distributed (both in amount and priority) to its variable interest holders. The probability weighted present value of each estimated outcome should be calculated and then used to compute each variable interest holders expected losses and expected residual returns based on the potential variability of these estimated outcomes from the expected outcome, which is the fair value of each holders variable interest. We believe this approach to allocating expected outcomes to each variable interest holder and then computing each holders expected losses and expected residual returns best accommodates the complex distribution agreements that commonly exist today. For example, many structures provide for profits to be distributed to equity holders based on their relative ownership until one equity holder achieves a stated rate of return, at which point the profits may be allocated differently to provide one of the equity owners with an incentive to achieve superior performance.
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Allocation of a VIEs expected losses and expected residual returns
This illustration is based on a hypothetical pool of financial assets with total contractual cash flows of $1 million The entity issued to one enterprise for $733,333 an $800,000 par zero-coupon debt that matures in one year Another enterprise made an investment of $23,810 for all of the entitys equity The total proceeds of $757,143 were invested in a pool of assets All of the entitys assets will be liquidated at the end of one year The appropriate discount rate (the interest rate on default risk-free investments) is 5%
Analysis As illustrated below, the entitys expected losses and expected residual returns are $26,667. Because the equity investment at risk ($23,810) is insufficient to absorb the entitys expected losses ($26,667), the entity is a VIE (see the Interpretative guidance and Questions in Chapter 9). Table 1 shows the entitys possible outcomes, the probabilities associated with these outcomes (column b) and how the outcomes are allocated to the debt holder (column c) and the equity holder (column d). The debt holder receives all of the VIEs cash flow up to $800,000, at which point the debt has been repaid and any further cash flows are to be received by the equity holder.
Table 1 Allocation of outcomes to variable interest holders Possible end of year one outcomes (a) $ 650,000 700,000 750,000 800,000 850,000 900,000 Outcomes to: Probability (b) 5% 10% 25% 25% 20% 15% $ Debt (c) 650,000 700,000 750,000 800,000 800,000 800,000 $ Equity (d) 50,000 100,000
Table 2 shows how expected losses and expected residual returns for the debt holder are computed. The present value of each possible outcome received by the debt holder is compared to the fair value of the debt holders variable interest. That difference is multiplied by the probability of occurrence to compute the debt holders expected losses and expected residual returns. For example, in the potential outcome where $650,000 is received from the entitys assets, all of the cash flows would be allocated to the debt holder. The fair value of that outcome is $619,048 ($650,000 discounted at the assumed risk-free rate of 5%). That potential outcome represents negative variability from the expected outcome of the debt holder, which is $733,333. The difference between these two amounts is multiplied by the probability of occurrence (5%) and results in an expected loss of $5,714.
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Table 2 Debt holder expected losses and expected residual returns Present value of possible debt outcomes (e)=(c)/(1+RF rate) $ 619,048 666,667 714,286 761,905 761,905 761,905 (5,714) (6,667) (4,762) $ (17,143) $ 733,333 (f) $ Expected losses Expected residual returns [(e)-(f)]*(b) $ 7,143 5,714 4,286 17,143
Fair value of variable interest
Table 3 shows how expected losses and expected residual returns are computed for the equity holder. This computation is consistent with the computations presented in Table 2.
Table 3 Equity holder cash flow variability Equity holder outcome variability Present value of possible equity outcomes (g) = (d)/(1+RF rate) $ 47,619 95,238 (1,191) (2,381) (5,952) (5,952) $ (15,476) $ 23,810 (h) $ Expected losses Expected residual returns [(g)-(h)]*(b) $ 4,762 10,714 15,476
Fair value of variable interest
The expected losses and expected residual returns of the variable interest holders, and of the entity, may be summarized as follows:
Expected losses Debt holder (Table 2) Equity holder (Table 3) Total variable interests Total entity $ (17,143) (15,476) $ (32,619) $ (26,667) Expected residual returns $ $ $ 17,143 15,476 32,619 26,667
It should be noted that the sum of the expected losses and expected residual returns of the debt holder and equity holder exceeds the entitys expected losses and expected residual returns. This difference arises because an estimated outcome may cause one variable interest holder to receive an expected residual return while another variable interest holder absorbs an expected loss in the same outcome. For example, in the possible outcome in which $800,000 is to be received by the entity (Table 1), all of the returns are allocated to the debt holder, and based on the computation, the debt holder has an expected residual return ($7,143 from Table 2), while the equity holder has an expected loss ($5,952 from Table 3). We believe that the sum of the variable interest holders expected losses and expected residual returns must be adjusted to equal those of the entity. Question 10.7 discusses ways in which this adjustment may be made.
Sum of expected losses and expected residual returns of variable interest holders exceed those of the VIE
Question 10.7 The sum of the expected losses and expected residual returns of the variable interest holders in an entity generally will exceed the expected losses and residual returns of the VIE. Should an adjustment be made to the expected losses and expected residual returns of the variable interest holders such that their sum equals the expected losses and expected residual returns of the VIE? If so, how? As noted above, it may be necessary in certain situations to allocate a VIEs expected losses and expected residual returns to its variable interest holders. In general, we believe that to perform this analysis, the possible outcomes of the entity should be allocated to the entitys variable interest holders pursuant to the contractual arrangements among the parties. The contractual arrangements will determine how the entitys outcomes are to be distributed (both in amount and priority) to its variable interest holders. The probability-weighted present value of each estimated outcome should be calculated and then used to compute each variable interest holders expected losses and expected residual returns based on the potential variability of these estimated outcomes from the expected outcome, which is the fair value of each holders variable interest. However, when the possible outcomes of the VIE are allocated, and expected losses and residual returns are computed for the variable interest holders, the sum of the variable interest holders expected losses and expected residual returns generally will exceed those of the VIE. This is due to one or more variable interest holders in an entity having a senior priority to other variable interests. The most common example of this may be debt and preferred stock holders having a senior priority to common equity holders, but this will occur in most entities regardless of the actual form of the capital structure. The following illustration builds on the example in Question 10.6: Illustration 10-3 Sum of expected losses and expected residual returns of variable interest holders exceed those of the VIE
Assume a VIE has the following potential outcomes and related expected losses and residual returns:
Potential outcome $ 650,000 700,000 750,000 800,000 850,000 900,000 $ Expected losses $ (6,905) (9,048) (10,714) (26,667) $ Expected residual returns $ 1,191 10,476 15,000 26,667
The VIE has two variable interest holders, a senior debt holder and an equity holder. The expected losses and expected residual returns of each are as follows, based on an allocation of the VIEs potential outcomes to each based on the contractual arrangements.
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Debt holder Potential outcome $ 650,000 700,000 750,000 800,000 850,000 900,000
Equity holder Expected losses $ (1,191) (2,381) (5,952) (5,952) $ (15,476) $ $ Expected residual returns 4,762 10,714 15,476 $
Total VIs Expected losses (6,905) (9,048) (10,714) (5,952) $ (32,619) $ Expected residual returns $ 7,143 10,476 15,000 32,619
Expected losses $ (5,714) (6,667) (4,762) $ (17,143) $ $
Expected residual returns 7,143 5,714 4,286 17,143
As shown above, the sum of the expected losses and expected residual returns of the variable interest holders ($32,619) exceeds those of the entity ($26,667). The difference arises because in the $800,000 outcome, the debt holder receives an expected residual return of $7,143, while the equity holder absorbs an expected loss of $5,952. These two amounts net to the entity level expected residual return of $1,191. We believe that the expected losses and expected residual returns used to determine the primary beneficiary of an entity must equal the expected losses and expected residual returns of the entity under evaluation. There are two common approaches used to accomplish this: 1. For any outcome in which a variable interest holder experiences an expected loss while other variable interest holders receive an expected residual return, the expected loss is left with its variable interest holder(s). Further, beginning with the most senior variable interest holder, the variable interest holder(s) receiving the expected residual returns move the lesser of (1) the sum of the expected losses absorbed by the subordinated interests or (2) the expected residual returns inuring to the senior interests, from the expected residual returns of the senior interests to their expected losses. Using the amounts from the above examples, this is demonstrated below in the shaded portions of the table:
Debt holder Potential outcome $ 650,000 700,000 750,000 800,000 850,000 900,000 Expected losses $ (5,714) (6,667) (4,762) 5,952 $ (11,191) $ Expected residual returns $ 1,191 5,714 4,286 11,191 Equity holder Expected losses $ (1,191) (2,381) (5,952) (5,952) $ (15,476) $ Expected residual returns $ 4,762 10,714 15,476 Expected losses $ (6,905) (9,048) (10,714) $ (26,667) $ Total Expected residual returns $ 1,191 10,476 15,000 26,667
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After this adjustment, the sum of the expected losses and expected residual returns of the variable interest holders ($26,667) equals those of the entity ($26,667). 2. For any outcome in which a variable interest holder(s) experiences an expected loss while another variable interest holder(s) receives an expected residual return, all amounts allocated to each variable interest holder are shown as either an expected loss or expected residual return, depending on what the entity has experienced (i.e., the entity result serves as a control, such that if, for example, the entity experienced an expected loss for an outcome, all amounts for each variable interest holder will be reflected as an expected loss). Using amounts from the previous example, this method is demonstrated below in the shaded portions of the table:
Debt holder Potential outcome $ 650,000 700,000 750,000 800,000 850,000 900,000 Expected losses $ (5,714) (6,667) (4,762) $ (17,143) $ Expected residual returns $ 7,143 5,714 4,286 17,143 $ Equity holder Expected losses $ (1,191) (2,381) (5,952) (9,524) $ Expected residual returns $ (5,952) 4,762 10,714 9,524 Expected losses $ (6,905) (9,048) (10,714) $ (26,667) $ Total Expected residual returns $ 1,191 10,476 15,000 26,667
After this adjustment, the sum of the variable interest holders expected losses and residual returns again equals the entitys. However, under this method the debt holder is identified as the primary beneficiary because it absorbs 64% ($17,143 divided by $26,667) of the entitys expected losses. As ASC 810-10 does not provide any detailed interpretative guidance as to how any adjustment should be made, we believe either of the two methods is acceptable. However, an enterprise should make an accounting policy election as to which method it will use and apply that method consistently for all entities.
Reasonableness checks for an expected loss calculation

Question 10.8 What are reasonableness checks that should be used in a calculation of expected losses and expected residual returns? Pursuant to the expected cash flow approach in CON 7, fair value is computed as the mean of a distribution of possible outcomes. Accordingly, the sum of the products of (1) each possible outcome of the entity used in the computation and (2) the related probability for each such outcome, when discounted using the appropriate risk-free rate, should closely approximate the fair value of the enterprises net assets (exclusive of variable interests). Said another way, the mean of the probability weighted, discounted outcomes of the entity under evaluation should equal (or closely approximate) the fair value of the enterprises net assets (exclusive of variable interests).
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Reasonableness checks for an expected losses calculation
Assume that an entity has one asset, which is a zero coupon bond maturing in one year that has a fair value, based on quoted market prices, of $1.5 million. The possible cash flows that the entity may receive upon maturity of the bond, the judgmentally assigned probabilities of each possible outcome and the present values of each set of possible outcomes (discounted using an assumed risk-free rate of 5%) are as follows:
Possible end of year one outcomes $ 1,250,000 1,375,000 1,500,000 1,750,000 2,000,000 Present value of possible outcomes $ 1,190,476 1,309,524 1,428,571 1,666,667 1,904,762 Estimated probability of outcomes 20% 20% 20% 20% 20%
Analysis The fair value of the net assets of the enterprise, exclusive of variable interests, is equal to the fair value of the bond (as the bond is the entitys only asset and all other liabilities are variable interests). The fair value of the entity can be derived from the distribution of possible outcomes of the entity, as demonstrated below:
Possible end of year one outcomes $ 1,250,000 1,375,000 1,500,000 1,750,000 2,000,000 Present value of possible outcomes $ 1,190,476 1,309,524 1,428,571 1,666,667 1,904,762 Estimated probability of outcomes 20% 20% 20% 20% 20% 100% $ Fair value check $ 238,095 261,905 285,714 333,333 380,952 1,500,000
An entitys possible outcomes may have to be allocated to the entitys variable interest holders in certain situations. If so, the products of the possible outcomes allocated to the individual variable interest holders, when probability weighted (the probability weightings for each possible outcome should be the same as those of the entity for each variable interest holder that is, the probability weighting should remain constant throughout the computation) and discounted using the risk-free rate, should equal (or closely approximate) the fair value of each individual variable interest holders interest. Another reasonableness check is to ensure that the absolute value of expected losses equals expected residual returns. Expected losses and expected residual returns represent the potential variability in an entitys returns from an expected outcome, which is the mean of a distribution of possible outcomes for the entity. Because expected losses and expected residual returns represent potential negative and positive variability from the mean, the absolute value of expected losses and expected residual returns will be equal. This is true for expected losses and expected residual returns of an entity, as well as for expected losses and expected residual returns of variable interest holders in an entity.
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Reasonableness checks for an expected losses calculation
Using the same assumptions as in the example above, expected losses and expected residual returns of the entity can be computed as follows:
Possible end of year one outcomes $ 1,250,000 1,375,000 1,500,000 1,750,000 2,000,000 Present value of possible outcomes $ 1,190,476 1,309,524 1,428,571 1,666,667 1,904,762 Fair value of net assets $ 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 Estimated probability of outcomes 20% 20% 20% 20% 20% 100% $ Expected losses (61,905) (38,095) (14,286) $ (114,286) Expected residual returns $ 33,333 80,952 $ 114,286
Difference $ (309,524) (190,476) (71,429) 166,667 404,762
Analysis The absolute value of the entitys expected losses $114,286 is equal to its expected residual returns. Satisfying the reasonableness checks may prove challenging. Determining the possible outcomes and selecting the appropriate probability weightings of these possible outcomes that result in the expected outcome approximating the fair value of the entitys net assets exclusive of variable interests (and, if allocations must be made to variable interest holders, the fair value of the variable interest holders interests) will likely be an iterative process.
Number of possible outcomes needed

Question 10.9 In calculating expected losses and expected residual returns, are there a minimum number of potential outcomes that should be included in the calculation? There is no minimum number of possible outcomes that are required to be included in a calculation of expected losses and expected residual returns. Generally speaking, the more complex the type and amount of assets that an entity has, the greater the number of possible outcomes that will be required. Determining when a sufficient number of possible outcomes have been included in a calculation will depend on the applicable facts and circumstances and will require the exercise of professional judgment. We believe the following should be considered in determining the sufficient number of potential outcomes: All of the significant factors that drive variability in the entitys returns have been considered in the distribution of possible outcomes, If possible outcomes of the entity must be allocated to the variable interest holders, all relationships between the entitys variable interest holders, and how those relationships might affect the allocation of the entitys returns in various circumstances, have been considered, and The inclusion of additional possible outcomes is unlikely to change the determination of whether the entity is a VIE.
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Possible outcome projections for an entity with an indeterminate life

Question 10.10 If an entity under evaluation has an indeterminate life and plans continuing operations for the foreseeable future, how should expected losses and expected residual returns be computed? Should cash flows included in possible outcomes be projected over an indefinite period for such an entity? Expected losses and residual returns generally should be computed using possible outcomes incorporating cash flows over the anticipated life of the entity. Valuation techniques such as the application of an assumed terminal value multiple to the last year of projected cash flows may be used when preparing the distribution of possible cash flow outcomes for an entity with an indeterminate life. The terminal values will vary among the possible cash flow outcomes based on the different assumptions made in projecting each possible outcome.
Inability to obtain information necessary to calculate expected losses and expected residual returns
Question 10.11 An enterprise may need to obtain information from third parties to be able to calculate an entitys expected losses and expected residual returns. What if it is unable to obtain the necessary information? The inability to obtain information may make it difficult to complete a calculation of expected losses and expected residual returns for an entity in which a company has a variable interest. The Variable Interest Model does provide for a limited scope exception in situations in which an enterprise has a variable interest in a VIE, or potential VIE, but, after making exhaustive efforts, is unable to obtain the information necessary to (1) determine if the entity is a VIE, (2) determine whether it is the primary beneficiary of the VIE or (3) consolidate a VIE for which it determines it is the primary beneficiary (see the Interpretative guidance and Questions to Chapter 4). The exception is applicable only to entities formed prior to 31 December 2003. Additionally, the exception may be applied only until the necessary information is obtained, at which point the Variable Interest Models provisions apply. Companies have a continuing obligation to attempt to obtain the necessary information to make the appropriate accounting determinations. Disclosures are required during the period the scope exception is applied. The FASB limited the exception to entities formed prior to 31 December 2003 because it believes the need for the information necessary to apply the Variable Interest Model should have been contemplated in connection with the creation of an entity formed subsequent to 31 December 2003. If enterprises are unable to obtain information needed to complete the computation of the entitys expected losses and expected residual returns, and the entity was formed subsequent to 31 December 2003, the enterprise should make reasonable assumptions about the missing information and prepare the computation using those assumptions.
Effect of variable interests in specified assets on an entitys expected losses

Question 10.12 How do variable interests in specified assets of an entity affect the calculation of the entitys expected losses? ASC 810-10-25-55 and 25-56 indicate that if an enterprise has an interest that is limited to a specific asset, or group of assets, of a potential VIE that represents less than one-half of the total fair value of the entitys assets, the enterprise does not have a variable interest in the entity. Additionally, any expected losses absorbed by the enterprise holding an interest only in specified assets representing less than onehalf of the total fair value of the entity do not have to be supported by the at-risk equity holders of the entity. Accordingly, the expected losses absorbed by the holders of interests in specified assets of the entity are deducted from the total expected losses of the entity for purposes of determining the sufficiency of the at-risk equity.
See the Interpretative guidance and Questions in Chapter 8 for further discussion of variable interests in specified assets of an entity.
Inclusion of credit risk in an expected loss calculation

Question 10.13 The allocation of an entitys expected losses is determined by the contractual arrangements between the variable interest holders (e.g., if an asset declines in value, a guarantor may be called upon to make a payment that protects other variable interest holders from absorbing the loss). How should the risk that a variable interest holder may not perform according to the contractual arrangement be incorporated into an expected loss calculation? If a contractual agreement requires that one variable interest holder make a payment either to the entity or other variable interest holders in the entity upon the occurrence of certain losses, that contractual arrangement should be incorporated into the allocation of the entitys expected losses. However, the risk that the variable interest holder required to make the payment may not perform also should be incorporated into the calculation. The expected loss that the paying variable interest holder would otherwise absorb should be weighted based on the judgmentally determined likelihood of default. The amount of the expected loss that would otherwise be absorbed by the variable interest holder required to make the payment, multiplied by the likelihood of default, should be allocated to the other variable interest holders in the entity. Illustration 10-6: Facts An entity acquires Asset A for use in its operations. The fair value of Asset A is $300. The fair value of all of the entitys assets is $500. The entity finances the cost of Asset A in its entirety with debt from Lender A on a nonrecourse basis (i.e., the lender has access only to the cash flows generated by Asset A for payment of the loan and does not have access to the general credit of the entity). In connection with the financing, Lender A requires that the entity acquire a guarantee from Guarantor A that requires Guarantor A to make a payment for the amount by which the value of Asset A decreases below $200. The expected losses of the entity are $100. The expected losses associated with Asset A are $60. Of this amount, $40 is related to possible outcomes of the entity in which the value of Asset A decreases to amounts less than $200. It is judgmentally determined that there is a 5% chance that Guarantor A will not perform on the acquired guarantee if Asset As value drops below $200. Analysis In this example, in allocating the expected losses to the variable interest holders, the expected losses relating to Asset A would be allocated as follows: Lender A Guarantor A $ 22 38 Inclusion of credit risk in an expected losses calculation
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Because the loan by Lender A was made on a nonrecourse basis, it will absorb all expected losses related to any decreases in the value of Asset A from $300 to $200, or the total expected losses of $60 less the expected losses of $40 attributable to possible outcomes in which the value of Asset A decreases to amounts less than $200. Additionally, there is a 5% chance that Guarantor A will not perform on the guarantee. In such instances, the expected losses relating to decreases in Asset As value below $200 will be absorbed by Lender A. Accordingly, an additional $2 of expected losses are allocated to Lender A (5% of $40). Guarantor A is allocated the remaining expected losses relating to Asset A of $38 ($60-$22).
Inclusion of investors tax benefits in an expected loss calculation

Question 10.14 In certain circumstances, variable interest holders in an entity may be primarily motivated to invest in order to obtain tax benefits that occur outside the entity. Should tax benefits inuring to a variable interest holder outside an entity be considered when preparing an expected loss calculation for the entity? Generally, the effect on an investors taxable income or expense from holding a variable interest in an entity should not be considered when preparing an expected loss calculation for the entity, unless that effect occurs in the entity itself. However, in certain circumstances, enterprises may invest in entities primarily to obtain tax benefits that occur outside the entity and may even derive no other economic benefits from the investment other than the tax benefits themselves (e.g., investments in affordable housing partnerships). If investors in an entity have primarily acquired the right to receive tax benefits that are obtained or earned outside the entity, and those tax benefits are included in deriving the fair value of the investment, we generally believe that the tax expense or benefit borne by or inuring to variable interest holders should be included in the possible outcomes used to determine if the entity is a VIE and, if so, the entitys primary beneficiary. We understand the SEC staff shares this view. The following factors may indicate that an investment has been made primarily to obtain tax benefits: The cost of the interest is primarily a function of the projected tax benefits to be received by the investor Absent the tax benefits, the investor would receive a negative or substantially below market return from its investment in the entity Returns on the investment may be limited by having excess cash flows of the entity distributed to other investors The investors ability to participate in any profits from the sale of assets upon the entitys liquidation is limited Guarantees of the tax benefits to be received by the investor are provided by other variable interest holders such that the investor is provided a targeted rate of return on the project
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Inclusion of investors tax benefits in an expected losses calculation
Company A acquires a 99% limited partner interest in a limited partnership formed to provide affordable housing. It is anticipated that the partnership will generate housing credits and tax losses, including depreciation and interest expense, over the life of the project. These tax losses and credits will be allocated almost entirely to Company A, which anticipates that it will be able to utilize them in its consolidated income tax return to offset taxable income generated by its other operations and investments. Company As cost of acquiring the limited partner interest is based primarily on the estimated tax benefits to be earned. Analysis Because Company A has in substance acquired the right to receive tax benefits, and the fair value of the investment was based primarily on the anticipated receipt of those tax benefits, the tax benefits that Company A will realize should be included in the calculation of the partnerships expected losses and expected residual returns even though those benefits are realized outside of the partnership itself (by their inclusion in Company As consolidated income tax return). Excluding these benefits would not reflect the true variability in each variable interest holders returns.
Inclusion of interest rate risk in an expected loss calculation

Question 10.15 Should the variability due to changes in market interest rates be included in an expected loss calculation? Pursuant to ASC 810-10-25-33, variability arising from periodic interest payments/receipts should be excluded from the computation of expected losses and expected residual returns if the entity was not designed, based on the use of professional judgment, to create and distribute that risk. ASC 810-10-25-33 also indicates that variability due to interest rate risk generally should be included in developing potential outcomes for assets that will be sold prior to their maturity (i.e., various interest rate environments should be assumed in developing the cash flows to be received upon sale of an entitys fixed-rate investments).
Concepts underlying the application of Fair Value, Cash Flow and Cash Flow Prime Methods
Question 10.16 What are the underlying concepts in applying the Fair Value, Cash Flow and Cash Flow Prime Methods to computing expected losses and expected residual returns? The Fair Value, Cash Flow and Cash Flow Prime Methods measure variability differently because they use different combinations of cash flows and discount rates. We believe the probabilities assigned to the various scenarios should be consistent among the three methods. While the Fair Value and Cash Flow Methods use the same cash flows, they use different discounting techniques; the Fair Value Method varies the discount rate by scenario while the Cash Flow Method uses the forward yield curve to discount the cash flows. While the Cash Flow and Cash Flow Prime Methods both use the forward yield curve to discount the cash flows, the cash flows between the two methods vary. The Cash Flow Method projects various potential cash receipts from variable-rate assets, while the Cash Flow Prime Method projects and discounts the cash flows from variable-rate assets using the same forward yield curve. To illustrate the use of discounting techniques in applying the various approaches, consider the following examples:
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Fair Value Fixed rate US obligation Cash flow fixed. Discount rate varies by scenario. Expected losses and expected residual returns occur as fair value of cash flow varies. Cash flow projected based on forward yield curve and discounted at same curve. No expected losses and expected residual returns.
Cash Flow Cash flow fixed. Discounted using one yield curve. No expected losses and expected residual returns as cash flow is fixed. Cash flows vary by scenario but are discounted using one yield curve, giving rise to expected losses and expected residual returns.
Cash Flow Prime Cash flow fixed. Discounted using one yield curve. No expected losses and expected residual returns as cash flow is fixed. Cash flow projected based on forward yield curve and discounted at same curve. No expected losses and expected residual returns.
Variable rate US government obligation
Assume a fixed rate US government obligation has a par value of $1,000, a 5% coupon and matures in one year. Its cash flows are fixed at $1,050. The Fair Value Method discounts this fixed cash flow by various rates, reflecting the potential for changes in the yield curve that is, changes in the fair value of those cash flows. These different discount rates give rise to variability in fair values, resulting in expected losses and expected residual returns. For example, if the discount rate in one scenario was assumed to be 2%, the present value of that cash flow is $1,029 ($1,050/1.02), which gives rise to an expected residual return ($1,029 is greater than $1,000). As a further example, if the discount rate in another scenario was assumed to be 7%, the present value of that cash flow is $981 ($1,050/1.07), which gives rise to an expected loss. As indicated in the table, for a variable rate US government obligation, the Fair Value Method produces no expected losses or expected residual returns (because the rate used to project the cash flow is the same rate used to discount that cash flow). By varying the discount rate, mathematically, the sum of the present value of the probability weighted scenarios will equal the fair value of the instrument for which expected losses and expected residual returns are being computed. The Cash Flow Method produces expected losses and expected residual returns for a variable rate US government obligation because the cash flows vary by scenario, but are discounted using one forward yield curve. Conversely, for a fixed rate US government obligation, no expected losses or expected residual returns arise because the cash flows do not vary (they are fixed and there is no credit risk assumed). The Cash Flow Prime Method differs from the Cash Flow Method in that under the Cash Flow Prime Method, the cash flows for a variable rate US government obligation are projected and discounted using the same forward yield curve. As such, the Cash Flow Prime Method yields no expected losses or expected residual returns for a US government obligation, as the cash flows are fixed. While a reporting enterprise must compute expected losses and expected residual returns for an entity using only one method, the varying designs of each entity may mean that each of the methods is used by the reporting enterprises in applying the Variable Interest Models provisions. That is, the selection of a method to compute expected losses and expected residual returns is not an enterprise-wide accounting policy election that must be followed consistently for all variable interests in VIEs. The calculations under the Fair Value, Cash Flow and Cash Flow Prime Methods should be performed by: 1. Projecting, in both cases at the time of their expected distribution to variable interest holders, under a variety of probabilistic scenarios: a. The cash flows from the VIEs net assets (excluding all variable interests), and
b. The fair value of any VIE assets distributed to variable interest holders. To the extent distributed cash flows or asset values depend on future interest rates, foreign exchange rates or other factors (e.g., the price of oil), changes in those factors should be considered in making these calculations. 2. Allocating the cash flows computed in (1) to the applicable variable interest holders (or class of variable interest holders) pursuant to the VIEs contractual arrangements. 3. Discounting the cash flows computed in (1) and (2) to present value using the zero coupon risk-free rates that correspond to the cash flows of each scenario under the Fair Value Method and discounting using the same forward yield curve under the Cash Flow and Cash Flow Prime Methods. In addition, the present value of the probability-weighted cash flows should be reconciled to the fair value of the net assets and each variable interest. 4. Computing expected losses and expected residual returns for the VIEs net assets (excluding variable interests) and for each variable interest (or class of variable interests) using the net present values computed in (3). 5. Adjusting the variability computed in (4) so the sum of variability for the variable interests equals the variability for the VIE as a whole.
Effect of the application of the fair value accounting provisions in ASC 820
Question 10.17 How do the fair value provisions in ASC 820 affect the calculations of expected losses and expected residual returns? ASC 820, primarily codified from Statement 157, defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. Accordingly, the application of ASC 820s provisions generally should be considered in the measurement of fair value throughout GAAP. However, as noted in Chapter 2, the Variable Interest Model describes expected losses and expected residual returns as amounts derived from expected cash flows as described in [CON 7], and this guidance was not amended by the issuance of Statement 157. Under fair value theory, a market risk premium generally represents the compensation risk-averse market participants demand for bearing uncertainty in cash flows. Because of how expected losses and expected residual returns are defined, expected losses and expected residual returns are not fair value measurements themselves under either ASC 820 or CON 7. Therefore, we do not believe that the framework of the Variable Interest Model requires consideration of a market risk premium (as contemplated in a fair value measurement under ASC 820 and CON 7) in the computation of expected losses and expected residual returns. However, we do believe that consideration of the uncertainty in the timing and amount of the entitys cash flows themselves is an essential element of the calculation of expected losses and expected residual returns. (Said differently, while the compensation demanded for bearing the risk of cash flow uncertainty may not be included in the analysis, the uncertainty itself should be captured as it is fundamental to determining a variable interest entitys expected losses or expected residual returns under ASC 810-10.) Paragraphs 42 through 61 of CON 725 discuss two methodologies for incorporating cash flow uncertainty into a fair value measurement. The risk associated with cash flow uncertainty can be included in the discount rate (as described in the traditional approach) or in the cash flows of an expected cash flow approach.
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A similar discussion can be found in ASC 820-10-55-4 through 55-20. 205
Since an expected loss and expected residual return analysis under the Variable Interest Model is predicated on identifying discrete, possible outcomes in order to assess variability, we do not believe the traditional approach is appropriate for this analysis. Instead, we believe that the use of a risk-free interest rate is appropriate under the Variable Interest Model as, ideally, all of the cash flow uncertainty associated with the entity should be captured in the expectations of the cash flows and not the discount rate. The analysis should incorporate a number of possible outcomes sufficient to describe the full probability distribution of outcomes. Although determining the appropriate number of possible outcomes is based on professional judgment, we believe that an analysis that considers a limited number of possible outcomes (e.g., worst case, base case and best case) will, in many situations, be insufficient to capture appropriately the variability in the expected cash flows. Adequately determining the probability distribution of possible outcomes is critical to this analysis and can have a significant effect on the determination of expected losses and expected residual returns. For example, the calculation of expected losses and expected residual returns can differ significantly when the distribution of possible outcomes is performed using a less defined distribution instead of an approach that considers outcomes at a more granular level.
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Initial determination of VIE status

Consolidation Overall Recognition Initial Involvement with a Legal Entity 810-10-25-37 The initial determination of whether a legal entity is a VIE shall be made on the date at which a reporting entity becomes involved with the legal entity. For purposes of the Variable Interest Entities Subsections, involvement with a legal entity refers to ownership, contractual, or other pecuniary interests that may be determined to be variable interests. That determination shall be based on the circumstances on that date including future changes that are required in existing governing documents and existing contractual arrangements.
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The initial determination of whether an entity is a VIE is to be made on the date on which an enterprise becomes involved with the entity, which is generally when an enterprise obtains a variable interest (e.g., an investment, loan, lease, etc.) in the entity. The determination of whether an entity is a VIE and, if so, who is the entitys primary beneficiary, if any, is to be based on the circumstances that exist at the date of the assessment, including future changes that are required in existing governing documents and existing contractual arrangements. Anticipated (but not required) changes in contractual provisions should not be considered in this determination.
Is there a significance threshold in applying the Variable Interest Model?

Question 11.1 Is there a significance threshold in applying the Variable Interest Model? Prior to the adoption of Statement 167s amendments to the Variable Interest Model, an enterprise was not required to determine whether an entity with which it was involved was a VIE if it was apparent that the enterprises interest would not be a significant variable interest and if the enterprise, its related parties and its de facto agents did not participate significantly in the design or redesign of the entity. The amendments to the Variable Interest Model removed the significance threshold. The FASB concluded that the significance threshold should be removed from the Variable Interest Model because, as with all elements of the ASC, the provisions are not required to be applied to immaterial items. That is, whether an enterprise must determine if an entity is a VIE or provide the disclosures required by the Variable Interest Model should be based upon a materiality assessment. The FASB acknowledged that such an evaluation requires judgment, but believed that materiality, rather than significance, is the appropriate threshold as it is in applying all generally accepted accounting principles.
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11 Initial determination of VIE status
When considering materiality, an enterprise should consider the magnitude of its variable interest(s) or the potential VIE(s), both individually, and in the aggregate. Professional judgment should be used to determine whether a reporting enterprise may be able to avail itself of the immateriality clause.
Consideration of anticipated changes in an entitys design or activities

Question 11.2 May an enterprise consider anticipated changes in an entitys design, capitalization, or activities in determining if the entity is a VIE? The determination of whether an entity is a VIE is based on the circumstances that exist at the date of the assessment, including future changes required by existing governing documents and contractual arrangements. Anticipated changes to contractual provisions or the entitys activities should not be considered. This concept is included, in part, to ensure that variability in an entitys returns (i.e., expected losses and expected residual returns see the Interpretative guidance and Questions in Chapter 10) is not ascribed to an enterprise that does not currently hold a variable interest. Illustration 11-1: Example 1 Facts Hardco, a manufacturer of computer hardware, provides subordinated debt financing to a software company, Softco. At the date of the loan, Softcos equity investment at risk is insufficient to absorb its expected losses and, consequently, it is determined to be a VIE. Within six months of the origination of the loan, Softco is expected to complete development of and launch a new software product that Hardco and other hardware manufacturers will include in new hardware sold to end users. This will represent a new market for Softco and is expected to result in higher, and more stable, revenues than from sales of Softcos existing products. In connection with the launch of the new software product, Softco is expected to restructure its operations, including a workforce reduction, and discontinue the sale of certain existing software products. Additionally, upon launch of the new software product, Softco is expected to complete a private placement of equity securities. It is anticipated that after these events occur, Softco will no longer be a VIE. Analysis If, at the date of the loan, the restructuring of Softcos operations and the planned equity issuance are considered, Hardco may determine that Softco is not a VIE, and that it need not apply the Variable Interest Model to its investment in Softco. However, because Softco should be evaluated based on the circumstances existing as of the date of the loan, without regard to anticipated future changes in its capitalization and activities, it is a VIE, and Hardco would have to apply the Variable Interest Models provisions. Although a VIE at the date of the loan, if certain of the anticipated events occur (e.g., the anticipated equity issuance), Softcos VIE status will be reconsidered (see Interpretative guidance and Questions in Chapter 12). Changes in an entitys design or activities
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11 Initial determination of VIE status
Example 2 Facts A partnership is formed to construct and operate a commercial office building. A construction loan is obtained during the construction phase of the project, and permanent financing is expected to be obtained upon completion of the project. The construction loan is anticipated to be repaid from the proceeds of that permanent financing. Analysis In this situation, the initial determination of whether the entity is a VIE is based only on the contractual arrangements in place at inception of the venture (i.e., it should not be assumed that the permanent financing will be obtained and the construction loan will be repaid). The VIE status should be reconsidered when the construction loan is repaid and permanent financing is obtained because the contractual arrangements among the parties involved will have changed at that date (see Interpretative guidance and Questions in Chapter 12).
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Reconsideration events
Consolidation Overall Subsequent Measurement Reconsideration of Initial Determination of VIE Status 810-10-35-4 A legal entity that previously was not subject to the Variable Interest Entities Subsections shall not become subject to them simply because of losses in excess of its expected losses that reduce the equity investment. The initial determination of whether a legal entity is a VIE shall be reconsidered if any of the following occur: a. b. c. The legal entitys governing documents or contractual arrangements are changed in a manner that changes the characteristics or adequacy of the legal entitys equity investment at risk. The equity investment or some part thereof is returned to the equity investors, and other interests become exposed to expected losses of the legal entity. The legal entity undertakes additional activities or acquires additional assets, beyond those that were anticipated at the later of the inception of the entity or the latest reconsideration event, that increase the entitys expected losses. The legal entity receives an additional equity investment that is at risk, or the legal entity curtails or modifies its activities in a way that decreases its expected losses. Changes in facts and circumstances occur such that the holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entitys economic performance.
d. e.
12.1
Reconsideration of whether an entity is a VIE An entity that previously was not subject to the Variable Interest Model does not become subject to it simply because of losses that reduce the equity investment, even if they are in excess of expected losses, and even if the equity investment is reduced to zero. In other words, if the amount of the equity investment at risk at the entitys inception was determined to be sufficient, the incurrence of losses (in and of itself) does not trigger a need to reconsider whether the entity continues to have sufficient equity. The Variable Interest Model requires an enterprise to reevaluate the status of an entity as a VIE upon certain events that are listed in ASC 810-10-35-4. In providing such a list, the FASBs intention was that enterprises not be required to reevaluate whether each entity with which they are involved is a VIE at each periodic reporting date, but rather only upon the occurrence of certain significant events. An event is significant if it changes the design of the entity such that the event calls into question (1) whether the entitys equity investment at risk is sufficient or (2) whether the rights and obligations provided to holders of the entitys at-risk equity investment are characteristic of a controlling financial interest. Presumably, these types of events are occurrences of which variable interest holders in an entity will be, or should be, aware.
12 Reconsideration events
With the amendments to the Variable Interest Model in Statement 167, the FASB added an additional circumstance that requires reconsideration of whether an entity is a VIE. Under the amendments, an enterprise is required to reconsider whether an entity with which it is involved is a VIE when there are changes in facts and circumstances such that the holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entitys economic performance. The FASB added this event to address the potential situations in which the equity investor(s) lost power over an entity without triggering one of the previously enumerated reconsideration events. For example, if an entity that was previously considered a voting interest entity experienced severe losses such that another party (e.g., a guarantor or lender) obtained a controlling financial interest in the entity, the previously listed criteria may not have required a reconsideration of an entitys status. The FASB was troubled that, in this situation, the entity may not have been considered a VIE and may not have been consolidated by the party with a controlling financial interest. The addition of this provision could lead to more consolidation of borrowers by lenders in circumstances when a lender obtains power over the VIEs activities (see further discussion of troubled debt restructurings below). Upon the occurrence of a reconsideration event described above, we believe a redetermination must be made about the risks the entity is designed to create and distribute to its interest holders. The steps followed in Chapter 5 of this publication should be reperformed to determine whether there have been any changes to the risks the entity was designed to create and distribute. In addition, the amendments to the Variable Interest Model remove the previous exemption for troubled debt restructurings. Prior to the adoption of Statement 167, a troubled debt restructuring, as defined in ASC 310-40-15-5 and ASC 470-60-15-5, did not require a reconsideration of whether the entity involved is a VIE. The removal of the exemption for troubled debt restructurings could lead to more consolidation of borrowers by lenders in loan workouts that provide the lender with the power over the VIEs activities. Additionally, this amendment could expand the disclosure requirements for lenders that have variable interests in entities that become VIEs as a result of troubled debt restructurings. In removing the exception, the FASB concluded that application of the Variable Interest Model typically would identify the borrower as a VIE since economic events indicate that the entitys equity is not sufficient to permit it to finance its activities without additional subordinated financial support or a restructuring of the terms of its financing. The FASB believed removing the exemption for troubled debt restructuring will provide more relevant and reliable information to users of financial statements. The circumstances that will require an enterprise to reconsider whether an entity is a VIE will present ongoing accounting and reporting challenges. It is possible under the Variable Interest Model for entities to go in and out of VIE status as a result of events triggering the need to reassess the entitys status as a VIE. As a result, enterprises will be required to understand whether any of these events could occur and, if so, to monitor the activities of entities in which it holds variable interests. Companies must establish internal control procedures so that significant events requiring reconsideration of whether an entity is a VIE are identified on a timely basis. This may require establishing procedures for the routine receipt of information from entities in which companies holds variable interests (even if the company is not the primary beneficiary of the entity or the entity is not currently a VIE).
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Primary beneficiary reconsideration Prior to Statement 167s amendments to the Variable Interest Model, an enterprise was required to reconsider the primary beneficiary determination upon certain events. For example, the primary beneficiary of a VIE was reevaluated in the event of a change in an entitys design or capital structure and for transactions that impact the entitys equity at risk. The amendments to the Variable Interest Model eliminate the primary beneficiary reconsideration concept and effectively require a VIEs primary beneficiary to be evaluated continuously as facts and circumstances change. These ongoing assessments should not be limited to the end of each reporting period but, rather, should occur when circumstances warrant a change in an enterprises status as primary beneficiary. The FASB believes that the ongoing qualitative assessment of which enterprise, if any, is the primary beneficiary will require less effort and be less costly than the quantitative assessment previously required for determining the primary beneficiary of a VIE. Further, the FASB expects that the amendments to the requirements for determining the primary beneficiary will reduce the frequency in which the enterprise with the controlling financial interest changes. Intuitively, for the primary beneficiary to change, there must be a change in either the power or benefits. In practice, we believe that most changes to power will be evident to the party that ceases to be the primary beneficiary as a result of losing power or becomes the primary beneficiary as a result of obtaining power. Some examples of circumstances that may cause a change in the primary beneficiary include, but are not limited to: Acquisition or sale of interests that constitute a change of control Lapse of certain rights such as participating or substantive kick-out rights (e.g., a lapse in participating rights held by one party to determine the operating budget of a VIE after the first two years of a VIEs existence) Termination of contractual arrangements that conveyed power
The FASB believes that eliminating the specific reconsideration guidance and requiring ongoing assessments will provide users with more relevant and timely information about the nature of an enterprises interest(s) in a VIE and the associated risks and obligations of this interest. The amendment to require the continuous assessment of a primary beneficiary is more consistent with the application of ASC 810-10 to voting interest entities, which does not incorporate a reconsideration concept in its requirements and implicitly requires continuous consideration of whether consolidation is required. Given that the primary beneficiary analysis is required to be performed continuously, enterprises may need to establish new processes to capture shifts in power, changes in variable interests or changes to the status of de facto agent and related party relationships, in addition to those events that would qualify as a reconsideration of an entitys status as a VIE. Refer to Questions 6.8 for a discussion of reconsideration of a decision makers or service providers fees as variable interests.
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Common VIE status reconsideration events

Question 12.1 What are common events that may require the reconsideration of whether an entity is a VIE? Common reconsideration events may include the following when they, by design, change the structure of the entity (this list is not all-inclusive, and the determination of whether an event requires reconsideration of the entitys status as a VIE requires professional judgment): Additional contributions by existing equity investors Issuances of additional equity interests Returns of equity to investors (i.e., distributions in excess of earnings) Revisions to equity holders voting rights Entry into a significant new line of business that increases the entitys expected losses Purchases of guarantees or put options Significant curtailment of the entitys existing activities through sale of assets or discontinuance of a line of business Troubled debt restructuring Lapse of certain rights such as participating or substantive kick-out rights (e.g., a lapse in participating rights held by one party to determine the operating budget of a VIE after the first two years of a VIEs existence) Debt refinancings Retirement of debt at other than its contractual maturity date Entry into agreements with service providers Revisions to significant service contracts Leases of significant new assets Revisions to existing lease terms, including those that result in a new lease pursuant to ASC 840 Significant acquisitions of new assets Bankruptcy Acquisition or sale of interests that constitute a change of control Termination of contractual arrangements that conveyed power
Any of the above may trigger a need to reconsider whether an entity is a VIE if the event represents a significant change in the design of the entity in a manner that calls into question whether (1) the entitys at-risk equity investment is sufficient or (2) the rights and obligations provided to holders of the entitys at-risk equity investment are characteristic of a controlling financial interest. Nonsubstantive changes or events do not trigger the need for reconsideration. Judgment will be needed to determine whether an event is a significant occurrence requiring reconsideration of the entitys status.
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Design of an entity should be reconsidered

Question 12.2 Should the design of an entity be reconsidered upon the occurrence of a reconsideration event as described above? Yes. We believe that upon a reconsideration event, the steps outlined in the Interpretative guidance section of Chapter 5 of this publication should be reperformed because which risks the entity was designed to create and distribute to its interest holders must be redetermined. The status of the entity as a VIE and its primary beneficiary (if the entity is determined to be a VIE) also should be reconsidered. Careful consideration of the facts and circumstances for each entity will be necessary in determining whether there has been a change in the purpose and (or) design of an entity.
Conversions of accounts receivables into notes

Question 12.3 Vendors may, from time to time, convert past due trade accounts receivable from a customer into an interest bearing note receivable. Are such conversions reconsideration events? We believe that substantial conversions may constitute a reconsideration event if the entitys contractual arrangements are changed in a manner that changes the characteristics or adequacy of the entitys equity investment at risk. Prior to the adoption of Statement 167, such conversions generally were considered analogous to a troubled debt restructuring because the vendor is trying to make the best of a bad situation resulting from the customers inability to pay according to the contractual terms. Because a troubled debt restructuring is no longer exempted from constituting a reconsideration event under the Variable Interest Model, we believe that the conversion of past due trade accounts receivable could be an event requiring reconsideration of whether an entity is a VIE in certain circumstances.
Transfer of an entitys debt between lenders

Question 12.4 Would the transfer of an entitys debt between lenders be a change in the entitys contractual arrangements requiring reconsideration of whether the entity is a VIE? How should the acquirer of debt consider the provisions of the Variable Interest Model? We do not believe the transfer of an entitys debt would be a change in the entitys contractual arrangements requiring reconsideration if the entity is a VIE. Based on discussions with the FASB staff, we believe the acquirer of an entitys debt should look to the original design of the entity or its design at the last reconsideration event (whichever is later) to determine whether the entity is a VIE. If the entity was not a VIE upon its creation, or at the latest reconsideration date (if there was one), the acquirer of the debt would follow other GAAP to account for its investment.
Evaluation of the sufficiency of equity upon occurrence of a reconsideration event

Question 12.5 If a reconsideration event occurs, should the sufficiency of the entitys at-risk equity investment be evaluated based on carrying value or fair value? We believe fair value should be used to evaluate the sufficiency of an entitys at-risk equity investment (see the Interpretative guidance and Questions in Chapter 9 for additional discussion).
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Only substantive changes are reconsideration events

Question 12.6 Does any change to (1) an entitys governing documents or (2) the contractual arrangements among the parties involved in an entity require a reconsideration as to whether an entity is a VIE? We believe only events that substantively change the design of the entity or the ownership of variable interests in the entity such that the determination of whether (1) the entitys at-risk equity investment is sufficient or (2) the rights and obligations provided to holders of the entitys at-risk equity investment are characteristic of a controlling financial interest could require that a reconsideration of whether the entity is a VIE be performed. The amendments to the Variable Interest Model added guidance to emphasize that, for purposes of applying the Variable Interest Models provisions, only substantive terms, transactions and arrangements should be considered. Any term, transaction or arrangement that does not have a substantive effect on (a) an entitys status as a VIE, (b) an enterprises power over a VIE or (c) an enterprises obligation to absorb losses or its right to receive benefits of the entity are disregarded when applying the provisions of the Variable Interest Model. Judgment, based on consideration of all the facts and circumstances, is needed to distinguish substantive terms, transactions and arrangements from nonsubstantive terms, transactions and arrangements. Illustration 12-1: Facts A leasing company, Leaseco, is formed as an LLC and acquires four commercial office buildings for $400 million. The acquisition of the four buildings is financed with $100 million of equity contributions from Leasecos four equity investors and $300 million of senior, secured debt financing. The buildings are leased to multiple unrelated parties under operating leases based on market terms at inception of the leases. None of the leases contain residual value guarantees, purchase options or any similar features. Leaseco is determined to be a voting interest entity at its inception. During the third year of its existence, because of an increase in the fair value of a building, Leaseco refinances the debt. The proceeds are distributed to the equity owners of Leaseco. Analysis We believe the refinancing is an event requiring reconsideration of whether Leaseco is a VIE because it represents a change in the contractual arrangements among the parties involved in Leaseco that could change the determination of whether the entitys at-risk equity investment is sufficient. Additional facts After four years, a lease is modified to extend its term from an original ten year period to a twelve year period. Periodic rental payments due and other significant terms of the lease are unchanged. Analysis In this example, the extension of the lease period results in a new lease pursuant to ASC 840. Accordingly, the variable interest holders should reconsider whether Leaseco is a VIE. Additional facts During its fifth year of existence, Leaseco purchases another building and enters into an additional leasing arrangement with an unrelated third party. The acquisition of the building is a significant asset acquisition, significantly increasing Leasecos expected losses. Evaluating events as reconsideration events
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Analysis Because the acquisition is significant and significantly increases the entitys expected losses, which could change the determination of whether the entitys at-risk equity investment is sufficient, we believe Leaseco should be reconsidered as a potential VIE. Additional facts After six years of operations, the governing documents of Leaseco are modified to reflect a change in the way in which the equity investors can cast a vote. Equity investors are no longer required to be present in person to cast a vote at a board meeting but instead can do so via a conference call. Analysis Although this is a contractual change, it is not a substantive change to the design of the entity and, accordingly, there would be no need to reconsider whether the entity is a VIE. Additional facts After 10 years of operations, the equity holders agree to restructure Leaseco into a limited partnership. In connection with the restructuring, the partnership refinances the debt and issues additional equity to new investors. Analysis In this case, the restructuring of the entity would constitute a substantive change in the design of the entity requiring a reconsideration of whether the entity is a VIE.
Asset acquisitions and dispositions

Question 12.7 Does any asset acquisition or disposition require a reconsideration of whether an entity is a VIE? We believe that only acquisitions and dispositions of assets that result in a change to the design of the entity or significantly change the entitys expected losses are reconsideration events. Acquisitions and dispositions are significant and require reconsideration only if it could change the determination of whether (1) the entitys at-risk equity investment is sufficient or (2) the rights and obligations provided to holders of the entitys at-risk equity investment are characteristic of a controlling financial interest. For example, an entity that acquires office furniture for a headquarters facility may have acquired assets that are, in the aggregate, material to its balance sheet, but those assets will not generally significantly increase the entitys expected losses. Accordingly, no reconsideration event has occurred. In contrast, an entity that acquires an asset that significantly increases the entitys expected losses should be subject to reconsideration as a potential VIE.
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Asset acquisitions and dispositions as reconsideration events
A leasing company, Leaseco, is formed as an LLC and acquires two commercial office buildings for $200 million. The acquisition of the two buildings is financed with $100 million of equity contributions from Leasecos equity investors and $100 million of senior, secured debt financing. At the end of five years, Leaseco borrows $100 million from an unrelated lender and uses the proceeds to acquire an additional office building. The purchase of the office building significantly increases Leasecos expected losses. Analysis In this example, at the end of the fifth year, the variable interest holders in Leaseco should reconsider whether Leaseco is a VIE because the acquisition of the additional office building is a significant asset purchase that has increased the entitys expected losses and could change the determination as to whether Leasecos at-risk equity investment is sufficient. It should be noted that if the $100 million borrowing and related asset met the qualifications to be considered a silo (see Questions in Chapter 7), the variable interest holders in Leaseco would not be required to reconsider whether Leaseco is a VIE. The acquisition of the additional office building, although significant, does not increase the entitys expected losses (because expected losses related to siloed assets are not considered expected losses of the larger entity). Additional facts During year eight, two of the three buildings are sold at a substantial gain, and the proceeds from the sales are distributed in their entirety to Leasecos equity investors in accordance with the contractual arrangements among the investors. Analysis This is an event requiring reconsideration of whether Leaseco is a VIE. The sale of the buildings is a significant curtailment of the entitys activities, decreasing the entitys expected losses and potentially changing the determination of whether the entitys equity investment at risk is sufficient. Additionally, the distribution may represent a reconsideration event (see Question 12.8).
Distributions to equity holders

Question 12.8 Do all distributions to an entitys equity holders require a reconsideration of whether the entity is VIE? No. We believe a reconsideration of whether an entity is a VIE is required only if a return of equity is made that is in excess of earnings such that other variable interest holders become exposed to expected losses as a result of the distribution, thus calling into question whether the entitys remaining at-risk equity investment is sufficient. As a result, we believe returns on equity may be distributed without triggering the requirement to reconsider whether an entity is a VIE.
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Distributions to equity holders as reconsideration events
A leasing company, Leaseco, is formed as an LLC and acquires commercial office buildings to be leased to multiple unrelated parties under operating leases based on market terms at inception of the lease. At the end of five years, the LLC begins to annually dividend 80% of its annual net income to its members. Analysis These dividends represent distributions of returns on equity to the LLC equity holders. Accordingly, we believe the distributions would not trigger a requirement to reconsider whether the entity is a VIE. Additional facts At the end of eight years, Leaseco refinances the debt and, due to the buildings appreciation in fair value, is able to distribute to the LLC members an amount that exceeds the earnings of the LLC. Analysis In this example, the distribution exceeds the entitys return on equity and the lender is now exposed to more expected losses. Additionally, the loan represents a contractual change among the parties involved in the entity. Accordingly, the loan and distribution require the parties involved in the entity to reconsider whether Leaseco is a VIE.
Replacement of temporary financing with permanent financing

Question 12.9 Many entities use temporary financing when constructing assets and then obtain permanent financing when construction is completed. Is obtaining permanent financing an event requiring reconsideration of the entity as a VIE? Yes. Obtaining permanent financing by an entity that has used temporary financing is generally an event that requires reconsideration of whether the entity is a VIE. The permanent financing represents a change in the contractual agreements among the parties involved in the entity and could change the determination of whether (1) the entitys at-risk equity investment is sufficient or (2) the rights and obligations provided to the holders of the entitys at-risk equity investment are characteristic of a controlling financial interest. However, if the same lender provides the construction period financing and the permanent financing, and all significant terms of the permanent financing are contractually agreed to at the commencement of construction (including amount, interest rate, covenants, maturity date, etc.), we believe the rollover to permanent financing would not trigger a reconsideration event. Instead, the terms of the contractual arrangements and the rollover of the construction period financing to permanent financing should be considered in the initial determination of (1) whether the entity is a VIE and (2) if a VIE, the primary beneficiary.
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Refinancings as reconsideration events
An entity is formed with a temporary construction loan ($900) and equity ($100). At formation, the entity is determined to be a VIE. The proceeds from the debt and equity issuances are used to build a hotel. At the end of the construction phase, the hotels fair value is $3,000. At that time, the VIE obtains permanent financing at 80% of the hotels value ($2,400) and uses the proceeds to repay the construction loan ($900) and to make a distribution to the equity holders ($1,000). Analysis Obtaining permanent debt financing upon completion of construction is an event requiring reconsideration of whether the entity is a VIE. The replacement of the temporary financing (as well as the large distribution) is a substantive change in the contractual arrangements among the parties and could affect the determination of whether the entity is a VIE.
Adoption of accounting standards

Question 12.10 Does the adoption of new accounting standards require a reconsideration as to whether an entity is a VIE? No. We do not believe the adoption of a new accounting standard is an event requiring reconsideration of whether an entity is a VIE unless the new standard specifically requires reconsideration.
Incurrence of losses that reduce the equity investment at risk

Question 12.11 Do the losses that reduce the equity investment at risk trigger a need to reconsider whether the entity continues to have sufficient equity? No. The incurrence of losses that reduce the equity investment at risk, even if they are in excess of expected losses, and even if the equity investment is reduced to zero, does not trigger a need to reconsider whether the entity continues to have sufficient equity. In other words, if the amount of the equity investment at risk at the entitys inception was determined to be sufficient, the incurrence of losses (in and of itself) does not trigger a VIE reconsideration event. However, if an entity that previously was considered a voting interest entity experienced severe losses such that another party (e.g., a guarantor or lender) obtained a controlling financial interest in the entity, a VIE reconsideration is required.
Acquisition of a business that has a variable interest

Question 12.12 Does the acquisition of a business that holds a variable interest in an entity constitute a reconsideration event for that entity? We do not believe there has been a reconsideration event for the entity unless the entitys design has changed or one of the VIE reconsideration criteria in ASC 810-10-25-4 has been met. We generally believe that the acquisition of a business represents a transfer of variable interests between holders, which generally does not result in a change in the design of the underlying entities. That is, the transfer generally does not call into question the sufficiency of the entitys equity investment or the rights and obligations provided to the entitys at-risk equity holders. However, if the acquirer also holds a variable interest in the entity or is otherwise involved with the entity, the acquisition of a business that holds a variable interest in an entity may require reconsideration of the business scope exception for that entity if the acquiree previously has based its consolidation conclusion on that exception. See Chapter 4 for additional discussion of the business scope exception.
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As the amendments to the Variable Interest Model eliminate the primary beneficiary reconsideration concept and effectively require a VIEs primary beneficiary to be evaluated continuously as facts and circumstances change, any primary beneficiary assessments of the acquiree should be reconsidered upon acquisition as appropriate.
Bankruptcy
Question 12.13 Does filing for bankruptcy by an entity constitute a VIE reconsideration event? Generally, when an entity files for bankruptcy, the equity holders of the entity as a group lose the power from voting rights or similar rights to direct the activities of the entity that most significantly impact the entitys economic performance. Therefore, subsequent to Statement 167s amendments to the Variable Interest Model, we believe that when an entity files for bankruptcy, an enterprise should reconsider whether the entity is a VIE. In most instances, if an entity files for bankruptcy, it would be a VIE due to the lack of sufficient equity at risk, and the equity holders may lose power. In addition, it is typical that once an entity files for bankruptcy, the entity is under the control of the bankruptcy court. Therefore, if the enterprise previously consolidated the entity that filed for bankruptcy under either the voting interest or variable interest model, it is likely that the enterprise will deconsolidate the bankrupt entity as the enterprise will no longer have the power to direct the activities that most significantly impact the entitys economic performance.
Loss of power or similar rights

Question 12.14 Must there be an event for the holders of the equity investment at risk, as a group, to lose the power from voting or similar rights to direct the activities of the entity that most significantly impact the entitys economic performance? Often, there is an event that occurs for the holders of the equity investment at risk, as a group, to lose the power to direct the activities of the entity that most significantly impact the entitys economic performance. However, depending on the facts and circumstances, a loss of power or similar rights could occur through a mechanism in an agreement that defines and describes which party has the power and, if so, when that power is obtained. For example, a loan agreement may state that the lender obtains certain rights to manage the activities of the borrower if the collaterals fair value falls below the loans outstanding principal balance. Upon such an occurrence, if the lender is deemed to have obtained power to direct the activities of the borrower that most significantly impact the borrowers economic performance, then the equity holders no longer have power. However, if the loan agreement merely provides that the lender has the right to foreclose on the borrower upon an event of default, the equity holders loss of power or similar rights may not occur until the lender exercises its rights to foreclose and actually takes control of the borrower.
SEC reporting considerations following consolidation or deconsolidation after reconsideration event

Question 12.15 What are some SEC reporting considerations following the consolidation or deconsolidation of a VIE after a reconsideration event? Consistent with the discussions of the SEC Regulations Committee on 22 September 2009, an SEC registrant must consider whether it has any SEC reporting requirements following the consolidation or deconsolidation of a VIE after a reconsideration event. Refer to Questions 17.1 and 17.2 for further discussion.
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Development stage enterprises

Consolidation Overall Scope and Scope Exceptions 810-10-15-16 Because reconsideration of whether a legal entity is subject to the Variable Interest Entities Subsections is required only in certain circumstances, the initial application to a legal entity that is in the development stage is very important. Guidelines for identifying a development stage entity appear in paragraph 915-10-05-2. A development stage entity is a VIE if it meets any of the conditions in paragraph 810-10-15-14. A development stage entity does not meet the condition in paragraph 810-10-15-14(a) if it can be demonstrated that the equity invested in the legal entity is sufficient to permit it to finance the activities it is currently engaged in (for example, if the legal entity has already obtained financing without additional subordinated financial support) and provisions in the legal entitys governing documents and contractual arrangements allow additional equity investments. However, sufficiency of the equity investment should be reconsidered as required by paragraph 81010-35-4, for example, if the legal entity undertakes additional activities or acquires additional assets.
13.1
A development stage enterprise devotes substantially all of its efforts to establishing a new business and either (1) planned principal operations have not begun or (2) those operations have begun, but there has been no significant revenue generated from them. For purposes of applying the Variable Interest Model, a development stage enterprise is an entity that, if reporting using US GAAP, would prepare its financial statements in accordance with the provisions of ASC 915. In many development stage enterprises, the initial equity investment at risk of the enterprise is the amount necessary to achieve a certain goal (e.g., to develop a drug for clinical trials). Subsequent rounds of financing typically are anticipated in order to get to the next milestone (e.g., to perform the clinical trials and obtain FDA approval of a new drug). Without special provisions for determining whether to apply the Variable Interest Model, most development stage enterprises likely would be VIEs because the initial equity investment at risk (set at an amount to achieve a certain goal) will be less than the expected losses of the entity over its lifetime (because future activities must be performed to get the product ready for sale). Accordingly, the FASB provided an exception from ASC 810-10-15-14(a) such that the entitys equity at risk need only be sufficient to finance its current activities if certain conditions are met.
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13 Development stage enterprises
Development stage enterprises are not exempt from all VIE provisions
Question 13.1 Must the characteristics of a development stage enterprises equity investment at risk meet the criteria established in ASC 810-10-15-14(b) and (c)? The Variable Interest Model provides guidance on the application of the equity sufficiency criteria in the VIE determination for development stage enterprises that limits the amount of equity required to that sufficient to permit the entity to finance its current activities. Development stage enterprises are not exempt from the requirements of ASC 810-10-15-14(b) and (c) that relate to the characteristics of an equity investment at risk. Accordingly, for the consolidation of a development stage enterprise to be based upon the ownership of voting equity interests, the entitys equity investment at risk must have the characteristics of a controlling financial interest as described in ASC 810-10-15-14(b) and (c) of the Variable Interest Model.
Assessment of a development stage enterprise as a potential VIE

Question 13.2 How should a development stage enterprise be assessed to determine if it is a VIE? The Variable Interest Model provides that a development stage enterprises equity investment at risk is sufficient if (1) it can be demonstrated that the equity invested in the entity is sufficient to permit it to finance its current activities (e.g., if the entity already has obtained financing without additional subordinated financial support), and (2) provisions in the entitys governing documents and contractual arrangements allow additional equity investments (although it does not have to commit the existing equity investors, or others, to future funding). A development stage enterprise should be deemed to have sufficient equity to finance its current activities only if the equity investment at risk is sufficient to absorb the expected losses relating to the activities necessary to reach the next major milestone of its development efforts. Determining the next major milestone will be dependent upon the facts and circumstances and will require the use of professional judgment. Although this will not always be the case, for many entities the requirement for additional funding from the current investors may be tied to the achievement of the next major milestone. The equity must be demonstrated to be sufficient to absorb the expected losses of the entitys current activities through one of the methods discussed earlier (in Chapter 9). Illustration 13-1: Facts Assume that a development stage enterprise is formed to research and develop a new drug. The entity is capitalized originally with an equity investment of $1 million, which is determined to be at risk. The initial equity investment is sufficient to permit it to develop a drug that can be used in clinical trials, which is the next major milestone for the entity. Upon the commencement of clinical trials, the equity investors have an option to invest additional amounts. The characteristics of the equity investment at risk do not violate the provisions of ASC 810-10-15-14(b) or (c). Analysis Because the initial equity investment is sufficient to absorb the expected losses of the entity relating to its current activities, the contractual arrangements allow additional equity investments and the other criteria related to whether the entity is a VIE are met, the entity is not a VIE. Assessment of a development stage enterprise as a potential VIE
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13 Development stage enterprises
Reconsideration of the sufficiency of a development stage enterprises equity investment at risk

Question 13.3 When should the sufficiency of the equity investment at risk of a development stage enterprise be reconsidered? The sufficiency of a development stage enterprises equity investment at risk should be reconsidered whenever an event occurs that represents a significant change in the design of the entity in a manner that calls into question whether (1) the entitys at-risk equity investment is sufficient or (2) the rights and obligations provided to holders of the entitys at-risk equity investment are characteristic of a controlling financial interest in the entity (see Interpretative guidance and Questions in Chapter 12 of this publication). One of the events requiring reconsideration of whether an entity is a VIE is the commencement or curtailment of significant activities (see the Interpretative guidance and Questions in Chapter 12 of this publication). Accordingly, we believe the sufficiency of a development stage enterprises equity investment at risk should be reconsidered whenever the entity completes its current activities (i.e., it achieves a milestone) and commences new activities, and when the entity emerges from the development stage.
Analogies to the provisions of the Variable Interest Model for development stage enterprises
Question 13.4 May other entities analogize to the Variable Interest Models provisions relating to the sufficiency of the equity investment at risk for development stage enterprises? We believe that provisions relating to the sufficiency of the equity investment at risk for development stage enterprises are restricted to entities that prepare their financial statements in accordance with ASC 915. Accordingly, we believe it would be inappropriate for enterprises that are not within the scope of ASC 915 to analogize to these provisions.
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14
Primary beneficiary determination

Consolidation Overall Recognition Consolidation Based on Variable Interests 810-10-25-38 A reporting entity shall consolidate a VIE when that reporting entity has a variable interest (or combination of variable interests) that provides the reporting entity with a controlling financial interest on the basis of the provisions in paragraphs 810-10-25-38A through 25-38G. The reporting entity that consolidates a VIE is called the primary beneficiary of that VIE. 810-10-25-38A A reporting entity with a variable interest in a VIE shall assess whether the reporting entity has a controlling financial interest in the VIE and, thus, is the VIEs primary beneficiary. This shall include an assessment of the characteristics of the reporting entitys variable interest(s) and other involvements (including involvement of related parties and de facto agents), if any, in the VIE, as well as the involvement of other variable interest holders. Paragraph 810-10-25-43 provides guidance on related parties and de facto agents. Additionally, the assessment shall consider the VIEs purpose and design, including the risks that the VIE was designed to create and pass through to its variable interest holders. A reporting entity shall be deemed to have a controlling financial interest in a VIE if it has both of the following characteristics: a. b. The power to direct the activities of a VIE that most significantly impact the VIEs economic performance The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. The quantitative approach described in the definitions of the terms expected losses, expected residual returns, and expected variability is not required and shall not be the sole determinant as to whether a reporting entity has these obligations or rights.
Only one reporting entity, if any, is expected to be identified as the primary beneficiary of a VIE. Although more than one reporting entity could have the characteristic in (b) of this paragraph, only one reporting entity if any, will have the power to direct the activities of a VIE that most significantly impact the VIEs economic performance. 810-10-25-38B A reporting entity must identify which activities most significantly impact the VIEs economic performance and determine whether it has the power to direct those activities. A reporting entitys ability to direct the activities of an entity when circumstances arise or events happen constitutes power if that ability relates to the activities that most significantly impact the economic performance of the VIE. A reporting entity does not have to exercise its power in order to have power to direct the activities of a VIE.
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14 Primary beneficiary determination
810-10-25-38C A reporting entitys determination of whether it has the power to direct the activities of a VIE that most significantly impact the VIEs economic performance shall not be affected by the existence of kick-out rights or participating rights unless a single reporting entity (including its related parties and de facto agents) has the unilateral ability to exercise those kick-out rights or participating rights. A single reporting entity (including its related parties and de facto agents) that has the unilateral ability to exercise kick-out rights or participating rights may be the party with the power to direct the activities of a variable interest entity that most significantly impact the entitys economic performance. These requirements related to kick-out rights and participating rights are limited to this particular analysis and are not applicable to transactions accounted for under other authoritative guidance. Protective rights held by other parties do not preclude a reporting entity from having the power to direct the activities of a variable interest entity that most significantly impact the entitys economic performance. Glossary 810-10-20 Kick-Out Rights The ability to remove the reporting entity with the power to direct the activities of a VIE that most significantly impact the VIEs economic performance. Participating Rights The ability to block the actions through which a reporting entity exercises the power to direct the activities of a VIE that most significantly impact the VIEs economic performance. Protective Rights Rights designed to protect the interests of the party holding those rights without giving that party a controlling financial interest in the entity to which they relate. For example, they include any of the following: a. Approval or veto rights granted to other parties that do not affect the activities that most significantly impact the entitys economic performance. Protective rights often apply to fundamental changes in the activities of an entity or apply only in exceptional circumstances. Examples include both of the following: 1. A lender might have rights that protect the lender from the risk that the entity will change its activities to the detriment of the lender, such as selling important assets or undertaking activities that change the credit risk of the entity. Other interests might have the right to approve a capital expenditure greater than a particular amount or the right to approve the issuance of equity or debt instruments.
2. b. c.
The ability to remove the reporting entity that has a controlling financial interest in the entity in circumstances such as bankruptcy or on breach of contract by that reporting entity. Limitations on the operating activities of an entity. For example, a franchise agreement for which the entity is the franchisee might restrict certain activities of the entity but may not give the franchisor a controlling financial interest in the franchisee. Such rights may only protect the brand of the franchisor.
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Recognition 810-10-25-38D If a reporting entity determines that power is, in fact, shared among multiple unrelated parties such that no one party has the power to direct the activities of a VIE that most significantly impact the VIEs economic performance, then no party is the primary beneficiary. Power is shared if two or more unrelated parties together have the power to direct the activities of a VIE that most significantly impact the VIEs economic performance and if decisions about those activities require the consent of each of the parties sharing power. If a reporting entity concludes that power is not shared but the activities that most significantly impact the VIEs economic performance are directed by multiple unrelated parties and the nature of the activities that each party is directing is the same, then the party, if any, with the power over the majority of those activities shall be considered to have the characteristic in paragraph 810-10-25-38A(a). 810-10-25-38E If the activities that impact the VIEs economic performance are directed by multiple unrelated parties, and the nature of the activities that each party is directing is not the same, then a reporting entity shall identify which party has the power to direct the activities that most significantly impact the VIEs economic performance. One party will have this power, and that party shall be deemed to have the characteristic in paragraph 810-10-25-38A(a). 810-10-25-38F Although a reporting entity may be significantly involved with the design of a VIE, that involvement does not, in isolation, establish that reporting entity as the entity with the power to direct the activities that most significantly impact the economic performance of the VIE. However, that involvement may indicate that the reporting entity had the opportunity and the incentive to establish arrangements that result in the reporting entity being the variable interest holder with that power. For example, if a sponsor has an explicit or implicit financial responsibility to ensure that the VIE operates as designed, the sponsor may have established arrangements that result in the sponsor being the entity with the power to direct the activities that most significantly impact the economic performance of the VIE. 810-10-25-38G Consideration shall be given to situations in which a reporting entitys economic interest in a VIE, including its obligation to absorb losses or its right to receive benefits, is disproportionately greater than its stated power to direct the activities of a VIE that most significantly impact the VIEs economic performance. Although this factor is not intended to be determinative in identifying a primary beneficiary, the level of a reporting entitys economic interest may be indicative of the amount of power that reporting entity holds.
14.1
Interpretative guidance Power and benefits

Statement 167 revised the Variable Interest Model to require that an enterprise perform a qualitative analysis, rather than a quantitative analysis, to determine if it has a controlling financial interest and is therefore the primary beneficiary of a VIE. The qualitative analysis considers the purpose and design of the VIE as well as the risks that the VIE was designed to create and pass through to its variable interest holders. An enterprise is required to consolidate a VIE if it has both (a) the power to direct the activities of a VIE that most significantly impact the entitys economic performance (power) and (b) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE (benefits). Prior to Statement 167s amendments, an enterprise was required to consolidate a VIE if the enterprise had a variable interest (or interests) that absorbed the majority of the entitys expected losses, received a majority of the entitys expected residual returns or both. In most cases, an enterprise would perform a quantitative analysis of the expected losses and residual returns by calculating the variability in the fair value of the entitys net assets exclusive of its variable interests.
The FASB believes that a qualitative approach focusing on power and benefits is more effective for determining the primary beneficiary of a VIE. An evaluation under this principles-based approach will require the use of significant judgment. Power In evaluating the power criterion, an enterprise first should consider the purpose and design of the VIE and the risks that the VIE was designed to create and pass to its variable interest holders. In evaluating purpose and design, an enterprise should consider the nature of the entitys activities, including the terms of the contracts the entity has entered into, the nature of variable interests issued and how the entitys interests were marketed to potential investors. The entitys governing documents, marketing materials and contractual arrangements should be closely reviewed. The risks that the VIE was designed to create and pass to its variable interest holders may include, but are not limited to: Credit risk Interest rate risk (including prepayment risk) Foreign currency exchange risk Commodity price risk Equity price risk Operations risk
Refer to Chapter 5 for further discussion on the evaluation of the purpose and design of a VIE and the risks that a VIE is designed to create and pass to its variable interest holders. Prior to the adoption of Statement 167, many enterprises may not have considered where power rests within the VIEs that they were involved with. We believe that it will be critical for an enterprise to establish a disciplined approach in evaluating the power criterion. To assess power, an enterprise must identify which activities most significantly impact the VIEs economic performance. Those activities may differ by the type of entity being analyzed. Generally, some subset of the total activities and decisions made within an entity would be considered significant. Additionally, particular care should be given to ensure the activities identified are part of the VIE being evaluated for consolidation and are not activities outside of the entity.26 In assessing which activities are significant, it may be helpful to consider how the activities of the VIE affect fair value, revenues, margins or cash flows of the VIE. After the activities that are considered to have the most significant impact on the VIEs economic performance have been identified, an enterprise should evaluate whether it has power to direct those activities. Power may be exercised through the voting rights of the equity holders, the board of directors (on behalf of the equity holders), a management contract or other arrangements. An enterprises ability to direct the activities of a VIE when circumstances arise or events occur constitutes power if that ability relates to the activities that most significantly impact the economic performance of the VIE. It is important to note that an enterprise does not actively have to exercise its power in order to have power to direct the activities of an entity. We believe that virtually all entities have some level of decision-making and that few, if any, are on auto-pilot. As more fully discussed below, involvement in the design of an entity may indicate that an enterprise had the opportunity and incentive to establish arrangements that result in the enterprise being the party with the power. However, that involvement in isolation does not establish that enterprise as the enterprise with the power. For entities with a limited range of activities, such as certain securitization entities or other special-purpose entities, we believe that power should be determined based on how that limited range of activities is directed.
26
See speech made by Wesley R. Bricker at the 2010 AICPA National Conference on Current SEC and PCAOB Developments available at www.sec.gov. 227
In some limited circumstances, an enterprise may conclude that no one party has the power over a VIE. To illustrate one such scenario in which no party has the power, assume that three unrelated parties form a venture (which is a VIE) to manufacture, distribute and sell beverages. Each party has one-third of the voting rights and each has one seat on the board of directors. The board of directors hires a management team to carry out the day-to-day operations of the venture. All significant decisions are taken to the board of directors for approval. Decisions are made by the board of directors based on majority vote. Under this fact pattern, the VIE does not have a primary beneficiary as no one party has the power to direct the activities that most significantly impact the economic performance of the entity. Refer to the Shared power heading below for a discussion on when power within an entity may be shared. The following is a summary of certain examples included in ASC 810-10 illustrating the application of the Variable Interest Model. Refer to ASC 810-10-55-93 through 55-205 for all examples in their entirety. Illustration 14-1: Power
Power-Example 1 (Securitization) Assume a VIE that is financed with debt and equity uses the proceeds from its financing to purchase commercial mortgage loans from a Transferor. The primary purposes for which the entity was created were to (1) provide liquidity to the Transferor and (2) provide investors with the ability to invest in a pool of commercial mortgage loans. The entity was marketed to debt investors as an entity that would be exposed to the credit risk associated with the possible default by the borrowers with respect to principal and interest payments with the equity tranche designed to absorb the first dollar risk of loss. The Transferor retains primary servicing responsibilities, which are administrative in nature and include remittance of payments on the loans, administration of escrow accounts and collections of insurance claims. Upon delinquency or default by the borrower, the responsibility for administration of the loan is transferred from the Transferor to the Special Servicer (the equity holder). The Special Servicer, as the equity holder, also has the approval rights for budgets, leases and property managers of foreclosed properties. The economic performance of the entity is impacted most significantly by the performance of its underlying assets. Thus, the activities that most significantly impact the entitys economic performance are the activities that most significantly impact the performance of the underlying assets. Therefore, the Special Servicers ability to manage the entitys assets that are delinquent or in default provides the Special Servicer with the power. Power-Example 2 (Asset-backed collateralized debt obligation) Assume a VIE that is financed with debt and equity uses the proceeds from its financing to purchase a portfolio of asset-backed securities with varying tenors and interest rates. The equity tranche is held 35% by the manager of the entity (Manager) and 65% by a third-party investor. The primary purposes for which the entity was created were to (1) provide investors with the ability to invest in a pool of asset-backed securities, (2) earn a positive spread between the interest that the entity earns on its portfolio and the interest paid to debt investors and (3) generate management fees for the Manager. The entity was marketed to potential debt investors as an investment in a portfolio of asset-backed securities with exposure to the credit risk associated with the possible default by the issuers of the asset-backed securities in the portfolio and to the interest rate risk associated with the active management of the portfolio. The equity tranche was designed to absorb first dollar risk of loss and receive any residual returns from a favorable change in interest rates or credit risk.
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The assets of the entity are managed with the parameters established by the underlying trust documents. The parameters provide the Manager with the latitude to manage the entitys assets while maintaining an average portfolio rating of single B-plus or higher. If the average rating of the portfolio declines, the entitys governing documents require that the Managers discretion in managing the portfolio be curtailed. The third-party equity investor has rights that are limited to administrative matters. The economic performance of the entity is impacted most significantly by the performance of the entitys portfolio of assets. Thus, the activities that most significantly impact the entitys economic performance are the activities that most significantly impact the performance of the portfolio of assets. Therefore, the Managers ability to manage the entitys assets within the parameters of the trust documents provides the Manager with the power. Power-Example 3 (Lease) Assume a VIE that is financed with five-year fixed-rate debt and equity uses the proceeds from its financing to purchase property to be leased to a lessee with an AA rating. The lease has a five-year term and is classified as a direct finance lease by the lessor and as an operating lease by the lessee. However, the lessee is considered the owner of the property for tax purposes and, thus, receives tax depreciation benefits. Additionally, the lessee is required to provide a first-loss residual value guarantee for the expected future value of the leased property at the end of the five years (the option price) up to a specified percentage of the option price, and it has a fixed-price purchase option to acquire the property for the option price. If the lessee does not exercise the fixed-price purchase option at the end of the lease term, the lessee is required to remarket the property on behalf of the entity. The lessee is entitled to the excess of the sales proceeds over the option price. The primary purpose for which the VIE was created was to provide the lessee with the use of the property for five years with substantially all of the rights and obligations of ownership, including tax benefits. The entity was marketed to potential investors as an investment in a portfolio of AA-rated assets collateralized by leased property that would provide a fixed-rate return to debt holders equivalent to AA-rated assets. The return to the equity investors is expected to be slightly greater than the return to the debt investors because the equity is subordinated to the debt. The residual value guarantee transfers substantially all of the risk associated with the underlying property to the lessee, and the fixed-price purchase option effectively transfers substantially all of the rewards from the underlying property to the lessee. The entity is designed to be exposed to the risks associated with a cumulative change in fair value of the leased property at the end of five years as well as credit risk related to the potential default by the lessee of its contractually required lease payments. The governing documents for the entity do not permit the entity to buy additional assets or sell existing assets during the five-year holding period, and the terms of the lease agreement and the governing documents for the entity do not provide the equity holders with the power to direct any activities of the VIE. The economic performance of the VIE is significantly impacted by the fair value of the underlying property and the credit of the lessee. The lessees maintenance and operation of the leased property has a direct effect on the fair value of the underlying property, and the lessee directs the remarketing of the property. Therefore, the lessee has the power. Benefits In evaluating whether an enterprise has satisfied the benefits criterion, the use of professional judgment will be required to determine whether the benefits could potentially be significant to the VIE. An enterprise should consider all facts and circumstances regarding the terms and characteristics of the variable interest(s), the design and characteristics of the VIE and the other involvements of the enterprise with the VIE. Benefits can be current benefits or future benefits. The FASB decided not to
provide additional guidance or bright-lines on determining whether an enterprise has satisfied the benefits criterion. The FASB noted that if an enterprise concludes that it does not have a variable interest in an entity, then it would not meet this criterion. We believe that if an interest meets the definition of a variable interest,27 it would often represent an obligation or benefit that could potentially be significant to the VIE. Additionally, we believe that if an enterprise has a variable interest in a VIE, the presumption should be that the enterprise has satisfied the benefits criterion as we believe that it will be uncommon that an enterprise would conclude that it has a variable interest but does not have benefits. Refer to Chapter 6 for guidance on assessing whether fees paid to a decision maker or a service provider represent a variable interest.
Consideration of both the power and benefits criterion

Question 14.1 In determining which party is the primary beneficiary of a VIE, must the primary beneficiary meet both of the criterion in ASC 810-10-25-38A (i.e., power and benefits)? Yes. An enterprise has a controlling financial interest in a VIE only if it has both of the following characteristics: The power to direct the activities of a VIE that most significantly impact the VIEs economic performance (power) The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE (benefits)
While the primary beneficiary must have both power and benefits, the primary beneficiary need not have both the obligation to absorb losses and the right to receive benefits. Either the obligation to absorb losses or the right to receive benefits constitutes benefits. For example, if an enterprise has power and has provided a significant guarantee on assets or obligations of the VIE, it is the primary beneficiary even though it may not be entitled to receive any upside. Similarly, if an enterprise has power and has the right to receive upside but has no obligation to absorb losses, it is the primary beneficiary.
Multiple primary beneficiaries

Question 14.2 Can a VIE have more than one primary beneficiary? No. ASC 810-10-25-38A states that [o]nly one reporting entity, if any, is expected to be identified as the primary beneficiary of a VIE. Although more than one reporting entity could have the characteristic in (b) of this paragraph, only one reporting entity if any, will have the power to direct the activities of a VIE that most significantly impact the VIEs economic performance. While more than one enterprise could meet the benefits criterion, only one enterprise can have the power. Given that more than one enterprise may evaluate a VIE for consolidation, it is possible that different enterprises may make different judgments when identifying the primary beneficiary. The FASB has acknowledged that inconsistent application of the Variable Interest Model among parties with interests in the same entity could result. However, as noted in the Basis for Conclusions to Statement 167, the Board believes that if (a) the information used in the assessment is complete and accurate and (b) the
27
See Chapter 5 for further discussion of variable interests. 230
analyses of the pertinent factors and characteristics of both the variable interests and the variable interest entity are performed using sound judgment, then the risk of inconsistency should be mitigated to an acceptable level.
Effect of the variable interest determination on the primary beneficiary analysis

Question 14.3 Must the primary beneficiary of a VIE have a variable interest in the VIE? Yes. The Variable Interest Model indicates that [a] reporting entity shall consolidate a VIE when that reporting entity has a variable interest (or combination of variable interests) that provides the reporting entity with a controlling financial interest on the basis of the provisions in ASC 810-10-25-38A through 25-38G [emphasis added]. Additionally, Statement 167s Basis for Conclusions states that a party cannot be the primary beneficiary of an entity if that party does not hold a variable interest in the entity. Therefore, if an enterprise concludes that it does not have a variable interest in an entity, we believe that the enterprise is not required to evaluate the provisions of the Variable Interest Model further to account for its interest. This includes determining whether the enterprise is the primary beneficiary of the entity and whether the enterprise is subject to the disclosure provisions of the Variable Interest Model. Additionally, we believe that for purposes of the primary beneficiary determination, an enterprise must receive power and benefits through a variable interest or a combination of variable interests. If, for example, an enterprise has power, but its power does not come through a variable interest (e.g., a decision maker fee that does not meet the criteria in ASC 810-10-55-37 and 55-38 to be a variable interest), then the enterprise would conclude that it is not the primary beneficiary. Refer to Question 6.7 for further discussion.
Entities with no substantive decision-making

Question 14.4 Are there entities for which there is no substantive decision-making? We believe that there are few structures that provide for no substantive decision-making. That is, we believe that virtually all entities have some level of decision-making and that few, if any, are on autopilot. However, entities with limited decision-making require additional scrutiny to determine which party has the power. In doing so, careful consideration is required regarding the purpose and design of the entity. In addition, the evaluation of power may require an analysis of the decisions made at inception of the entity, including a review of the entitys governing documents, as the activities at formation may affect the determination of power. For entities with a limited range of activities, such as certain securitization entities or other special-purpose entities, we believe that power should be determined based on how that limited range of activities was established and directed. For entities with limited decision-making, the following considerations may be relevant: An enterprises ability to direct the activities of a VIE only when specific circumstances arise or events occur may constitute power if that ability relates to the activities that most significantly impact the economic performance of the VIE. Refer to Question 14.14 for an example of power when circumstances arise or events happen An enterprise does not actively have to exercise its power in order to have power to direct the activities of an entity Involvement in the design of an entity may indicate that an enterprise had the opportunity and incentive to establish arrangements that result in the enterprise being the party with the power The magnitude of the disproportionality, if any, between an enterprises obligation to absorb losses or its right to receive benefits compared to its stated power the greater the enterprises obligation
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to absorb losses or receive benefits, the more likely that it would be incented to have the power over the enterprise. Accordingly, a conclusion that an entity with the obligation to absorb significant losses or the right to receive significant benefits does not have power should be evaluated carefully
Consideration of related parties in the primary beneficiary determination

Question 14.5 How should related parties and de facto agents be considered in determining which party is the primary beneficiary? In evaluating whether an enterprise is the primary beneficiary of a VIE, an enterprise first determines whether it has power and benefits. If the enterprise meets the requirements to be the primary beneficiary under the power and benefits criteria, the enterprise does not evaluate the related party provisions of the Variable Interest Model (i.e., ASC 810-10-25-44) further. However, if an enterprise concludes that no party alone has power and benefits, but, as a group, the enterprise and its related parties (including de facto agents) (see Chapter 15) have those characteristics, an enterprise then considers the related party provisions of the Variable Interest Model in determining the primary beneficiary (see Chapter 16). In that circumstance, the member of the related party group that is most closely associated with the VIE is the primary beneficiary.
Relationship of the assessment of power in the VIE determination vs. the primary beneficiary determination
Question 14.6 Are the activities that most significantly impact the economic performance in the assessment of power in the VIE determination the same as those in the assessment of power in the primary beneficiary determination? Yes. The Variable Interest Model requires that, as a group, the holders of the equity investment at risk have the power to direct the activities of an entity that most significantly impact the entitys economic performance. Otherwise, the entity is a VIE. Likewise, when evaluating whether an enterprise is the primary beneficiary of a VIE, the enterprise also must have the power to direct the activities of an entity that most significantly impact the entitys economic performance. We believe that the identified activities that most significantly impact an entitys economic performance would be the same for the purposes of the VIE determination (ASC 810-10-15-14(b)(1)) and the determination of the primary beneficiary.
Reconsideration of which party has the power

Question 14.7 As the party with the power to direct the activities of an entity that most significantly impacts the entitys economic performance changes, should an enterprise reconsider which party is the primary beneficiary of the VIE? Yes. Statement 167 amended the Variable Interest Model to eliminate the primary beneficiary reconsideration concept. Therefore, the Variable Interest Model effectively requires a VIEs primary beneficiary to be evaluated continuously as facts and circumstances change. Some examples of circumstances that may cause a change in the primary beneficiary include, but are not limited to, the following: Acquisition or sale of interests that constitutes a change of control Lapse of certain rights such as participating or substantive kick-out rights (e.g., a lapse in participating rights held by one party to determine the operating budget of a VIE after the first two years of a VIEs existence) Termination of contractual arrangements that conveyed power
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Refer to Question 14.25 for further discussion of different parties having power over the entitys life cycle.
Examples where no party has the power

Question 14.8 What are examples of situations in which no party has the power over a VIE? The following are examples of situations in which no party has the power over a VIE: Power is shared amongst parties such that mutual consent of each party sharing power is required to make decisions that most significantly impact the economic performance of the entity (refer to the section below on Shared power for additional discussion) Power is not shared, but the activities that most significantly impact the VIEs economic performance are directed by multiple parties, with each party directing the same activities, and no party has the power over the majority of the activities (refer to the section below on Shared power for additional discussion) Power is conveyed through the board of directors of an entity, and no one party controls the board of directors
The above listing may not be all-inclusive. Additionally, in each of the above circumstances, to the extent that an enterprise has a related party or de facto agent with involvement in a VIE, it may be necessary for the enterprise to evaluate the related party provisions of the Variable Interest Model to determine which party should consolidate the VIE (refer to Question 14.5 for further discussion).
Power under the Variable Interest Model vs. control for voting interest entities
Question 14.9 Does the power to direct the activities of an entity that most significantly impact the economic success of an entity under the Variable Interest Model equate to control for voting interest entities? No. While the concepts of power and control have their similarities, we do not believe that the two concepts are necessarily synonymous. Control for voting interest entities generally is based upon whether an enterprise owns more than 50% of the outstanding voting shares of an entity. For other entities such as partnerships, the general partner is presumed to control an entity unless certain rights (i.e., substantive kick-out or participating rights) are held by the limited partners. For voting interest entities, there is not a requirement to identify which decisions are most significant. Rather, there is a rebuttable presumption that the controlling party has the unilateral ability to make all significant decisions. In determining whether an entity is a VIE, an enterprise must evaluate whether the equity holders, as a group, have the ability to make decisions that most significantly impact the entitys economic performance. Not all activities of an entity will have a significant impact on the economic performance of the entity. This concept requires an enterprise to identify the most significant decisions from the population of all decisions that may affect an entity. As such, we generally believe that power would be based upon the ability to make decisions on a subset of the total activities and decisions made within an entity. Additionally, we believe that the identified activities that most significantly impact an entitys economic performance would be the same for the purposes of the VIE determination (ASC 810-10-15-14(b)(1)) and the determination of the primary beneficiary.
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It is important to note that, for the purpose of determining the primary beneficiary of a VIE, it is possible that an enterprise may be the primary beneficiary of a VIE without having the power to direct all activities that most significantly impact economic performance. ASC 810-10-25-38E indicates if the power rests with multiple unrelated parties, and the nature of the activities that each party is directing is not the same, then an enterprise should identify which party has the power over the activities that are most significant.
Power to significantly impact the entitys economic performance

Question 14.10 In evaluating the power criterion, should the activities that represent power be only those that significantly impact the economic benefits absorbed by the equity holders, or those that significantly impact the economic benefits absorbed by all variable interest holders? In evaluating the power criterion, an enterprise first should consider the purpose and design of the VIE and the risks that the VIE was designed to create and pass to all its variable interest holders. In evaluating purpose and design, an enterprise should consider the nature of the entitys activities, including the terms of the contracts the entity has entered into, the nature of all variable interests issued and how the entitys interests were marketed to potential investors. To assess power, an enterprise must identify which activities most significantly impact the VIEs economic performance. Those activities may differ by the type of entity being analyzed. While the Variable Interest Model does not define economic performance, it does indicate that the evaluation of power is with respect to the entitys economic performance. Therefore, in evaluating the power criterion, all activities that significantly impact the entitys economic performance should be considered regardless of which variable interest holder(s) the benefits inure to.
Evaluating rights held by the board of directors and an operations manager in an operating venture
Question 14.11 In many operating ventures, the venture is governed by a board of directors with an operations manager performing certain day-to-day functions. In these circumstances, how should an enterprise assess whether the equity holders have power (through their representation on the board of directors) or the manager has power? To assess power, an enterprise must identify which activities most significantly impact the VIEs economic performance based upon the purpose and design of the entity. Power may be exercised through the voting rights of the equity holders, the board of directors (on behalf of the equity holders), a management contract or other arrangements. In many operating ventures, decision-making over certain activities may rest with the board of directors, while decision-making over other activities may rest with an operations manager. In these circumstances, it may be challenging to assess whether the board of directors or the manager has the power over the VIE. To illustrate through a possible scenario, assume that an operating venture (a VIE) is formed by two unrelated equity investors to distribute a product to an unrelated third party. Each equity investor receives one seat on the ventures board of directors, with all board decisions requiring a unanimous vote of the two board members. The two venture partners decide to hire an unrelated third party with distribution management experience to manage the day-to-day operations of the venture. Assume that the operations manager has a variable interest in the venture through the fees it receives as a manager. After giving consideration to the purpose and design of the entity, assume that there are three activities that most significantly impact the ventures economic performance: financing decisions, capital decisions and operating decisions. The board of directors makes all financing and capital decisions and thus has power over those activities. The board of directors approves the operating budget. However, the
operating manager makes day-to-day decisions with respect to carrying out the operating budget and has certain latitude with respect to decisions including product procurement, product pricing, contract negotiation, hiring/firing line employees, etc. In these circumstances, determining whether the board of directors has power over operating decisions (through the budgeting process) or whether the operations manager has power over operating decisions (through day-to-day management) will require judgment. In making this assessment, relevant considerations may include, but may not be limited to, the following: The amount of detail set forth in the operating budget (greater detail may suggest that power rests with the board of directors). For example, if the budget is sufficiently detailed to effectively constrain the activities of the operating manager within the budget, then power over operating decisions may rest with the board of directors. It would be more likely that an operating budget that includes budgeted sales by product type and budgeted costs by department would effectively constrain the decision-making of an operating manager than a one-page operating budget containing a single line for sales and limited number of expense line items. The frequency and manner in which a comparison of the budget to actual results is reviewed by the board of directors (greater frequency and rigor in the review process may suggest that power rests with the board of directors). For example, if the budget reviews occur frequently, it may serve effectively to constrain the decision-making of the operating manager, which would indicate that power over operating decisions rests with the board of directors. It would be more likely that a monthly review of the operating budget to actual results by the board of directors would serve to constrain the operating manager than a review that occurs annually. Additionally, it would be more likely that the board of directors has power when protocols are in place forcing the operating manager to report budget deviations of 1% to the board of directors for resolution rather than deviations of 20%. The ability for the budget to be changed. The ability for the board of directors to make changes to the budget may suggest that power rests with the board of directors and may suggest that activities of the operating manager are constrained by the budgeting process. The manner in which the budget is prepared and reviewed. If the board of directors has significant involvement in the budgetary preparation and approval process, it may be more likely that power over operating decisions rests with the board of directors. If the operating manager is responsible for the budget preparation, then the involvement of the board of directors in the review process may provide insight into the party with power over operating decisions. For example, an on-site review process that spans multiple days and results in meetings with numerous management personnel might be more indicative of the budgeting process constraining the operating activities of the manager than a review that takes place remotely with little to no contact with the operations manager.
Careful evaluation of the facts and circumstances of each arrangement will be necessary. While none of these considerations are individually, or collectively, intended to be determinative, they may prove useful in evaluating power in similar arrangements. Continuing with the illustration above, if it is determined that the board of directors has power over the operating decisions, then neither equity holder would have power over the venture, as decision-making at the board of directors is shared. On the other hand, if it is determined that power over operating decisions rests with the operating manager, then further consideration is necessary to determine whether the operating manager would be the primary beneficiary of the venture because the board of directors (on behalf of the equity holders) direct capital and financing decisions (see additional discussion below when power to direct different activities rests with different parties).
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Concept of could potentially be significant in the determination of the primary beneficiary

Question 14.12 How should an enterprise evaluate could potentially be significant in the determination of whether an enterprise has benefits in the primary beneficiary assessment? We believe that the assessment of significance as part of the primary beneficiary determination contemplates possible outcomes over the life of the entity. In other words, we believe that a consideration of the likelihood or probability of the outcome generally is not relevant for this assessment. The FASBs use of the phrase could potentially be significant implies that the threshold is not what would happen, but what could happen. Accordingly, an enterprise would meet the benefits criterion if it could absorb significant losses or benefits, even if the events that would lead to such losses or benefits are not expected. That is, an enterprise would meet the benefits criterion if it could absorb significant losses or benefits in remote (yet possible) scenarios.
Quantitative analysis of benefits

Question 14.13 Do the provisions of the Variable Interest Model require a quantitative assessment of benefits in determining which party is the primary beneficiary? An enterprise is not required to perform a quantitative assessment of benefits in determining which party is the primary beneficiary. Statement 167 revised the Variable Interest Model to require that an enterprise perform a qualitative analysis, rather than a quantitative analysis, to determine if it has a controlling financial interest and is therefore the primary beneficiary of a VIE. Prior to Statement 167s amendments, an enterprise was required to consolidate a VIE if the enterprise had a variable interest (or interests) that absorbed the majority of the entitys expected losses, received a majority of the entitys expected residual returns or both. In most cases, an enterprise would perform a quantitative analysis of the expected losses and residual returns by calculating the variability in the fair value of the entitys net assets exclusive of its variable interests. While the requirement to perform a quantitative assessment to determine the primary beneficiary of a VIE has been amended, we believe that it may be relevant to consider a quantitative assessment in certain circumstances. For example, an enterprise that has previously performed a quantitative analysis to determine the primary beneficiary of a VIE may find that analysis useful in assessing whether the enterprise has benefits subsequent to Statement 167s amendments. Additionally, an enterprise may be able to demonstrate that it does not have benefits and thus is not the primary beneficiary through a quantitative analysis. ASC 810-10-25-38A(b) also indicates that [t]he quantitative approach described in the definitions of the terms expected losses, expected residual returns, and expected variability is not required and shall not be the sole determinant as to whether an enterprise has these obligations or rights. Thus, while not determinative, we believe that the concepts of expected losses and residual returns may be a relevant element of consideration in evaluating whether an enterprise receives benefits from the entity.
Power when circumstances arise or events happen

Question 14.14 Could you provide an example of power that is based upon the occurrence of circumstances or events? In evaluating the power criterion, an enterprise first should consider the purpose and design of the VIE and the risks that the VIE was designed to create and pass to its variable interest holders. To assess power, an enterprise must identify which activities most significantly impact the VIEs economic performance. Generally, some subset of the total activities and decisions made within an entity would be considered significant.
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ASC 810-10-25-38B indicates that [a] reporting entitys ability to direct the activities of an entity when circumstances arise or events happen constitutes power if that ability relates to the activities that most significantly impact the economic performance of the VIE. A reporting entity does not have to exercise its power in order to have power to direct the activities of a VIE. To illustrate, in many receivable securitization structures, the securitizations economic performance is impacted most significantly by the performance of its underlying assets. Generally, the investors are exposed to the credit risk associated with the possible default by the underlying borrowers with respect to principal and interest payments. Therefore, if the purpose and design indicates that the entitys most important activity is to manage the assets when they become delinquent, the enterprise may determine that the party with the ability to manage the entitys assets upon default is the primary beneficiary. The decision-making by the party that has power is subject to the event of default occurring. Notwithstanding the fact that defaults may not yet have occurred and this power has not been exercised, the party that has the current right to make these decisions has the power. While the provisions of ASC 810-10-25-38B are applicable to all arrangements, we believe that these provisions may be more relevant to entities in which decision-making is limited.
Power when circumstances arise or events happen vs. protective rights

Question 14.15 How should an enterprise distinguish between power exercisable upon future circumstances and protective rights? In certain circumstances, an enterprises ability to direct the activities of an entity when circumstances arise or events happen may constitute power. However, protective rights (as discussed further below) do not constitute power and do not preclude another enterprise from having power. To illustrate, assume that a special servicer in a receivable securitization has the ability to manage the entitys assets at the point in time when the receivables become delinquent or are in default. The rights of the special servicer are current rights over decisions that are expected to occur and are necessary for the entity to carry out its purpose and design. Thus, these rights would be relevant in the assessment of which party has the power, and, in many cases, the special servicer will be the primary beneficiary. Alternatively, a lender to the servicing arrangement may have the right to remove the servicer upon the servicers breach of contract and to take over the servicing responsibilities. This type of right generally would not be viewed as a current right as the servicers breach of contract most likely would not have been contemplated in the purpose and design of the entity. The right may be included in the arrangement to provide the debt provider with a protective right in the event of an exceptional circumstance. Thus, this protective right should not be considered in the determination of the primary beneficiary of the securitization facility. In some circumstances, it may be difficult to distinguish between power and protective rights. In these instances, we believe that it will be particularly important to consider the purpose and the design of the VIE. It may be helpful to distinguish between those decision-making rights that relate to activities that are expected to arise for the entity to carry out its purpose and design versus contingent rights that are triggered upon events that arise outside the purpose and design of the entity, or upon an exceptional circumstance. The latter type of contingent rights often may be thought of as protective rights and may result in an enterprise obtaining power should a future event occur, but would not necessarily represent current power.
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A VIE can be the primary beneficiary of another VIE

Question 14.16 Can a VIE be the primary beneficiary of another VIE? Yes. If one VIE (the first VIE) holds a variable interest in another VIE (the second VIE), has the power over the second VIE and receives benefits from the second VIE, it should consolidate the second VIE as its primary beneficiary. In such cases, the primary beneficiary of the first VIE (if any) would include the consolidated financial statements of the first VIE (i.e., those financial statements consolidating the second VIE) in its consolidated financial statements. Additionally, a VIE could be the primary beneficiary of a silo within a second VIE (see Interpretative guidance and Questions in Chapter 7).
Performing the primary beneficiary assessment prior to the VIE determination

Question 14.17 If an enterprise determines that it would not be the primary beneficiary of an entity whether the entity was a VIE, must the enterprise still make the VIE determination? Yes. The Variable Interest Model requires certain disclosures for an enterprise that holds a variable interest in a VIE but is not the VIEs primary beneficiary. Thus, the determination of whether an entity is a VIE is necessary for disclosure purposes. However, if the entity is not within the scope of the Variable Interest Model, no further analysis under the Variable Interest Model is required.
Consideration of potential voting rights (e.g., call options, convertible instruments) when assessing power
Question 14.18 How should potential voting rights (e.g., call options, convertible instruments) be considered when assessing power in the Variable Interest Model? The Variable Interest Model does not specifically address potential voting rights. However, we generally do not believe that the existence of a potential voting right alone provides its holder with power. While potential voting rights should be considered in the evaluation of an entitys purpose and design and in the evaluation of power, an arrangement providing an enterprise with a potential voting right generally does not, in and of itself, give that enterprise the power over the most significant activities of a VIE when decisions about those activities need to be made. Rather, such a right provides the holder with an economic benefit that potentially includes an opportunity to obtain power at a future date. Consequently, the holder of a potential voting right has power only when another incremental contractual right gives the holder power. However, the exercise of a potential voting right would require reconsideration of the primary beneficiary of a VIE. We understand that the FASB staff shares these views. Consistent with these views, we generally do not believe that an instrument that is contingently exercisable or a forward contract should be included in the analysis of power until exercise or settlement of such contingently exercisable instrument or forward contract. In certain circumstances, the terms and conditions of a potential voting right (e.g., a fixed-price call option that is deep in the money with little economic outlay required to exercise) may require further consideration to determine whether the substance of the potential voting right conveys power to the holder. For example, if an enterprise acquires fixed-priced call options to purchase shares of an entity for $1 when the per-share price of the entity is $200 at inception of the arrangement, consideration of the purpose and design of the entity and the arrangement would be warranted to evaluate whether the call option conveys power to the enterprise.
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14.2
Interpretative guidance Kick-out rights, participating rights and protective rights

Kick-out rights and participating rights Note: The FASB currently has a project on its agenda that would modify the Variable Interest Models provisions for evaluating an enterprise as a principal or an agent (see Chapter 6) and the provisions for evaluating the substance of kick-out rights and participating rights (see Chapter 9 and this Chapter), among other things. Readers should monitor developments in this area closely. In determining whether an enterprise has the power, an enterprise should not consider kick-out rights or participating rights unless a single enterprise (including its related parties and de facto agents) has the unilateral ability to exercise such rights. In those circumstances, a single enterprise (including its related parties and de facto agents) that has the unilateral ability to exercise such rights may be the enterprise with the power. The FASB acknowledged the inconsistencies in the consideration of kick-out rights between the Variable Interest Model and the provisions of ASC 810-20-25 for voting interest entities. When evaluating the consolidation of voting interest entities under ASC 810-20-25, kick-out rights are considered in the circumstances in which those rights can be exercised by a simple majority of the equity holders (as opposed to one party) and are otherwise substantive. In arriving at its conclusion, the FASB reasoned that kick-out rights rarely are exercised in practice and, thus, should not be considered until exercised unless one party has the unilateral ability to exercise such rights. The FASB was concerned that if consideration of kick-out rights in the determination of the primary beneficiary was consistent with the consideration of those rights for voting interest entities, there would have been obvious structuring opportunities. The FASB was concerned that these structuring opportunities would allow enterprises to avoid consolidation by inserting kick-out rights that are unlikely to be exercised such that no single party had power over an entity. With respect to participating rights, the FASB believes that participating rights are substantively similar to kick-out rights and, thus, should be subject to the same restrictions as kick-out rights. That is, the FASB decided that the determination of the primary beneficiary should not be affected by participating rights unless a single party (including its related parties and de facto agents) has the unilateral ability to exercise such participating rights and the rights are substantive. The FASB has indicated that it may address these inconsistencies at a later date by reconsidering the conclusions reached for voting interest entities in their current project to reconsider consolidation accounting more broadly. The Variable Interest Model does not specifically address an enterprises ability to dissolve, or liquidate, an entity (liquidation rights). Consistent with the guidance in ASC 810-20-25, we believe that, for the purpose of the Variable Interest Model, kick-out rights encompass liquidation rights. However, it is important to distinguish liquidation rights from withdrawal rights. Withdrawal rights must be analyzed carefully, and the specific facts and circumstances must be considered. In certain limited circumstances, withdrawal rights may be considered to be substantive kick-out rights. For example, if a limited partnership were economically compelled to dissolve, or liquidate, upon the withdrawal of one limited partner, that withdrawal right may be considered a substantive kick-out right if there were no barriers to exercise (as discussed in Question 14.20), and the right was otherwise considered substantive. However, withdrawal rights that do not explicitly require the dissolution or liquidation of the entire limited partnership generally would not be considered a substantive kick-out right.
The Variable Interest Model defines participating rights as the ability to block the actions of the enterprise with the power. Although the FASB agreed that a participating right is the ability of one party to block certain actions, the FASB believes that this ability should affect the determination of the primary beneficiary only if those actions are related to the activities that most significantly impact the economic performance of an entity. Examples of participating rights would be the rights to block decisions that would convey power. Determining what would constitute participating rights likely will vary by entity. Selecting, terminating and setting the compensation of management or establishing operating budgets as discussed in ASC 810-10 for voting interest entities may or may not represent participating rights. Power and, more specifically, the activities that most significantly impact the economic performance of the entity, likely will be different for different entities. Protective rights Protective rights held by other parties do not preclude an enterprise from having the power. The Variable Interest Models notion of protective rights is similar to that for voting interest entities in ASC 810-1025-10 and ASC 810-20-25-19. However, these lists of protective rights should not be viewed as allinclusive, and determining whether a right is participating or protective is a matter of professional judgment.
Consideration of the board of directors when assessing power

Question 14.19 Can a board of directors be viewed as a single enterprise when evaluating whether one party has the unilateral ability to exercise kick-out rights? No. We believe that a board of directors acts in a fiduciary capacity on behalf of the shareholders (i.e., the board of directors is an extension of the shareholders). Any kick-out right held by a board of directors essentially represents a kick-out right that is held by the shareholders. Therefore, unless one shareholder (and its related parties and de facto agents) has unilateral control over the board of directors, we believe that the kick-out rights held by the board of directors should not be considered when assessing which party is the primary beneficiary. We understand that the FASB staff and SEC staff share this view.
Evaluating the substance of kick-out rights in the Variable Interest Model

Question 14.20 How should an enterprise evaluate whether kick-out rights are substantive for purposes of applying the Variable Interest Model? The Variable Interest Model does not provide implementation guidance or examples for evaluating the substance of kick-out rights for purposes of determining the primary beneficiary in the Variable Interest Model. Therefore, we believe that the provisions of ASC 810-20-25 in the context of the voting interest model may provide relevant considerations with respect to this evaluation. However, we do not believe that an evaluation of the criteria within ASC 810-20-25 necessarily should be considered determinative. We believe, and the SEC staff also has expressed, that it is important for an enterprise to evaluate carefully the facts and circumstances of each arrangement.
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The following barriers to exercise may indicate that the kick-out rights held by a single enterprise are not substantive: Kick-out rights subject to conditions that make it unlikely they will be exercisable; for example, conditions that narrowly limit the timing of the exercise Financial penalties or operational barriers associated with replacing the decision maker that would act as a significant disincentive for removal The absence of an adequate number of qualified replacement decision makers or inadequate compensation to attract a qualified replacement The absence of an explicit, reasonable mechanism in the arrangement by which the party that possesses the kick-out rights can exercise them
In addition, the economic terms could make it unlikely that the kick-out rights would be exercised and thus the presumption of control would not be overcome. For example, a partnership that is a VIE has within its partnership agreement a provision that the general partner can be removed by one limited partner, but is still entitled to its economic interest (i.e., 1% from its legal ownership and its 20% carried interest, which is earned after the limited partners receive a preferred return) over the remaining life of the partnership. We believe that the kick-out rights would not be substantive in this example because it is unlikely that the limited partner would remove the general partner when it must continue to pay that general partner for services for which the replacement general partner also will be compensated. Other partnership agreements may provide that the general partner is to be paid an amount equal to the fair value of its interest on the termination date. All of the related facts and circumstances should be evaluated to determine whether such a provision acts as a financial barrier. For example, a partnership that is invested in one real estate property may have insufficient liquidity to pay the general partner without selling the property, creating a significant disincentive for a limited partner to exercise the kickout rights.
Consolidation through participating rights

Question 14.21 If an enterprise only holds participating rights, can that enterprise be deemed the primary beneficiary of a VIE? Generally, no. Participating rights are defined in the Variable Interest Model as [t]he ability to block the actions through which a reporting entity exercises the power to direct the activities of a VIE that most significantly impact the VIEs economic performance. We do not believe that an enterprises ability to block actions provides the enterprise with power over those same actions. Thus, an enterprise that only holds participating rights over the decisions that otherwise constitute power would not be the primary beneficiary of a VIE by virtue of the participating rights. However, to the extent that an enterprise has other rights, careful consideration will be required to evaluate the combination of those rights and the participating rights in the primary beneficiary analysis as the enterprise could be considered the primary beneficiary in those circumstances. For example, assume an enterprise identifies the population of decisions that most significantly impacts the entitys economic performance. Assume that the enterprise has participating rights with respect to each of those decisions, except for decisions related to financing and asset transfers which the enterprise has the unilateral ability to direct. In this scenario, we believe that the enterprise likely would be deemed the primary beneficiary of the entity.
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Liquidation rights as kick-out rights

Question 14.22 Should liquidation rights be considered the same as kick-out rights for purposes of evaluating the provisions of the Variable Interest Model? Generally, yes. The Variable Interest Model does not specifically address an enterprises ability to dissolve or liquidate an entity (liquidation rights). The guidance in ASC 810-20-20 for voting interest entities defines kick-out rights and states that [t]he rights underlying the limited partners ability to dissolve (liquidate) the limited partnership or otherwise remove the general partners are collectively referred to as kick-out rights. Thus, we believe that, for the purpose of the Variable Interest Model, kickout rights encompass liquidation rights. We understand that the FASB staff shares a similar view.
Call options as kick-out rights

Question 14.23 In a venture established by two equity investors, should a call option held by one investor to acquire the other investors equity interest be considered the same as a kick-out right for purposes of evaluating the Variable Interest Model? Generally, no. The Variable Interest Model does not specifically address call options. However, we generally do not believe that a call option to acquire another partys equity interest should be viewed as a kick-out right for purposes of applying the Variable Interest Model. That is, we generally believe that the exercise of a call option is an event that would require reconsideration of the primary beneficiary of a VIE. An option generally provides the holder with an economic benefit and not current power. Refer to Question 14.18 for additional considerations.
Kick-out right holder as party with the power

Question 14.24 If a single enterprise has the unilateral ability to exercise kick-out rights (or liquidation rights), is that enterprise the party with the power to direct the activities of the VIE that most significantly impact the entitys economic performance? Although we believe that the party with unilateral kick-out rights often will be the party with power, this may not necessarily be the case. ASC 810-10-25-38C indicates that [a] single reporting entity (including its related parties and de facto agents) that has the unilateral ability to exercise kick-out rights or participating rights may be the party with the power to direct the activities of a variable interest entity that most significantly impact the entitys economic performance. Determining whether a single enterprise that has the unilateral ability to exercise kick-out rights (or liquidation rights) is the party with the power will require a careful evaluation of facts and circumstances. Considerations that may be relevant in making this determination include the following: Other rights held by the holder of the kick-out rights Whether the holder of the kick-out rights has the ability to appoint the replacement to the party removed (e.g., the majority holder of the controlling interest in a securitization trust) Whether the holder of the liquidation rights receives its relative share of the entitys assets upon liquidation or receives a cash payment
As noted in Question 14.21, we generally do not believe that participating rights, in and of themselves, constitute power.
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14.3
Interpretative guidance Shared power

If an enterprise determines that power is shared among multiple unrelated parties such that no one party has the power to direct the activities of a VIE that most significantly impact the VIEs economic performance, then no party is the primary beneficiary. Power is shared if each of the unrelated parties sharing power is required to consent to the decisions relating to the activities that most significantly impact the VIEs performance. The governance provisions of an entity should be evaluated to ensure that the consent provisions are substantive.28 The SEC staff has indicated that they approach assertions that power is shared with skepticism and focus on whether the parties have demonstrated that power over the VIEs significant activities is shared.29 To illustrate the concept of shared power, assume two unrelated parties form a venture (which is a VIE) to manufacture, distribute and sell beverages. Assume that one party is responsible for manufacturing the beverage, and the other party is responsible for distributing and selling the beverage. Both parties have 50% of the voting rights, and each has 50% representation on the board of directors. The manufacturer is required to consent to the decisions of the distributor/seller, and the distributor/seller is required to consent to the decisions of the manufacturer. Both parties through their voting interests and board representation jointly decide all other matters related to the entity. In this example, the VIE does not have a primary beneficiary because the power is shared between both parties. However, if the two parties are related parties or de facto agents, one of the parties must be identified as the primary beneficiary (because together they have power). The Variable Interest Models related party provisions would be used to determine which party is the primary beneficiary of the entity (see discussion of the related party provisions in Chapter 16). If an enterprise concludes that power is not shared but the activities that most significantly impact the VIEs economic performance are directed by multiple parties, and each party is directing the same activities, the party, if any, with the power over the majority of the activities is the primary beneficiary of the VIE (provided they have benefits). If no party has the power over the majority of the activities, then no party would be the primary beneficiary under the power and benefits provisions. Assume two parties form a venture (which is a VIE) to manufacture, distribute and sell beverages, with each holding an equity interest. Assume that each party manufactures, distributes and sells the beverages in different locations. Power is not shared as each party is not required to consent to the others decisions. As each party is directing the same activities, the party with the power over the majority of the activities is the primary beneficiary of the VIE. Determining which of these parties has power over the majority of the activities could prove difficult and will require a careful assessment of the facts and circumstances. In this example, because there are only two decision makers, we believe that one must have the power over a majority of the activities, and, therefore, one party must be identified as the primary beneficiary. If there had been three or more decision makers, it is possible that no one party would have power over a majority of the activities (e.g., if each party had power over 33% of the decisions). If power is not shared but the activities that most significantly impact the VIEs economic performance are directed by multiple parties, and each party is performing different activities, then an enterprise must identify which party has the power to direct the activities that most significantly impact the entitys economic performance. That is, one party has the power. Determining which party is the primary beneficiary in these circumstances will require an enterprise to evaluate the purpose and design of the entity and to consider the factors that may provide insight into which entity has the power.
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For example, an enterprise should consider what occurs in the event that consent is not given (e.g., remedies) and how those provisions may affect the determination of whether consent is truly substantive. See speeches made by Wesley R. Bricker at the 2010 AICPA National Conference on Current SEC and PCAOB Developments, and Paul A. Beswick at the 29th Annual SEC and Financial Reporting Institute Conference available at www.sec.gov. 243
Assume two parties form a venture (which is a VIE) to manufacture, distribute and sell beverages with each holding an equity interest. Assume that one party is the manufacturer and the other party is responsible for distribution and sales. In this instance, either the manufacturer or the distributor/seller is the primary beneficiary. Determining which of these roles require decisions that most significantly impact the entitys performance could prove difficult and will require a careful assessment of the facts and circumstances.
Different parties with power over the entitys life cycle

Question 14.25 How should an enterprise evaluate which party is the primary beneficiary of a VIE when, by design, power shifts between parties over the various stages of the entitys life cycle? To illustrate, assume that an entity is formed to develop and ultimately manufacture a highly speculative drug candidate. One investor has power over the research and development (R&D) activities. A second investor has power over the drug manufacturing should the R&D activities be successful and should the drug receive FDA approval. In evaluating which party has the power, an enterprise should consider carefully the entitys purpose and design. In this fact pattern, the entity was designed to develop a drug candidate with the hope of ultimately manufacturing the drug for sale. In assessing which activities most significantly impact the entitys economic performance, it is determined that there are two primary activities R&D and manufacturing. In this example, we believe that determining which party has the power at the inception of the entity requires a consideration of the probability that the parties involved will have power through the different stages of the entity. For an entity that has different stages, as in the example above, we believe that an enterprise should evaluate the probability of successfully moving from one stage to the next and the nature of the different stages. Additionally, we believe that an enterprise should consider which activities most significantly impact the economic performance of the entity over its remaining life as of the date of the assessment. In this example, we believe that the party with power over the R&D activities is the primary beneficiary at inception. This conclusion is based on the significant uncertainty of the drug ever reaching the manufacturing stage. If the R&D activities are unsuccessful, the manufacturing of the drug will never occur. We believe that the party with the ability to direct the manufacturing decisions has a current right to obtain power that is contingently exercisable upon completion of the R&D phase. Therefore, as the entity evolves, we believe that the primary beneficiary of the entity may change as characteristics and assumptions with respect to the entity may change. For example, an enterprise may conclude that once FDA approval of the drug candidate is received, the party with power over the entitys manufacturing processes is the primary beneficiary. For entities in which the power shifts between various stages of the entitys life cycle, the determination of the primary beneficiary will require a careful analysis of the facts and circumstances. We generally believe that the greater the certainty of the completion of a stage, the more likely that an enterprise would look through the stage to other stages of the entitys life cycle or the more likely that an enterprise would discount the importance of that stage in evaluating which party has the power. Also, the length of a particular stage may be a relevant consideration in the primary beneficiary determination. Additionally, an enterprise carefully should evaluate whether rights of certain parties to an arrangement constitute protective rights. However, protective rights do not constitute power.
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14.4
Interpretative guidance Involvement with the design of the VIE

The FASB included the provisions in ASC 810-10-25-38F to emphasize the need for enterprises to assess their involvement in the design of an entity when determining whether they are the primary beneficiary of an entity. However, an enterprises involvement with the design of a VIE does not, in and of itself, establish the enterprise as the party with the power, even if that involvement was significant. Rather, that involvement may indicate that the enterprise had the opportunity and the incentive to establish arrangements that result in the enterprise being the variable interest holder with the power. An example of this concept might include a sponsors explicit or implicit financial responsibility to ensure that an entity operates as designed. In that situation, a sponsor may have an implicit agreement to fund an entitys losses to protect the sponsors reputation. In circumstances in which an enterprise established the decisions that were encompassed in the governing documents of the entity, there should be increased scrutiny as to whether that enterprise has the power, particularly if the sponsor has a potentially significant explicit or implicit variable interest. When there are many parties involved with the design of an entity, this provision of the Variable Interest Model may be less relevant.
14.5
Interpretative guidance Disproportionate power and benefits

We believe that the greater an enterprises exposure to benefits, the more incentivized the enterprise would be to obtain power over an entity. In other words, most enterprises would not be willing to accept a high level of economic risk in an entity without having elements of power. However, this provision of the Variable Interest Model is not determinative. Rather, in circumstances in which an enterprise has a disproportionately greater obligation to absorb losses or right to receive benefits compared to its stated power, an enterprise should approach the evaluation of the primary beneficiary with greater skepticism. This may require an enterprise to consider whether it has clearly identified the characteristics of power with respect to the entity. In the circumstances in which, after careful consideration of the disproportionality, an enterprise concludes that it has appropriately determined which party has the power, we believe that the enterprise should clearly document its judgments with respect to its determination of power and its consideration of the disproportionality in power and benefits. At the December 2009 AICPA National Conference on Current SEC and PCAOB Developments, the SEC staff30 expressed concerns with certain proposed structures in which an enterprise may have asserted that power was shared but there was disproportionality between power and benefits. With respect to these circumstances, the staff also highlighted that ASC 810-10 indicates that only substantive terms, transactions and arrangements should be considered in arriving at a consolidation conclusion. In circumstances in which an enterprise believes that power is shared, but there is significant disproportionality between power and benefits, we believe that an entity carefully must consider purpose and design and whether the activities of the entity that most significantly impact economic performance have been appropriately identified. In doing so, only substantive terms, transactions and arrangements should be considered (refer to Chapter 3 for additional interpretative guidance).
30
Speech made by Arie S. Wilgenburg at the 2009 AICPA National Conference on Current SEC and PCAOB Developments, available at www.sec.gov. 245
Evaluating disproportionate power and benefits

Question 14.26 Can the fact that a party has disproportionately greater benefits compared to its stated power be determinative in the primary beneficiary assessment? No. As noted in ASC 810-10-25-38G, the FASB did not intend for this provision addressing disproportionate power and benefits to be determinative. Rather, in circumstances in which an enterprise has a disproportionately greater obligation to absorb losses or right to receive benefits compared to its stated power, an enterprise should approach the evaluation of the primary beneficiary with greater skepticism. In other words, in such circumstances, an enterprise should reevaluate whether all elements of power have been appropriately identified.
Effect of VIE determination anti-abuse clause (ASC 810-10-15-14(c)) on the identification of the primary beneficiary
Question 14.27 If an enterprise concludes that an entity is a VIE pursuant to the anti-abuse clause (ASC 810-10-1514(c)), does that conclusion affect the primary beneficiary determination? To prevent an entity from avoiding consolidation of a VIE by structuring it with non-substantive voting rights, ASC 810-10-15-14(c) provides that an entity is a VIE when (1) the voting rights of some investors are not proportional to their obligations to absorb the expected losses of the entity, their rights to receive the expected residual returns of the entity, or both and (2) substantially all of the entitys activities either involve or are conducted on behalf of an investor (including the investors related parties, except its de facto agents under ASC 810-10-25-43(d)) that has disproportionately few voting rights. We do not believe that the holders of the equity interests of an entity that meet the criterion of ASC 810-10-15-14(c) should be presumed to have non-substantive voting rights. As such, determining the primary beneficiary of an entity that is a VIE pursuant to ASC 810-10-15-14(c) will require a careful examination of all facts and circumstances. In particular, the provisions of ASC 810-10-25-38G addressing situations in which a reporting entitys economic interest in a VIE, including its obligation to absorb losses or its right to receive benefits, is disproportionately greater than its stated power to direct the activities of a VIE should be considered carefully. Additionally, the provisions of ASC 810-10-1513A and 15-13B addressing substantive terms, transactions and arrangements should be evaluated. Under the Variable Interest Model prior to Statement 167s amendments, the primary beneficiary of an entity that was a VIE as a result of ASC 810-10-15-14(c)s provisions was often the party with disproportionally few voting rights. This outcome was due to the previous Variable Interest Models quantitative approach for assessing which party was the primary beneficiary. Subsequent to the amendments, the primary beneficiary of a VIE is the party that has (1) the power to direct activities of a VIE that most significantly impact the entitys economic performance and (2) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE. Therefore, the party with disproportionally few voting rights may or may not be the primary beneficiary. However, in circumstances in which an enterprise has a disproportionately greater obligation to absorb losses or right to receive benefits compared to its stated power, an enterprise should approach the evaluation of the primary beneficiary with greater skepticism.
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15
Related parties and de facto agents

Consolidation Overall Recognition The Effect of Related Parties 810-10-25-42 For purposes of determining whether it is the primary beneficiary of a VIE, a reporting entity with a variable interest shall treat variable interests in that same VIE held by its related parties as its own interests. 810-10-25-43 For purposes of the Variable Interest Entities Subsections, the term related parties includes those parties identified in Topic 850 and certain other parties that are acting as de facto agents or de facto principals of the variable interest holder. All of the following are considered to be de facto agents of a reporting entity: a. b. c. d. A party that cannot finance its operations without subordinated financial support from the reporting entity, for example, another VIE of which the reporting entity is the primary beneficiary A party that received its interests as a contribution or a loan from the reporting entity An officer, employee, or member of the governing board of the reporting entity A party that has an agreement that it cannot sell, transfer, or encumber its interests in the VIE without the prior approval of the reporting entity. The right of prior approval creates a de facto agency relationship only if that right could constrain the other partys ability to manage the economic risks or realize the economic rewards from its interests in a VIE through the sale, transfer, or encumbrance of those interests. However, a de facto agency relationship does not exist if both the reporting entity and the party have right of prior approval and the rights are based on mutually agreed terms by willing, independent parties. A party that has a close business relationship like the relationship between a professional service provider and one of its significant clients.
e.
15.1
Subsequent to the effective date of Statement 167s amendments to the Variable Interest Model, an enterprise first determines whether it individually has the power to direct the activities of the VIE that most significantly impact the entitys economic performance and also has the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. That is, if the enterprise meets the requirements to be the primary beneficiary under the power and benefits criteria, then it is not necessary to assess the enterprises related parties or de facto agents as the enterprise must consolidate the VIE. However, if an enterprise concludes that neither it nor one of its related parties individually meets the power and benefits criteria, but, as a group, the enterprise and its related parties have those characteristics, an enterprise then considers the related party provisions in determining the primary beneficiary (discussed further in the next chapter).
15 Related parties and de facto agents
The Variable Interest Model defines related parties as those identified by the related party guidance in ASC 850. The following summarizes related parties identified in ASC 850-10-20: Affiliates Entities for which investments would be required, absent the election of the fair value option under ASC 825, to be accounted for by the equity method Trusts for the benefit of employees that are managed or under the trusteeship of management Principal owners and members of their immediate families Management and members of their immediate families Other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests
In addition, the Variable Interest Model incorporates the concept of de facto agents into its consideration of related party relationships. Under the Variable Interest Model, a party that has an agreement that it cannot sell, transfer or encumber its interests in a VIE without the prior approval of an enterprise is considered a de facto agent of that enterprise if that right could constrain the partys ability to manage the economics of its interest in a VIE. When applying the Variable Interest Model, de facto agents are considered along with related parties when evaluating the Variable Interest Models related party provisions. Historically, many enterprises have found themselves evaluating whether a de facto agency relationship exists as sale, transfer or encumbrance restrictions are present in many arrangements. Given the breadth of the definition of a de facto agent in the Variable Interest Model, enterprises frequently determined that a de facto agency relationship was present. During the comment process on Statement 167, some respondents expressed concerns over the broad applicability of the de facto agency provisions and that a de facto agent relationship currently exists in circumstances where the transfer restrictions are the result of negotiations between willing and independent parties. Respondents also noted that these provisions often are important to preserve the strategic intent of the entity. As a result, the FASB decided to amend the de facto agency provisions to address the concerns raised by these respondents who were troubled that many enterprises with substantive mutual transfer restrictions would be required to consolidate VIEs even in situations in which power is in fact shared (refer to Chapter 14 for Interpretative Guidance and Questions). Statement 167 amended the guidance to provide an exception to the de facto agency provision, in certain circumstances. Under the amended Variable Interest Model, a de facto agency relationship does not exist if both the enterprise and the other party have the right of prior approval and those rights are based on mutually agreed terms entered into by willing, independent parties and the rights are substantive. Notwithstanding the above amendment, substantive transfer restrictions that create de facto agency relationships will continue to arise in practice. Such a transfer restriction might exist when the restriction is one-sided (i.e., one party approves transfers but is not restricted itself). However, the existence of a substantive transfer restriction does not obviate the need for each party involved with such a restriction to determine if it is the primary beneficiary of a VIE (as further discussed in Chapter 14). That is, if the enterprise meets the requirements to be the primary beneficiary, it is not necessary to assess the enterprises related parties or de facto agents; the enterprise must consolidate the VIE.
The amendments to the de facto agency provisions represent a significant change to the previous practice of determining the primary beneficiary through an evaluation of the Variable Interest Models related party provisions, as fewer enterprises will be required to do so under the amended Variable Interest Model. Thus, it is possible that an enterprise that is the primary beneficiary of a VIE prior to the adoption of Statement 167 to conclude that it is no longer the primary beneficiary upon adoption of Statement 167. This may be true for enterprises with involvement in joint ventures and other business ventures in which transfer restrictions are prevalent, but those restrictions qualify for the exception.
Application of the phrase without the prior approval of the reporting entity to common contractual provisions
Question 15.1 How should the phrase without the prior approval of the reporting entity be applied to contractual provisions such as a right of first refusal, right of first offer and an approval that cannot be unreasonably withheld? Following are common contractual terms and our analysis of how the Variable Interest Models de facto agent concept should be applied to them. Right of first refusal A right of first refusal gives the holder the right to meet any other offer before the proposed contract is accepted. For example, a right of first refusal may exist between two parties to a joint venture that is a VIE that requires one party to notify the other as to the price and payment terms of a variable interest that is proposed to be sold and provides the other party the right and option to purchase the transferring partys interest at the same price. These are also common in the sale and leaseback of real estate. We believe that a right of first refusal generally does not create a de facto agency relationship because the variable interest holder is permitted to sell or transfer its interest. The right of first refusal simply provides the holder the right to meet another offer before an interest is sold or transferred to another party. Right of first offer A right of first offer provision requires a party to give notice to another party prior to selling it to a third party. That notice constitutes an offer by the party to sell its interest on the price, terms and conditions set forth in such notice. The potential buyer can decide either to accept or reject the terms of the offer. If the potential buyer fails to accept the offer, it generally is deemed to have consented to the proposed sale and the party may sell its interest to another party, provided, however, that the party may not sell the interest at any price less than the price stated in the first offer and on terms any more favorable to the purchaser than the terms included in the first offer notice. The right of first offer may provide some constraint over the sellers ability to sell its interest to a party of its own choosing. However, we believe that a right of first offer provision does not create a de facto agency relationship among parties because the seller is not limited in its ability to sell its interest. Approval not to be unreasonably withheld A party may have an agreement that it cannot sell, transfer or encumber its interests in the entity without the prior approval of the enterprise, and such approval is not to be unreasonably withheld. Because the Variable Interest Model does not distinguish the degree of difficulty to obtain such approval, we believe that any sale, transfer or encumbrance that requires prior approval of the enterprise may
result in a de facto agency relationship. For purposes of analyzing whether a de facto agency relationship exists for an enterprise when the sale, transfer or encumbrance of a variable interest cannot occur without prior approval of another variable interest holder, the fact that the approval is not to be unreasonably withheld should not be considered in the analysis, even if it is explicitly stated in the contractual arrangements among the parties. * * *
Also in evaluating whether a de facto agency relationship exists, we believe that the provisions generally were intended to apply to equity interests. However, we also believe that these provisions may be applicable to variable interests other than equity interests depending on the facts and circumstances. Professional judgment should be used after considering all relevant facts and circumstances in applying the Variable Interest Models without prior approval criterion.
Conditions in ASC 810-10-25-43(d) on an agreement that it cannot sell, transfer or encumber its interests in the VIE without the prior approval of the reporting entity are inclusive
Question 15.2 How should ASC 810-10-25-43(d) conditions on an agreement that it cannot sell, transfer or encumber its interests in the VIE without the prior approval of the reporting entity be applied when an agreement provides for a restriction on only one of the activities specified in that paragraph, but not all three? We believe that the or in this criterion should be inclusive, meaning that if the party has the ability to obtain all or most of the cash inflows that are the primary economic benefit of the variable interest either by selling, transferring, or encumbering it, then a de facto agency relationship does not exist. Otherwise, a de facto agency relationship could be constructed to achieve a desired accounting result by simply adding a prohibition that may be unimportant to that party. The legal agreements and the defined terms used in them should be read carefully before concluding as to whether each of the three restrictions exists. For example, we have observed instances in which it appears that only transfers of the interest are restricted, but the term transfer is defined in the legal agreement as any sale, exchange, assignment, encumbrance, hypothecation, pledge, foreclosure, conveyance in trust, gift or other transfer of any kind, among other actions. Legal counsel may need to be consulted in evaluating this criterion. We believe all of the relevant facts and circumstances should be considered in determining whether restrictions on a partys ability to sell, transfer or encumber its variable interest creates a de facto agency relationship. For example, an enterprise may seek to avoid creating a de facto agency relationship with a party by restricting it only from selling or transferring its variable interest (but not from encumbering it), knowing that the party is already restricted from encumbering its interest for a separate regulatory or legal reason. In that instance, we believe a de facto agency relationship exists because the enterprise restricted the party from selling or transferring its interest, and is aware that the party is also restricted from encumbering its interest. Restrictions on the sale, transfer or encumbrance of a variable interest should be carefully evaluated to ensure that they are substantive before concluding that a de facto agency relationship exists among parties. We believe that ASC 810-10-25-43s provisions generally were intended to apply to equity interests. However, we also believe that these provisions may be applicable to variable interests other than equity interests depending on the facts and circumstances.
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Close business relationship condition

Question 15.3 What types of business relationships should be considered in evaluating whether the close business relationship condition has been met? We believe the close business relationship test was constructed to identify a party that provides a significant amount of professional services or similar services to a variable interest holder because that variable interest holder may avoid consolidation of a VIE by arranging to protect its interest or indirectly expand its holdings through other parties. While other types of business relationships may be identified to meet this condition, we generally believe that this condition sought to identify the relationship between an enterprise and its investment bankers, attorneys and other service providers that assist in structuring a transaction. Those business relationships should be evaluated carefully to determine whether the enterprise is a significant client to the service provider. This determination is highly dependent on the specific facts and circumstances.
Substantive sale, transfer or encumbrance restriction that is one-sided

Question 15.4 Would a restriction on the sale, transfer or encumbrance of an interest that is one-sided constitute a de facto agency relationship? Yes. A de facto agency relationship would exist if the substantive sales, transfer or encumbrance restriction is one-sided (i.e., one party approves a sale, transfer or encumbrance of another partys interest but is not restricted itself). For example, assume a VIEs variable interest holders consist of Investor A and Investor B. Further assume that Investor A has an agreement with Investor B pursuant to which Investor B is prohibited from selling, transferring and encumbering its interest in the VIE without Investor As prior approval. However, Investor A is not restricted by Investor B from selling, transferring and encumbering its interest in the VIE. Since the restriction is one-sided, a de facto agency relationship exists. However, a de facto agency relationship does not exist if both the enterprise and the party have an agreement that they cannot sell, transfer or encumber their interests in an entity without the prior approval and the rights are based on mutually agreed terms entered into by willing, independent parties.
Separate accounts of life insurance enterprises as related parties

Question 15.5 How should an insurance enterprise consider separate accounts31 as potential related parties for purposes of applying the Variable Interest Model? Pursuant to ASC 944-80-25-3, when evaluating an entity for consolidation, an insurance enterprise should not: Consider any separate account interests held for the benefit of policy holders to be the insurance enterprises interests Combine any separate account interests held for the benefit of policy holders with the insurance enterprises general account interest in the same investment
31
The guidance in this response applies if the separate account arrangement (as defined in ASC 944-80-20) meets the conditions in ASC 944-80-25-2. 251
However, separate accounts interests held for the benefit of a related party policy holder should be combined with the insurance enterprises general account interest when the Variable Interest Model requires the consideration of related parties. For this purpose, a related party policy holder includes any party identified in ASC 810-10-25-43 except: An employee of the insurance enterprise (and its other related parties), except if the employee is used in an effort to circumvent the provisions of the Variable Interest Model An employee benefit plan of the insurance enterprise (and its other related parties), except if the employee benefit plan is used in an effort to circumvent the provisions of the Variable Interest Model
The above guidance was issued as part of Accounting Standards Update (ASU) 2010-15, How Investments Held through Separate Accounts Affect an Insurers Consolidation Analysis of Those Investments (ASU 2010-15). ASU 2010-15 should be applied retrospectively in fiscal years beginning after 15 December 2010, and interim periods within those fiscal years. Earlier application is permitted. We believe that ASU 2010-15 largely will codify existing practice within the insurance industry.
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16
Determining the primary beneficiary from a related party group

Consolidation Overall Recognition 810-10-25-44 In situations in which a reporting entity concludes that neither it nor one of its related parties has the characteristics in paragraph 810-10-25-38A but, as a group, the reporting entity and its related parties (including the de facto agents described in the preceding paragraph) have those characteristics, then the party within the related party group that is most closely associated with the VIE is the primary beneficiary. The determination of which party within the related party group is most closely associated with the VIE requires judgment and shall be based on an analysis of all relevant facts and circumstances, including all of the following: a. b. c. d. The existence of a principal-agency relationship between parties within the related party group The relationship and significance of the activities of the VIE to the various parties within the related party group A partys exposure to the variability associated with the anticipated economic performance of the VIE The design of the VIE.
16.1
Prior to Statement 167s amendments to the Variable Interest Model, if two or more related parties (including de facto agents) held variable interests in a VIE, and the aggregate variable interests held by the related party group would, if held by a single party, identify the group as the primary beneficiary, then the party within the related party group that is most closely associated with the VIE is the primary beneficiary. These related party provisions were considered prior to determining whether an enterprise is individually the primary beneficiary (i.e., excluding related parties and de facto agents). Statement 167 amends the Variable Interest Model with respect to the circumstances in which the related party provisions are considered. As discussed in Chapter 14, when determining the primary beneficiary of a VIE, an enterprise first determines whether it individually has the power to direct the activities of the VIE that most significantly impact the entitys economic performance and also has the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. That is, if the enterprise meets the requirements to be the primary beneficiary under the power and benefits criteria, then the enterprise does not need to assess its related parties or de facto agents as the enterprise must consolidate the VIE. However, if an enterprise concludes that neither it nor one of its related parties individually meets the criteria to be the primary beneficiary, but, as a group, the enterprise and its related parties have those characteristics, an enterprise then considers the Variable Interest Models related party provisions in determining the primary beneficiary. The member of the related party group that is most closely associated with the VIE should consolidate it as the primary beneficiary.
16 Determining the primary beneficiary from a related party group
Furthermore, in situations in which no one member, but rather the related party group, is considered the primary beneficiary of a VIE, the parties within the related party group cannot conclude that power is shared. In other words, the parties within the related party group are required to identify one party within the related party group as the primary beneficiary of the entity. Statement 167 also amends the portion of the most closely associated test within ASC 810-10-25-44 to require that an enterprise consider exposure to variability associated with the anticipated economic performance of the VIE rather than expected losses. While ASC 810-10-25-44 no longer requires a calculation of expected losses, the FASB decided that the evaluation of which party within a related party group is most closely associated with a VIE should include an evaluation of each partys exposure to variability (both positive and negative) associated with the anticipated economic performance of the VIE. While a detailed calculation of expected losses may not be required, ASC 810-10-25-44 does require an analysis of variability associated with anticipated economic performance and, therefore, may require some quantitative analysis in its application. We believe that in certain circumstances, the Variable Interest Models requirement to consider the power and benefits principle prior to the related party provisions will have a significant effect on the primary beneficiary determination of a VIE. As an example, enterprises that have previously identified themselves as the primary beneficiary under the most closely associated test but do not have power will deconsolidate these VIEs upon adoption of Statement 167s amendments to the Variable Interest Model if (1) another enterprise in the related party group is the enterprise with the power, or (2) the parties are not related or de facto agents because of the amendments to the de facto agency provisions discussed in Chapter 15. The determination of which party from a related party group is most closely associated with a VIE is generally qualitative and is dependent upon the facts and circumstances. The qualitative assessment also requires the use of professional judgment. The Variable Interest Model lists factors to consider in making the determination but does not identify any single factor as determinative.
Principal-agency relationship
Question 16.1 How should a member of a related party group determine if a principal-agency relationship exists and, if so, which party is the principal and which party is the agent? Generally, a principal-agency relationship exists if one member of a related party group (the agent) is acting on behalf of another member (the principal). In certain cases, the existence of this type of relationship may not be readily identifiable based on the facts and circumstances of the arrangement. A principal-agency relationship is presumed to exist if a de facto agent is identified through application of the concepts in ASC 810-10-25-43 (see the Interpretative guidance and Questions in Chapter 15). In some cases (such as when one member of the related party group is the employer of another, or one member is the parent company of another), it may be apparent that one member is a principal and another is an agent. However, in other cases, the determination of whether one member is acting on behalf of another member may not be clear and should be based on an analysis of the specific facts and circumstances of the arrangement. The general indicators of a principal and an agent as described in ASC 605-45 may be helpful in making this determination.
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Based on the provisions of ASC 605-45, we believe the following would be characteristics of a member that is a principal in a principal-agency relationship with other members: The member is easily identifiable as the prime representative or leader of the related party group to outside parties (i.e., that member is the one in charge). The member either directly or indirectly influenced other members to obtain a variable interest in the entity. One member previously has acted as an agent of another member.
An agent, by contrast, generally would not possess these characteristics. Other characteristics also exist and should be considered, if present.
Determining the relationship and significance of a VIEs activities to members of a related party group
Question 16.2 What factors should be considered when assessing the relationship and significance of a VIEs activities to members of a related party group that, in the aggregate, is identified as the primary beneficiary of a VIE? When assessing the relationship and significance of a VIEs activities to the members of a related party group, the following factors should be considered: Did any member significantly influence the design or redesign of the entity or the determination of its primary operations, products or services? Are the operations of any member substantially similar in nature to the activities of the VIE? Does the variable interest in the VIE represent a substantial portion of the total assets of any member? Are the products or services produced by the VIE significant inputs to any members operations? Has any member outsourced certain of its activities to the VIE? Are the majority of any members products or services sold to the VIE? Are the products or services of any member significant inputs to the VIEs operations? Are employees of any member actively involved in managing the operations of the VIE? Do employees of the VIE receive compensation tied to the stock or operating results of any member? Is any member obligated to fund operating losses of the VIE if they occur? If the entity conducts research and development activities, does any member have the right to purchase any products or intangible assets resulting from the entitys activities? Has a significant portion of the VIEs assets been leased to or from any member? Does any member have a call option to purchase the interests of the other members? Do the other members have an option to put their interests to any member?
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Relationship and significance of a VIEs activities to members of a related party group
An automobile manufacturer, Autoco, establishes an entity (a VIE), Safetyco, to research and develop enhanced safety technologies for automobiles. Autoco contributes technology with a fair value of $2 million to the entity in exchange for a 50% common equity interest. An auto parts supplier, Partco, invests $2 million in exchange for the remaining common equity interest. Autoco holds 25% of the common stock of Partco and accounts for this investment using the equity method, as specified by ASC 323. Safetyco obtains a $10 million loan from Autoco Credit, a majority owned consolidated subsidiary of Autoco. Autoco has an option to acquire a five year exclusive license for any enhanced safety technologies developed by Safetyco for use in the automobiles it manufactures. After five years, Partco may also license the technologies and sell products incorporating the technologies to other auto manufacturers. Autoco, Autoco Credit and Partco are related parties under ASC 850. If each party concludes that neither it nor one of its related parties individually meets the power and benefits criteria, they are required to aggregate their variable interests for purposes of determining the primary beneficiary of Safetyco since, as a group, Autoco, Autoco Credit and Partco meet the power and benefits criteria. Analysis In this example, we believe the relationship and significance of the VIEs activities are more closely associated with Autoco. The following facts were considered in making this determination: Safetyco was formed to research and develop enhanced safety technologies for automobiles. Autoco is a manufacturer of automobiles. Autoco contributed the primary technology that Safetyco will attempt to further develop. Autoco has an option to acquire an exclusive license to any new technologies developed by Safetyco for an extended period of time.
The other factors in ASC 810-10-25-44 also should be considered in determining which party is the VIEs primary beneficiary. In the specific circumstance described above, based on the assumptions presented, Autoco should consolidate Safetyco as the primary beneficiary. However, the 50% ownership held by Partco should be accounted for in consolidation as a noncontrolling interest (see Question 16.4).
One member of a related party group not clearly identified as primary beneficiary
Question 16.3 ASC 810-10-25-44 provides certain factors to consider when determining which member of a related party group should be identified as a VIEs primary beneficiary. How should a member be identified as the primary beneficiary if the factors tend to point to multiple members of the related party group? In certain cases, the factors provided may tend to identify multiple members of the related party group as a VIEs primary beneficiary. In such cases, we believe that careful consideration of the individual facts and circumstances is necessary to determine the enterprise that is most closely associated to the VIE.
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One member of a related party group not clearly identified as primary beneficiary
Two parties (Party A and Party B) form a joint venture (which is a VIE) to manufacture, distribute and sell widgets. Both parties have 50% of the voting rights, and each represents 50% of the board of directors. Party A and Party B are related parties, and each requires the consent of the other party to make any decisions related to manufacturing, distributing, and sale of the widgets. Both parties through their voting interests and board representation jointly decide all other matters related to the VIE. In general, Party As core business is to manufacture, distribute and sell widgets, while Party Bs core business is to manufacture, distribute and sell other products. Analysis In this example, Party A and Party B together have the power to direct the activities of the VIE that most significantly impact the entitys economic performance, and decisions about those activities require the consent of each other. However, since Party A and Party B are related parties, one of the parties must be identified as the primary beneficiary because, together, they have power to direct the activities that most significantly impact the VIEs economic performance. Both Party A and Party B were involved in the design of the VIE and are equally exposed to the expected losses of the VIE. Also, since Party A and Party B are not related parties by virtue of a de facto agency relationship, a principal-agency relationship does not appear to exist between Party A and Party B. However, since Party A is in the business to manufacture, distribute and sell widgets while Party Bs core business is to manufacture, distribute and sell other products, the activities of the VIE are most closely related to Party A. Therefore, in this example, we believe Party A should consolidate the VIE because it is the member of the related party group to which the activities of the VIE are most closely associated.
Equity interests held by related parties of the primary beneficiary are noncontrolling interests
Question 16.4 If related parties of a VIEs primary beneficiary hold equity interests in the VIE, should these interests be accounted for as a noncontrolling interest in consolidation? Yes. Unless the related parties also are consolidated by the primary beneficiary, equity interests that the related party of the VIEs primary beneficiary hold in the VIE should be accounted for as noncontrolling interests by the primary beneficiary when consolidating the VIE.
Determining which party within the related party group is primary beneficiary
Question 16.5 How should the determination be made of which party within the related party group is most closely associated with the VIE? As discussed in the Interpretative guidance section, we believe the determination should be based on an analysis of all relevant facts and circumstances. While ASC 810-10-25-44 provides certain factors to consider in making this determination, these factors are not all-inclusive, and the use of professional judgment is required. We do not believe any one factor is determinative. The SEC staff has indicated that it shares this view. Note that while the following speech was intended to address accounting under FIN 46(R) (prior to the Statement 167 amendments), we believe that the concepts remain relevant to the Variable Interest Model in ASC 810-10. Note that the references to paragraph 17 of FIN 46(R) equate to ASC 810-10-25-44.
Speech Excerpts by Jane D. Poulin

2004 AICPA Conference on SEC and PCAOB Developments It is important to read the words in paragraph 17 plainly. Paragraph 17 requires an overall assessment of which party is the most closely associated with the entity. When considering questions under paragraph 17, the staff considers all the factors in paragraph 17 and any other factors that may be relevant in making this overall assessment. We do not view paragraph 17 to be a matter of checking the boxes for the four factors listed and adding up who has the most boxes checked. Instead we look at all relevant factors in their entirety considering the facts and circumstances involved. We have also been asked whether any of the factors in paragraph 17 carry more weight than any others or whether any of the factors in paragraph 17 are determinative. There is no general answer to this question. Instead, the facts and circumstances of the situation should be considered to determine whether one factor or another is more important.
Quantitative analysis in determining the primary beneficiary from a related party group
Question 16.6 Should an enterprise perform a quantitative analysis in determining the primary beneficiary from a related party group? Under ASC 810-10-25-44, an enterprise is required to consider exposure to variability associated with the anticipated economic performance of the VIE rather than expected losses. While a detailed calculation of expected losses may not be required, ASC 810-10-25-44 does require consideration of the variability associated with anticipated economic performance and, therefore, may require some quantitative analysis in its application.
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17
Initial measurement and consolidation

Consolidation Overall Initial Measurement Entities under Common Control 810-10-30-1 If the primary beneficiary of a variable interest entity (VIE) and the VIE are under common control, the primary beneficiary shall initially measure the assets, liabilities, and noncontrolling interests of the VIE at amounts at which they are carried in the accounts of the reporting entity that controls the VIE (or would be carried if the reporting entity issued financial statements prepared in conformity with generally accepted accounting principles [GAAP]). Entities Not under Common Control 810-10-30-2 The initial consolidation of a VIE that is a business is a business combination and shall be accounted for in accordance with the provisions in Topic 805. All Primary Beneficiaries 810-10-30-3 When a reporting entity becomes the primary beneficiary of a VIE that is not a business, no goodwill shall be recognized. The primary beneficiary initially shall measure and recognize the assets (except for goodwill) and liabilities of the VIE in accordance with Sections 805-20-25 and 805-20-30. However, the primary beneficiary initially shall measure assets and liabilities that it has transferred to that VIE at, after, or shortly before the date that the reporting entity became the primary beneficiary at the same amounts at which the assets and liabilities would have been measured if they had not been transferred. No gain or loss shall be recognized because of such transfers. 810-10-30-4 The primary beneficiary of a VIE that is not a business shall recognize a gain or loss for the difference between (a) and (b): a. The sum of: 1. 2. 3. b. The fair value of any consideration paid The fair value of any noncontrolling interests The reported amount of any previously held interests
The net amount of the VIEs identifiable assets and liabilities recognized and measured in accordance with Topic 805.
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17 Initial measurement and consolidation
17.1
ASC 810-10-30-1 through 30-4 provide guidance for the initial consolidation of a VIE by its primary beneficiary. Chapter 21 discusses the recognition and measurement of a VIEs assets, liabilities and noncontrolling interests upon the initial adoption of the amendments to the Variable Interest Model. The primary beneficiary of a VIE is required to measure the assets, liabilities and noncontrolling interests of the newly-consolidated entity in accordance with ASC 805s guidance for business combinations at the date the enterprise first becomes the primary beneficiary, with the following two exceptions: Exception #1 (ASC 810-10-30-1) When a VIEs primary beneficiary changes between entities that are under common control, the new primary beneficiary initially should measure the assets, liabilities and noncontrolling interests of the VIE at the amounts at which they were carried in the accounts of the enterprise that formerly controlled the VIE (i.e., carryover basis should be used with no adjustment to current fair values, and no gain or loss should be recognized). This accounting is similar to the accounting applied to transactions between entities under common control as described in ASC 805-50-30-5. Exception #2 (ASC 810-10-30-3) When an enterprise transfers assets and liabilities to a VIE that is not a business shortly before, in connection with, or shortly after becoming the VIEs primary beneficiary, the primary beneficiary initially should measure the assets and liabilities transferred to the VIE (and only those assets and liabilities) at the same amounts at which the assets and liabilities would have been measured had they not been transferred. All other assets (except goodwill), liabilities and noncontrolling interests should be measured in accordance with the provisions of ASC 805. The objective of this provision is to prevent the improper recognition of gains or losses due to the transfer of assets and liabilities to a VIE by its primary beneficiary. If an enterprise transfers assets and liabilities to a VIE shortly after becoming its primary beneficiary, then the transaction would represent a transaction among entities under common control (i.e., a transaction between a parent and subsidiary). Thus, the transaction should be accounted for similarly to transactions falling under the common control provisions of ASC 805-50-30-5. With respect to transfers of assets and liabilities occurring shortly before an enterprise becomes a VIEs primary beneficiary, it may be unclear as to whether the transaction is a separate economic exchange or is in contemplation of the change in control. As a result, the Variable Interest Model requires that when an enterprise transfers assets and liabilities to a VIE that is not a business shortly before becoming the VIEs primary beneficiary that the transaction be treated as a common control transaction. An enterprise will be required to exercise professional judgment in determining what would qualify as shortly before. Any goodwill recognized in the initial consolidation of a VIE should be evaluated for impairment pursuant to the provisions of ASC 350. Refer to our Financial reporting developments publication, Business combinations, for additional discussion regarding the provisions of ASC 805.
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Form 8-K and pro forma reporting requirements

Question 17.1 Article 11 of SEC Regulation S-X (Article 11) describes the SECs requirements for registrants to provide pro forma financial information. Article 11 applies to registration statements, certain proxy statements and Form 8-K filings. Item 2.01 of Form 8-K addresses the information reporting requirements relating to a registrants acquisition or disposition of a significant amount of assets. Does consolidation or deconsolidation of a VIE trigger a potential Article 11 reporting requirement or Form 8-K filing requirement? The SEC staff has indicated that the initial adoption of the provisions of Statement 167 would not trigger a requirement to report under Article 11 or Item 2.01 of Form 8-K.32 However, the SEC staff believes that a registrant may be required to report under Article 11 or Item 2.01 of Form 8-K for ongoing application of the Variable Interest Model.
Form 8-K and SEC Regulation S-X Rules 3-05 and 3-14 reporting requirements
Question 17.2 Rule 3-05 of SEC Regulation S-X (Rule 3-05) and Item 9.01(a) of Form 8-K describe the SECs requirements for registrants to provide audited financial statements of a business acquired or to be acquired, including the acquisition of an interest in a business accounted for under the equity method. Rule 3-14 of SEC Regulation S-X (Rule 3-14) describes the requirements for audited financial statements of real estate operations acquired or to be acquired. Does consolidation of a VIE trigger a financial statement reporting requirement pursuant to Rule 3-05, Rule 3-14 or Item 9.01(a) of Form 8-K by the primary beneficiary? The SEC staff has indicated that consolidation upon the initial adoption of the provisions of Statement 167 would not trigger a requirement to report under Rule 3-05, Rule 3-14 or Item 9.01(a) of Form 8-K.32 However, the SEC staff does believe that subsequent to the adoption of Statement 167 a registrant may be required to report under Rule 3-05, Rule 3-14 or Item 9.01(a) of Form 8-K for the ongoing application of the Variable Interest Model.
Pre-existing hedge relationships under ASC 815

Question 17.3 Pursuant to ASC 810-10, an enterprise is required to consolidate another entity (or remove an entity from its consolidated financial statements) and consequently must discontinue a pre-existing hedging relationship that qualified as an accounting hedge under ASC 815 in the enterprises financial statements. What adjustments should be made, if any, with respect to the previous hedge accounting in the enterprises financial statements? This issue originally was addressed with respect to the Variable Interest Model by Statement 133 Implementation Issue No. E22. Excerpts of Issue E22 are included below. Note that Issue E22 is not included in the Codification because it related specifically to the initial adoption of FIN 46(R). The FASB elected not to include this historical transition guidance in the Codification. The guidance in Issue E22 applies to the adjustments made to the previous hedge accounting for a preexisting hedging relationship that was discontinued because of consolidation or deconsolidation of another entity due to the initial application of FIN 46 or FIN 46(R). Although this guidance was intended
32
The SEC staff shared this view with the Center for Audit Quality SEC Regulations Committee (CAQ Alert #2010-20 April 9, 2010). 261
to be applicable only to the initial application of FIN 46 or FIN 46(R), we believe that subsequent consolidation or deconsolidation required pursuant to the Variable Interest Model (including under Statement 167 on or subsequent to its adoption) should not result in the immediate recognition of previously deferred derivative gains and losses if a surrogate hedge item can be identified. Issue E22 states that its guidance should also be applied by analogy to situations in which the issuance of new authoritative guidance results in a reporting entity becoming a primary beneficiary under FIN 46(R) and, therefore, must consolidate the related VIE. We believe that Statement 167 represents an amendment to FIN 46(R)s variable interest model, and as such, we believe that Issue E22 provides for an explicit analogy to its guidance upon adoption of Statement 167. Illustration 17-1: Statement 133 Implementation Issue No. E22
Hedging General: Accounting for the Discontinuance of Hedging Relationships Arising from Changes in Consolidation Practices Related to Applying FASB Interpretation No. 46 or 46(R) Example 1 Discontinued Cash Flow Hedge Arising from Consolidation A special purpose leasing entity is established based on a $3,000 equity contribution by an independent equity participant. The leasing entity borrows $97,000 with LIBOR-based interest payable quarterly and principal repayable as a lump sum at maturity and purchases a $100,000 asset. Company A leases the asset for a variable quarterly lease payment equal to the sum of (a) the leasing entitys LIBOR-based quarterly interest payment, (b) a fixed return to the equity participant that is paid quarterly, and (c) a fixed amount to cover the leasing entitys insurance, maintenance, and other costs. Assume that the due dates for the quarterly interest payments and the quarterly lease payments are the same. Company A enters into a receive-LIBOR, pay-fixed interest rate swap (with a notional amount not exceeding $97,000) and designates the swap as a cash flow hedge of all or a portion of its exposure to the variability of its LIBOR-based cash outflows under the lease. Prior to the initial application of Interpretation 46 or 46(R), Company A had not been consolidating the special-purpose leasing entity. Upon initial application of Interpretation 46 or 46(R), the special-purpose leasing entity is considered a variable interest entity; assume that it must be consolidated by Company A. The original cash flow hedge must be discontinued because the hedged forecasted transactions (the LIBOR-based lease payments) are no longer eligible forecasted transactions of the consolidated entity with a third party (because they are now intercompany transactions that are eliminated in consolidation). Assume that upon consolidation of the variable interest (leasing) entity, the noncontrolling interest in the newly consolidated leasing entity will be reported as equity (minority interest). At issue is the accounting upon consolidation for the net gain or loss that had been reported in accumulated OCI related to that discontinued cash flow hedge. Example 2 Discontinued Cash Flow Hedge Arising from Consolidation A special-purpose leasing entity is established based on a $3,000 equity contribution by an independent equity participant whose terms are mandatorily redeemable for a fixed amount. The leasing entity borrows $97,000 with LIBOR-based interest payable quarterly and principal repayable as a lump sum at maturity and purchases a $100,000 asset. Company A leases the asset for a variable quarterly lease payment equal to the sum of (a) the leasing entitys LIBOR-based quarterly interest payment, (b) a LIBOR-based return to the equity participant that is paid quarterly, and (c) a fixed amount to cover the leasing entitys insurance, maintenance, and other costs. Company A enters into a receive-LIBOR, pay-fixed interest rate swap (with a $100,000 notional amount) and designates the swap as a cash flow hedge of all of its exposure to the variability of its LIBOR-based cash outflows under the lease. Prior to the initial application of Interpretation 46 or 46(R), Company A had not been consolidating the special-purpose leasing entity.
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Upon initial application of Interpretation 46 or 46(R), the special-purpose leasing entity is considered a variable interest entity; assume that it must be consolidated by Company A. The original cash flow hedge must be discontinued because the hedged forecasted transactions (the LIBOR-based lease payments) are no longer eligible forecasted transactions of the consolidated entity with a third party (because they are now intercompany transactions that are eliminated in consolidation). Assume that upon consolidation of the variable interest (leasing) entity, the noncontrolling interest in the newly consolidated leasing entity will be reported as a liability in the consolidated financial statements. At issue is the accounting upon consolidation for the net gain or loss that had been reported in accumulated OCI related to that discontinued cash flow edge. Example 3 Discontinued Fair Value Hedge Arising from Deconsolidation Bank B establishes a special-purpose trust to issue preferred stock to investors. The preferred stock is mandatorily redeemable on a specified date and specifies a fixed periodic (such as quarterly or annual) dividend. The proceeds of the issuance are paid to Bank B and the bank records a liability to the trust. However, because Bank B consolidates the trust, the banks liability to the trust is eliminated in its consolidated financial statements. Assume that the trusts mandatorily redeemable preferred stock is reported as a trust preferred certificates liability in the consolidated financial statements. Bank B enters into a receive-fixed, pay-LIBOR interest rate swap (with a $100,000 notional amount) and designates the swap as a fair value hedge of its exposure to changes in the fair value of the liability for the trust preferred certificates. (Had the trusts mandatorily redeemable preferred stock not been reported as a liability in the consolidated financial statements, the preferred stock could not have been designated as the hedged item in a fair value hedge under Statement 133.) Assume that upon initial application of Interpretation 46 or 46(R), Bank B concludes that the specialpurpose trust is a variable interest entity and that the bank is not the primary beneficiary of the trust; consequently, Bank B deconsolidates the trust, thereby excluding the trust preferred certificates from the consolidated financial statements. However, Bank B would report its liability to the trust in the consolidated financial statements. The original fair value hedge must be discontinued because the hedged item (that is, the liability for the trust preferred certificates) no longer exists as a liability in Bank Bs consolidated financial statements. At issue is the accounting upon deconsolidation for the net effect of fair value hedge accounting adjustments on the carrying amount of the hedged item and whether that net effect on the date of deconsolidation can be reported as an adjustment of the carrying amount for the banks liability to the trust. Response If a reporting entity is required to discontinue a pre-existing hedging relationship upon the initial application of Interpretation 46 or 46(R) due to the required consolidation of another entity in (or the deconsolidation of that entity from) the reporting entitys consolidated financial statements, the adjustments of the reporting entitys financial statements must reflect the ongoing effect of the previous hedge accounting for those discontinued relationships in a manner consistent with the reporting entitys risk management policy and the objectives of those discontinued hedging relationships. Reflecting that ongoing effect of those discontinued relationships will involve identification and designation of surrogate hedged items for discontinued fair value hedges and surrogate hedged forecasted transactions for discontinued cash flow hedges. The surrogate hedged items and hedged forecasted transactions would need to have met (on a retroactive basis) the qualifying criteria applicable to those items and transactions (other than the requirement for contemporaneous documentation).
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The identification of surrogate hedged items and hedged transactions relates solely to reflecting the ongoing effect of the discontinued hedging relationships, that is, how the basis adjustments arising from fair value hedge accounting and the amounts in OCI arising from cash flow hedge accounting should affect earnings in future periods. Example 1 Discontinued Cash Flow Hedge Arising from Consolidation Because the hedged forecasted transactions (that is, the LIBOR-based lease payments to the specialpurpose leasing entity) on the discontinued cash flow hedge were related to the LIBOR-based interest payments on the leasing entitys LIBOR-based variable-rate debt, Company A should, upon consolidation of the variable interest (leasing) entity, designate the LIBOR-based interest payments on that newly consolidated debt as the surrogate hedged forecasted transactions for purposes of the subsequent accounting for the amounts in accumulated OCI related to the discontinued cash flow hedge at the date the hedge was discontinued. Under that surrogate designation, the amounts in accumulated OCI related to the discontinued cash flow hedge would be reclassified into earnings in the same period or periods during which the hedged LIBOR-based interest payments on the newly consolidated debt affects earnings, pursuant to the provisions of paragraph 31 of Statement 133. The amounts in accumulated OCI related to the discontinued cash flow hedge would not be reclassified into earnings immediately upon consolidation. The provisions of paragraphs 28 and 37 of Interpretation 46 and Interpretation 46(R) do not specifically address the amounts in OCI because those paragraphs address the carrying amounts of only the assets, liabilities, and noncontrolling interests of the variable interest (leasing) entity. But the notion in those paragraphs about measurement in the consolidated financial statements being determined as if the Interpretation had been effective when the reporting entity first met the conditions to be the primary beneficiary is relevant to the subsequent accounting for the amounts in OCI related to the discontinued cash flow hedge. The accounting under Statement 133 should be based on the assumption that if the leasing entity had been consolidated, that entitys receive-LIBOR, pay-fixed interest rate swap would have likely been designated as the hedging instrument in a cash flow hedge of all or a portion of the consolidated entitys exposure to the variability of the LIBORbased cash outflows related to the interest payments on the leasing entitys debt. Example 2 Discontinued Cash Flow Hedge Arising from Consolidation Because the hedged forecasted transactions (that is, the LIBOR-based lease payments to the specialpurpose leasing entity) on the discontinued cash flow hedge were related to (a) the quarterly LIBORbased interest payments on the leasing entitys LIBOR-based variable-rate debt and (b) the LIBORbased return to the equity participant that is being paid quarterly, Company A should, upon consolidation of the variable interest (leasing) entity, designate both the quarterly LIBOR-based interest payments on that newly consolidated debt and the quarterly payments on the newly consolidated liability to the equity participant as the surrogate hedged forecasted transactions for purposes of the subsequent accounting for the amounts in accumulated OCI related to the discontinued cash flow hedge at the date the hedge was discontinued. Under that surrogate designation, only 97 percent of the amounts in accumulated OCI related to the discontinued cash flow hedge would relate to the LIBOR-based interest payments (on that newly consolidated debt) that are being designated as the surrogate hedged forecasted transactions (for 97 percent of the hedging swap). Because the noncontrolling interest is reported as a liability, the remaining 3 percent of the amounts in accumulated OCI related to the discontinued cash flow hedge would relate to the LIBOR-based payments to that noncontrolling interest (the equity participant), which would be designated as the surrogate hedged forecasted transactions (for 3 percent of the hedging swap). (In contrast, if the noncontrolling interest would have been reported as equity (minority
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interest) in the consolidated financial statements, the LIBOR-based payments to that noncontrolling interest would not be eligible under paragraph 29(f) of Statement 133 for designation as the hedged forecasted transaction, in which case the remaining 3 percent of the amounts in accumulated OCI related to the discontinued cash flow hedge would be removed from accumulated OCI and recognized as part of the cumulative effect of an accounting change.) If any timing difference exists between the LIBOR-based lease payments to the special-purpose leasing entity (the original hedged transaction) and the LIBOR-based interest payments on the leasing entitys variable-rate debt (the surrogate hedged transaction) that creates ineffectiveness with respect to the surrogate hedged transaction that would have been recognized under paragraph 30 of Statement 133, that ineffectiveness should be recognized as part of the cumulative effect of an accounting change and should adjust the 97 percent of the amounts in accumulated OCI related to the discontinued cash flow hedge. For the 97 percent of the amounts in accumulated OCI related to the discontinued cash flow hedge, they would be reclassified into earnings in the same period or periods during which the LIBOR-based interest payments on the newly consolidated debt affect earnings, pursuant to the provisions of paragraph 31 of Statement 133. Similarly, for the remaining 3 percent of those amounts in accumulated OCI, they would be reclassified into earnings in the same period or periods during which the LIBOR-based payments on the liability to the equity participant affect earnings. The amounts in accumulated OCI related to the discontinued cash flow hedge would not all be reclassified into earnings immediately upon consolidation. Example 3 Discontinued Fair Value Hedge Arising from Deconsolidation Because the hedged item (that is, the liability for the trust preferred certificates) on the discontinued fair value hedge was related to Bank Bs liability to the trust, Bank B should, upon deconsolidation of the variable interest entity (the trust), designate its liability to the trust as the surrogate hedged item for purposes of removing the trust from the consolidated financial statements. The net basis adjustment of the liability for the trust preferred certificates made under fair value hedge accounting and remaining at the date the fair value hedge is discontinued should be used to adjust the carrying amount of Bank Bs liability to the trust. Although the classification of trust preferred certificates is addressed in FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, at the time this Implementation Issue was cleared, the Board had deferred the effective date of the guidance in Statement 150 with respect to certain instruments, including the trust preferred certificates in this example. Refer to FASB Staff Position No. FAS 150-3, Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. Special Application of the Shortcut Method If the initial application of Interpretation 46 or 46(R) causes the discontinuance of a pre-existing hedging relationship for which effectiveness was being assessed under the shortcut method in paragraph 68 of Statement 133 and the company designates a new hedging relationship, the new hedging relationship can qualify for the shortcut method if the following criteria are met: The new hedging relationship meets all conditions in paragraph 68 other than the condition in paragraph 68(b). The designation of the new hedging relationship was completed at the same time that the preexisting hedging relationship was discontinued. The hedging derivative in the new hedging relationship is all or a proportion of the hedging derivative used in the discontinued pre-existing hedging relationship.
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The hedged item or the hedged transaction in the new hedging relationship is the surrogate for the discontinued pre-existing hedging relationship. The discontinued pre-existing hedging relationship had qualified for and had been accounted for under the shortcut method.
If an entity had already applied Interpretation 46 and had designated a new hedging relationship (that meets all of the above criteria) contemporaneous with the discontinuance of a pre-existing hedging relationship due to the change in consolidation practices, the entity is allowed to apply the shortcut method to that new hedging relationship even though the use of the shortcut method had not been documented at the inception of that new hedging relationship. That entity should report the accounting effects of initially applying the shortcut method to the new hedging relationship as a cumulative change in accounting principles in the first fiscal quarter that ends after November 10, 2003 (as discussed in the effective date and transition section below). Application of This Guidance The guidance in this Issue applies to the adjustments made with respect to the previous hedge accounting for a pre-existing hedging relationship that was discontinued because of the consolidation or deconsolidation of another entity due to the initial application of Interpretation 46 or 46(R). The guidance in this Issue should also be applied by analogy to situations in which the issuance of new authoritative guidance results in a reporting entity becoming a primary beneficiary under Interpretation 46(R) and, therefore, must consolidate the related VIE. The guidance does not address the discontinuance of hedging relationships attributable to the consolidation or deconsolidation of another entity due to a change in ownership, control, or other circumstances. The guidance in this Issue does not affect the designation of new hedging relationships on or after the date of initial application of Interpretation 46 or 46(R). Such new hedging relationships need to comply with all applicable requirements of Statement 133 (as amended) except with respect to the special use of the shortcut method as previously discussed. At its November 5, 2003 meeting, the Board reached the above answer. Absent that, the staff would not have been able to provide guidance that permits (a) the identification of a surrogate hedged item or hedged transaction that would impact the ongoing effect of the previous hedge accounting for those hedging relationships discontinued due to a change in consolidation practices related to application of Interpretation 46 or 46(R) and (b) the new hedging relationship to qualify for the shortcut method without meeting the conditions in paragraph 68(b) at the inception of that hedging relationship.
Continuation of leveraged lease accounting by an equity investor in a deconsolidated lessor trust

Question 17.4 Upon application of the Variable Interest Models provisions, an equity investor in a previously consolidated lessor trust is required to deconsolidate the trust. The equity investor previously accounted for the lease between the lessor trust and the lessee as a leveraged lease pursuant to ASC 840. Subsequent to the deconsolidation of the lessor trust, may the equity investor continue to account for its investment in the lessor trust as a leveraged lease pursuant to ASC 840? Yes. Through discussions with the FASB staff, we understand that the deconsolidation of a previously consolidated lessor trust by an equity investor through application of the Variable Interest Model should not change the equity investors accounting for the lease between the lessor trust and the lessee. That is, if the equity investor appropriately applied leveraged lease accounting prior to deconsolidation, that accounting treatment should continue to be followed.
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18
Accounting after initial measurement

Consolidation Overall Subsequent Measurement 810-10-35-3 The principles of consolidated financial statements in this Topic apply to primary beneficiaries accounting for consolidated variable interest entities (VIEs). After the initial measurement, the assets, liabilities, and noncontrolling interests of a consolidated VIE shall be accounted for in consolidated financial statements as if the VIE were consolidated based on voting interests. Any specialized accounting requirements applicable to the type of business in which the VIE operates shall be applied as they would be applied to a consolidated subsidiary. The consolidated entity shall follow the requirements for elimination of intra-entity balances and transactions and other matters described in Section 810-10-45 and paragraphs 810-10-50-1 through 50-1B and existing practices for consolidated subsidiaries. Fees or other sources of income or expense between a primary beneficiary and a consolidated VIE shall be eliminated against the related expense or income of the VIE. The resulting effect of that elimination on the net income or expense of the VIE shall be attributed to the primary beneficiary (and not to noncontrolling interests) in the consolidated financial statements.
18.1
After initial measurement, the assets, liabilities and noncontrolling interests of a consolidated VIE should be accounted for in the primary beneficiarys consolidated financial statements as if the entity were consolidated based on voting interests. The consolidation principles in ASC 810-1045 and disclosure requirements in ASC 810-10-50-1 through ASC 810-10-50-1B should be followed subsequent to the initial measurement of a VIEs assets, liabilities and noncontrolling interests. For example, intercompany balances and transactions should be eliminated in their entirety. The amount of intercompany profit or loss to be eliminated is not affected by the existence of a noncontrolling interest. The complete elimination of the intercompany profit or loss is consistent with the underlying assumption that the primary beneficiarys consolidated statements represent the financial position and operating results of a single enterprise. However, there is a significant difference between the general consolidation guidance contained in ASC 810-10 and the consolidation procedure guidance under the Variable Interest Model as to how the effect of intercompany eliminations may be attributed to the noncontrolling interests in consolidation. ASC 810-10-45-18 states that such effects may be allocated between the majority (controlling) and noncontrolling interests. Under the Variable Interest Model, when a VIE is consolidated, the effect of intercompany eliminations must be attributed to the primary beneficiary. The difference is intended to address the effect of fees or other sources of income from a consolidated VIE, which may continue to be recognized in the consolidated net income of the primary beneficiary when these fees have been realized. For example, if the primary beneficiary has no equity interest in the variable interest entity and receives a fee from the entity that simultaneously expensed that fee, the amount of the fee that is eliminated in consolidation would be allocated to the primary beneficiary even if the remainder of the entitys net income is allocated to the entitys noncontrolling interest. On a consolidated basis, the primary beneficiary will no longer recognize revenue for the fees received from the VIE (these will be eliminated in consolidation), but will recognize the benefit of the fee income in its share of net income.
18 Accounting after initial measurement
Given that the requirements for accounting for the elimination of intercompany transactions and the allocation of a subsidiarys income under the Variable Interest Model may differ significantly from the general consolidation guidance in ASC 810-10, the results of accounting for the elimination of intercompany transactions pursuant to the Variable Interest Model may be counterintuitive. Accordingly, the nature and terms of the intercompany transactions should be evaluated carefully in determining how they should be eliminated. Similar to the general consolidation guidance in ASC 810-10-45-21, when losses applicable to the noncontrolling interest exceed the noncontrolling interest equity of a consolidated VIE, such excess and any further losses applicable to the noncontrolling interest should continue to be charged to the noncontrolling interest.
Attribution of intercompany eliminations in consolidation

Question 18.1 ASC 810-10-35-3 provides that when a primary beneficiary consolidates a VIE, the effect of intercompany eliminations should be attributed to the primary beneficiary and not the noncontrolling interest. Is this different from the manner in which the effect of intercompany eliminations are generally attributed when consolidating under the general consolidation guidance of ASC 810-10? Although the general consolidation principles are followed by a primary beneficiary when consolidating a VIE, there is a difference between how that guidance and the Variable Interest Model treat the effect of intercompany eliminations in consolidation. The general consolidation guidance based upon majority voting interests states that such effects may be allocated between the controlling and noncontrolling interests. In contrast, the Variable Interest Model provides that when a VIE is consolidated, the effect of intercompany eliminations must be attributed to the primary beneficiary. This difference was intended to ensure that the effect of fees or other sources of income from a consolidated VIE will continue to be recognized in the net income attributable to the primary beneficiary when these fees have been realized. That is, if a primary beneficiary did not hold an equity interest, and if the elimination of intercompany profits or losses were allocated based on relative equity ownership, the primary beneficiarys income (and VIEs expense) would be fully eliminated, and the effect of the eliminating entries would be allocated to the noncontrolling interest in their entirety. Thus, the primary beneficiary would reflect no benefit of the contractual arrangements between the variable interest holders in its consolidated financial statements. To illustrate, if a primary beneficiary with no equity interest in the entity consolidates a VIE due to a loan, the amount of interest expense eliminated in consolidation would be allocated to the primary beneficiary, which will increase the parents interest in the subsidiarys earnings, even if the remainder of the entitys net income is allocated to the entitys equity holders. On a consolidated basis, the primary beneficiary will no longer have interest income recognized (as it will be eliminated in consolidation) but will recognize the benefit of the interest income received from the VIE in its share of net income. The nature of intercompany transactions should be reviewed carefully in applying consolidation procedures to VIEs because the accounting by the VIE for amounts paid to the primary beneficiary can impact whether those amounts should be recognized by the primary beneficiary in its attributed income. Moreover, the determination of intercompany eliminations for VIEs may lead to counterintuitive results. The following illustrates how the general consolidation guidance in ASC 810-10 based upon majority voting interests and the provisions of the Variable Interest Model may differ with respect to elimination entries.
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Assume that an entity is a VIE and has two variable interest holders, A and B. B holds all of the equity investment in the VIE. A has made a loan to the VIE from which it has recognized interest income of $100 in its stand-alone financial statements. A is the primary beneficiary of the VIE. Analysis If A consolidated the VIE pursuant to the general consolidation procedure guidance in ASC 810-10 and allocated the effects of the intercompany eliminations proportionately between the controlling and noncontrolling interests based on ownership of equity interests, the consolidating adjustments and the consolidated income statement of A would be as follows: A
Revenues Cost of revenues Operating income Selling, general and administrative Other Interest income Interest expense Net income Net income attributable to noncontrolling interest Net income attributable to controlling interest $ 10,000 6,000 4,000 1,000 100 3,100 3,100 $
VIE
1,000 600 400 200 (100) 100 100
Adjustments
$ (100) 100 200 (200)
Consolidated
$ 11,000 6,600 4,400 1,200 3,200 200 3,000
$ $ $
$ $ $
$ $ $
$ $ $
If the effects of the intercompany eliminations are allocated to the noncontrolling interest in proportion to equity ownership, the interest income that A has recognized due to the intercompany transactions with the VIE is eliminated in consolidation. As net income has been reduced by $100 to $3,000. The effect of the intercompany elimination of As interest income has been attributed to the noncontrolling interest through elimination of the interest expense at the VIE (because A does not have an equity interest in the VIE). However, because the VIE is consolidated pursuant to the Variable Interest Model, the consolidating adjustments and the consolidated income statement of A would be as follows:
A Revenues Cost of revenues Operating income Selling, general and administrative Other Interest income Interest expense Net income Net income attributable to noncontrolling interest Net income attributable to controlling interest $ 10,000 6,000 4,000 1,000 100 3,100 3,100 $ VIE 1,000 600 400 200 (100) 100 100 Adjustments $ Consolidated
$ 11,000 6,600 4,400 1,200 3,200 100 3,100
$ $ $
$ $ $
$ $ $
(100) 100
100 (100)
$ $ $
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As above, the interest income that A has recognized due to the intercompany transactions with the VIE has been eliminated in consolidation. However, As net income has remained unchanged as the effect of the interest income eliminated in consolidation has been attributed entirely to A. The differing results can also be summarized as follows:
General consolidation guidance in ASC 810-10 Separate net income of A Interest income attributed to noncontrolling interest Net income attributable to controlling interest Variable Interest Model Separate net income of A Interest income attributed to noncontrolling interest Net income attributable to controlling interest $ $ 3,100 3,100 $ $ 3,100 (100) 3,000
Illustration 18-2: Facts Year 1
Assume Investor A and Investor B each contribute $200,000 in exchange for an equal ownership interest in the equity of a VIE. The VIE obtains debt of $800,000 and uses a portion of the proceeds ($500,000) to buy and construct a building. Investor A provided development services to the VIE for a fee of $300,000, and it incurred costs of $100,000 to provide those services. Investor A is the primary beneficiary of the VIE. The consolidated financial presentation and consolidating adjustments of Investor A in Year 1, pursuant to the provisions of the Variable Interest Model are as follows:
Investor A Balance sheet Cash Building Investment in VIE Total assets Debt Noncontrolling interest (equity) Stockholders equity Total liabilities/equity Income statement Revenues Cost of revenues Net income Net income attributable to noncontrolling interest Net income attributable to controlling interest
(a) (b)
VIE $ 400,000 800,000 $ 1,200,000 $ 800,000
Adjustments $ (200,000) (a) (200,000) (b) $ (400,000) 200,000 (b) (400,000) (b) (200,000) (a) $ (400,000) $
Consolidated $ 900,000 600,000 $ 1,500,000 $ 800,000 200,000
$ 500,000 200,000 $ 700,000 $
700,000 $ 700,000
400,000 $ 1,200,000
500,000 $ 1,500,000
$ 300,000 100,000 $ 200,000 $
$ $ $ $
$ (300,000) (a) (100,000) (a) $ (200,000) $
$ $ $ $
$ 200,000
$ (200,000)
To reduce consolidated revenues, costs of revenues and the capitalized cost of the building for the effect of fees charged by Investor A to the consolidated VIE. To eliminate the intercompany investment in the consolidated VIE and to record the noncontrolling interest.
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This example illustrates how the entire fee is eliminated in the consolidated financial statements. The fees that have been capitalized by the consolidated VIE are not recognized in consolidated income because they have not been realized. The benefit of the eliminating entry is recognized prospectively through the recognition of an increase to the subsidiary VIEs income due to the elimination of the depreciation expense arising from the capitalized development fee, and the benefit of that elimination is allocated to the parent (Investor A). However, if instead of capitalizing the cost, the VIE currently expensed the fee, we believe net income attributable to controlling interest would include the benefit of the portion of the fee that was absorbed by the noncontrolling interest. That is, had the consolidated VIE expensed the fees charged to it by Investor A, a $150,000 loss would be reflected in the net income attributable to noncontrolling interest line in the consolidated entitys income statement as illustrated in the previous example above. Facts Year 2 Assume the VIE depreciates the building over 10 years, which results in annual depreciation expense of $80,000 ($800,000/10 years = $80,000). Further, assume there were no other transactions occurring in Year 2. The consolidated financial presentation and consolidating adjustments of Investor A in Year 2 are as follows:
Investor A Balance sheet Cash Building, net Investment in VIE Total assets Debt Noncontrolling interest (equity) Stockholders equity $ 500,000 200,000 $ 700,000 $ VIE $ 400,000 720,000 $1,120,000 $ 800,000 Adjustments $ (180,000) (a) (200,000) (b) $ (380,000) $ 160,000 (b) (400,000) (b) (200,000) (a) 60,000 $ (380,000) Consolidated $ 900,000 540,000 $ 1,440,000 $ 800,000 160,000
Total liabilities/equity Income statement Revenues Cost of revenues Net income Net income attributable to noncontrolling interest Net income attributable to controlling interest
(a)
700,000 $ 700,000
320,000 $1,120,000
480,000 $ 1,440,000
$ $ $ $
$ $ $ $
80,000 (80,000) (80,000)
(20,000) (a) $ (20,000) $ (40,000) (b) $ 60,000
$ $ $ $
60,000 (60,000) (40,000) (20,000)
To reduce the net prior year impact for the effect of the fees charged by Investor A to the consolidated VIE that were capitalized as a cost of the building by the VIE. The VIE capitalized the development fee of $300,000. Investor A incurred $100,000 of costs to provide these services, which were capitalized by the consolidated entity. Accordingly, the net impact is a reduction of depreciation expense totaling $20,000 [($300,000/10 years) ($100,000/10 years) = $20,000]. To eliminate the intercompany investment in the consolidated VIE and to record the net income attributable to noncontrolling interest.
(b)
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The results of the consolidation also can be summarized as follows:

Separate net income of A Portion of VIEs net loss allocable to Investor A (50%) Recognition of Investor As fees as a result of realization through VIE depreciation Recognition of depreciation expense for capitalized costs incurred by the consolidated group Net income attributable to controlling interest $ (40,000) 30,000 (10,000) $ (20,000)
Losses in excess of noncontrolling interests

Question 18.2 When consolidating a VIE, if losses applicable to the noncontrolling interest exceed the noncontrolling interest equity capital, should the excess losses applicable to the noncontrolling interest be charged against the primary beneficiary? ASC 810-10s consolidation procedures are generally the same for VIEs and voting interest entities (i.e., as if the VIE has been consolidated based on voting interests). As such, when losses applicable to the noncontrolling interest exceed the noncontrolling interest equity of a consolidated VIE, the excess and any further losses applicable to the noncontrolling interest should continue to be charged against the noncontrolling interest.
Consolidated versus combined financial statements

Question 18.3 If a reporting entity is the primary beneficiary of a VIE, would it be appropriate to issue combined financial statements rather than consolidated financial statements? No. ASC 810-10-55-1B permits combined financial statements in certain situations in which consolidated financial statements are not required. However, a primary beneficiary of a VIE must consolidate the VIE.
Primary beneficiarys acquisition of noncontrolling interest

Question 18.4 How does a primary beneficiary account for an acquisition of the noncontrolling interest in a consolidated VIE? A primary beneficiary of a VIE initially measures the assets, liabilities and noncontrolling interests of a consolidated VIE in accordance with ASC 805 (subject to the exceptions identified in the Interpretative guidance to this chapter) at the date the entity first becomes the primary beneficiary. We believe the primary beneficiarys acquisition of a noncontrolling interest should be treated as an equity transaction consistent with the principles of ASC 810-10-45-23. Thus, any difference between the price paid and the carrying value of the noncontrolling interest should not be reflected in net income (but instead reflected directly in equity).
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Accounting for liabilities after initial consolidation

Question 18.5 Many variable interest entities issue limited recourse obligations, which provide for payment only from cash flows generated from assets in the variable interest entity and other collateral pledged to it. Losses may occur in a consolidated variable interest entity that exceed the primary beneficiary and noncontrolling interests investment. Those losses ultimately will be borne by other variable interest holders in that variable interest entity upon its liquidation or termination and not by the primary beneficiarys stockholders or owners. Must losses incurred by a consolidated variable interest entity in excess of the consolidating enterprise and noncontrolling interests investment be recognized by the consolidating enterprise upon consolidation and thereafter, or may the liabilities in the consolidated variable interest entity be reduced to reflect the portion of those losses that ultimately will be absorbed by other variable interest holders? ASC 810-10s provisions state that after the initial measurement, the assets, liabilities and noncontrolling interests of a consolidated VIE are to be accounted for in consolidated financial statements as if the entity were consolidated based on voting interests. We believe a consolidated variable interest entitys liabilities cannot be reduced and presented at settlement value unless they have been extinguished pursuant to the requirements of ASC 860. Accordingly, losses would continue to be recognized and allocated to the controlling and noncontrolling interests.
Possible embedded derivative contained in certain limited recourse obligations

Question 18.6 With respect to Question 18.5, do limited recourse obligations issued by a legally isolated entity contain an embedded derivative that should be bifurcated pursuant to ASC 815? The economics of the VIEs limited recourse obligation can be described as including an embedded put option (or a contractual participation agreement through the payment waterfall terms). The put option is purchased by the VIE and written by the holder of the liability. The put option allows the issuer to put assets to the holder of the liability at a future date if the VIEs assets are insufficient to satisfy the obligation, in exchange for extinguishment of the liability. ASC 815 requires an embedded option to be bifurcated from its host instrument and separately accounted for if it is not clearly and closely related to the host instrument. A question arises whether the embedded purchased put should be bifurcated from the VIEs liabilities in the consolidated financial statements because the debt issued by the VIE contains the embedded purchased put that is indexed to the creditworthiness of an unrelated third party. When an issuer holds multiple assets from third parties and payments on these assets are passed through to pay the VIEs debt, the value of the debt is affected by the credit risk from all of the underlying assets, which some argue is not clearly and closely related to the creditworthiness of the issuer. Further, ASC 815-15-25-47 provides that if an instrument incorporates a credit risk exposure that is different from the risk exposure arising from the creditworthiness of the obligor under that instrument, such that the value of the instrument is affected by an event of default or a change in creditworthiness of a third party, then the economic characteristics and risks of the embedded credit derivative are not clearly and closely related to the economic characteristics and risks of the host contract, even though the obligor may own securities issued by that third party. ASU 2010-11,33 which was issued in March 2010, indicates that if a new credit risk is added
33
The amendments in Accounting Standards Update 2010-11, Scope Exception Related to Embedded Credit Derivatives, are effective for each reporting enterprise at the beginning of its first fiscal quarter beginning after 15 June 2010. Early adoption is permitted at the beginning of each reporting enterprises fiscal quarter beginning after the issuance of ASU 2010-11 (i.e., 5 March 2010). 273
to a beneficial interest by a written credit default swap in a securitization structure, the related embedded credit derivative feature is not clearly and closely related to the host contract, and, therefore, such a feature would be bifurcated. Except for the effect of a freestanding written credit default swap in a securitization structure, which is required to be bifurcated under ASU 2010-11, we generally do not believe that an embedded put option (arising due to the limited recourse nature of the beneficial interests) should be bifurcated from its host instrument for the following reasons: ASC 815 requires holders of interests in securitized financial assets to evaluate and determine, based on an analysis of the contractual terms of the interests, whether the beneficial interests are freestanding derivatives or contain an embedded derivative that would be required to be separated from the host contract. The creditworthiness of an obligor and the interest rate on a debt instrument are considered to be clearly and closely related. We believe ASC 815 provides that the creditworthiness of the financial instruments that a special purpose debtor holds (other than written credit default swaps) and the creditworthiness of the special purpose debtor itself are one and the same. The holders of beneficial interests in VIEs have only the credit risk exposure from the assets in the legally isolated entity (i.e., the VIE). That is, those beneficial interest holders will be paid if there is sufficient cash generated by the legally isolated entitys assets. Because the risk exposure of the investors return comes solely from the VIEs assets (unless one of those beneficial interests explicitly introduces a new credit risk not heretofore present in any of the assets held by that entity), and there is no risk exposure arising from the overall creditworthiness of the consolidating enterprise, we do not believe multiple credit risks exist such that bifurcation of an embedded derivative would be required pursuant to ASC 815. We do not believe that additional credit risk is introduced when a VIE is consolidated because the credit risk of the instruments issued by the VIE is the same regardless as to whether that VIE is consolidated by another enterprise. Accordingly, we also do not believe that the consolidation of a VIE is determinative as to whether a derivative should be bifurcated from its host. We have confirmed our understanding of ASC 815s provisions with the FASB staff.
Reduction of preferred stock noncontrolling interest after consolidation

Question 18.7 An enterprise is determined to be the primary beneficiary and therefore must consolidate a VIE that has common and preferred equity interests. A portion of the common and preferred equity interests are not held by the primary beneficiary and therefore would be classified as noncontrolling interests in the primary beneficiarys consolidated financial statements. If losses have occurred in the VIE beyond the enterprises investment, how much, if any, can be charged to the noncontrolling interest holders through a reduction of noncontrolling interest? For a noncontrolling interest represented by common stock ownership, we generally believe that the relative ownerships interests in a VIE should be used to allocate earnings and other comprehensive income, absent a substantive profit-sharing agreement. Additionally, pursuant to ASC 810-10-45-21, losses are attributed to the noncontrolling interest, even when the noncontrolling interests basis in the partially owned VIE has been reduced to zero. However, preferred stock normally does not represent a residual equity interest in the VIE because, unlike common stock, preferred stock is entitled to a liquidation preference, which generally will include a par amount and, in some cases, cumulative unpaid dividends (although economically a portion of those losses may be funded by the preferred stock). ASC 810-10-10-1 states that [t]he purpose of consolidated financial statements is to present, primarily for the benefit of the owners and creditors of the parent, the results of operations and the financial position of a parent and all its subsidiaries as if the consolidated group were a single economic entity. As a result, we believe that a noncontrolling interest
in a consolidated VIE that consists of preferred stock should be accounted for similar to preferred stock issued by the consolidating enterprise (although the preferred stock is classified as noncontrolling interest). Accordingly, earnings of the VIE are allocated to the noncontrolling interest based on the preferred stocks stated dividend and liquidation rights, and losses of the subsidiary normally are not allocated to the preferred stock classified as noncontrolling interest. In other words, the balance of the preferred stock noncontrolling interest generally should be equal to its liquidation preference. In some cases, the preferred stock does not have a liquidation preference and truly represents a residual equity interest in the entity (e.g., the equity interest may be called preferred stock because it participates disproportionally in returns but otherwise participates pari passu in losses). In these instances, the interest is tantamount to common stock. Therefore, in these circumstances, we believe it would be appropriate for a primary beneficiary to charge losses against the preferred stock noncontrolling interest, as it would the common interest. The guidance above only relates to preferred stock and should not necessarily be analogized to residual equity interests that provide preferential returns, which are common in partnerships.
Date to reflect deconsolidation of a VIE

Question 18.8 Is it appropriate to reflect a VIEs deconsolidation in any periods prior to when deconsolidation is permitted pursuant to the Variable Interest Model? We believe a primary beneficiarys financial statements should reflect the consolidation of a VIE for each reporting period until such time that it is not required to consolidate the VIE. That is, upon the occurrence of a deconsolidation event, it would not be appropriate to assume that event had occurred in prior reporting periods to enhance the comparability of financial statements. However, an enterprise should evaluate whether the deconsolidation event results in discontinued operations treatment for the entity being consolidated pursuant to ASC 205-20. To illustrate this concept, assume a reporting enterprise had been required to consolidate a VIE at 1 January 20X0, and on 31 October 20X0 sells its entire variable interest in the entity resulting in the entitys deconsolidation at that date. We believe the reporting enterprise is required to consolidate the VIE for the period 1 January 20X0 to 31 October 20X0. We do not believe it is appropriate for the enterprise to conclude that because it was not required to consolidate the VIE at 31 October 20X0, that it is able to account only for its variable interest during 20X0, without consolidating the VIEs results of operations from 1 January 20X0 to 31 October 20X0.
Attribution of income/loss in an asset-backed financing entity

Question 18.9 How should income or loss in an asset-backed financing entity be attributed to its variable interest holders when the beneficial interests are classified as liabilities? Background In many circumstances, the primary beneficiary (i.e., controlling financial interest holder) in an assetbacked financing entity (e.g., collateralized loan obligation (CLO)) has power through its service arrangement and benefits from (1) the fees earned through its service arrangement and (2) the ownership of beneficial interests (if any). The beneficial interests (including the most residual tranche) of an asset-backed financing entity often are classified as liabilities. Additionally, an asset-backed financing entity may have a nominal amount of equity-classified instruments to satisfy jurisdictional requirements. However, the holder of these equity-classified instruments (if any) is not exposed to any substantive risks or rewards of ownership.
Consolidation procedure Following the initial consolidation of an asset-backed financing entity, subsequent changes in the measurement of the assets and liabilities of the entity are recorded by the primary beneficiary (if any) in its consolidated income statement. However, subsequent changes in the measurement of the assets and liabilities may not fully offset in each reporting period giving rise to income or loss (e.g., the assets and liabilities are being recorded at fair value and the measurement guidance in ASC 820 results in the assets and liabilities being recorded at different amounts). Often the primary beneficiarys economic claim to the difference (i.e., the amount by which the changes in assets and liabilities do not offset) is limited to its proportion of the beneficial interests (if any). Therefore, questions have arisen as to how income or loss should be attributed to the primary beneficiary and the other variable interest holders (e.g., beneficial interest holders) of an asset-backed financing entity. ASC 810-10-20 defines noncontrolling interest as the portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent However, ASC 810-10-45-16A indicates that only a financial instrument classified as equity in the subsidiarys financial statements can represent noncontrolling interest. Through its service arrangement or beneficial interests (if any), the primary beneficiary of an assetbacked financing entity generally is not contractually (nor economically) entitled to all of the income or loss. Therefore, in the absence of a substantive equity-classified noncontrolling interest, the accounting literature is not clear as to how the income or loss of an asset-backed financing entity should be attributed to its variable interest holders on the consolidated income statement or balance sheet. Accounting considerations Outside of any service arrangement fees earned, we believe that it would be most appropriate for income or loss to be attributed to its primary beneficiary only to the extent the primary beneficiary holds beneficial interests that are economically and contractually entitled to income or loss. If there is no substantive-equity classified noncontrolling interest, we believe that it would be most appropriate for the remaining income or loss to be attributed to the noncontrolling interest line item on the face of the consolidated income statement, despite the fact that the beneficial interests are classified as liabilities. We understand that the SEC staff has not objected to this accounting application but has objected to a view that any excess of the amount of assets over the amount of liabilities be recorded as expense in the consolidated income statement (i.e., with a corresponding adjustment to the liability to the beneficial interest holders). We also understand that the SEC staff has not objected to a view that the portion of the income or loss attributable to noncontrolling interest on the consolidated income statement be reclassified into appropriated retaining earnings of parent in the consolidated balance sheet. It is relevant to note that, upon adoption of Statement 167, ASC 810-10-65-2(c) requires any cumulative effect adjustment to be recorded to retained earnings. We understand that the SEC staff view above also would apply to the relevant portion of the cumulative effect adjustment being recorded to appropriated retained earnings for asset-backed financing entities consolidated upon adoption. Different facts and circumstances might result in different acceptable accounting conclusions. In any event, we believe that an enterprises accounting policies should be fully disclosed and made transparent to the readers of the financial statements. Additionally, we understand that the FASB staff is aware of this issue. Readers should monitor any future developments in this area closely.
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Presentation
Consolidation Overall Other Presentation Matters 810-10-45-25 A reporting entity shall present each of the following separately on the face of the statement of financial position: a. b. Assets of a consolidated variable interest entity (VIE) that can be used only to settle obligations of the consolidated VIE Liabilities of a consolidated VIE for which creditors (or beneficial interest holders) do not have recourse to the general credit of the primary beneficiary.
19.1
Statement 167 amends the Variable Interest Model to require that a reporting enterprise separately present on the face of the balance sheet certain assets and liabilities of a consolidated VIE. The FASB concluded that separate presentation should be required by enterprises consolidating a VIE. In arriving at its conclusion, the FASB considered but rejected a single line-item display of assets and liabilities or net assets and liabilities of VIEs. In other words, qualifying assets and liabilities of VIEs should be presented separately on the balance sheet for each major class of assets and liabilities (e.g., cash, accounts receivable, property, plant and equipment). Although noncontrolling interests are not subject to separate presentation requirements, we believe an enterprise is permitted to do so in the equity section of the balance sheet so long as it is an accounting policy choice that is applied to all consolidated VIEs. While the Variable Interest Model requires separate presentation, it does not provide examples or detailed implementation guidance with respect to how enterprises would satisfy the separate presentation requirements. We believe that enterprises will have to consider carefully the separate presentation requirements and ensure that adequate financial reporting systems are established to track and capture the assets and liabilities of consolidated VIEs that meet the criteria for separate presentation.
Availability of aggregation principle for separate presentation

Question 19.1 Can an enterprise aggregate amounts in presenting the assets and liabilities of a consolidated VIE that otherwise are required to be presented separately on the statement of financial position? For certain enterprises that may consolidate numerous VIEs with assets and liabilities that meet the criteria for separate presentation under ASC 810-10-45-25, the presentation of separate line items on an enterprises statement of financial position related to each VIE may prove impractical. While not discussed with respect to separate presentation, the Variable Interest Models disclosure requirements include an aggregation principle. Specifically, the Variable Interest Model permits aggregation of
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disclosures for similar entities in situations in which separate reporting would not provide information that is more useful to financial statement users. In circumstances in which an enterprise consolidates numerous VIEs, we believe that the aggregation principle for disclosure should be considered when applying the separate presentation requirement. Enterprises should establish (and disclose) a policy for how similar entities are aggregated. That policy should contemplate both quantitative and qualitative information about the different risk and reward characteristics of each VIE and the significance of each VIE to the enterprise. For example, consider a circumstance in which an enterprise is required to consolidate three VIEs (VIE 1, VIE 2 and VIE 3). Each of those VIEs has accounts receivable, investments and liabilities that meet the separate presentation requirement. The enterprise determines VIEs 1 and 2 are similar under the enterprises established policy such that the separate assets and liabilities of VIEs 1 and 2 would be eligible for aggregation. In addition, the enterprise determines that separate presentation of those two VIEs assets and liabilities on a combined basis would provide information that is more useful to financial statement users. Accordingly, the enterprise will aggregate the receivables of VIEs 1 and 2, the investments of VIEs 1 and 2 and the liabilities of VIEs 1 and 2, respectively. The receivables, investments and liabilities of VIE 3 will be presented separately from those of the other VIEs.
Separate presentation on a net or a single line item basis

Question 19.2 Is it acceptable to present the net assets of a VIE as a single line item on the statement of financial position? Assume Enterprise A is the primary beneficiary of VIE 1. Assume that VIE 1s assets and liabilities meet the criteria for separate presentation in the financial statements of Enterprise A. The balance sheet of VIE 1 is as follows:
Assets Cash Accounts receivable PP&E net Total assets Liabilities and equity Accounts payable Long-term debt Equity Total liabilities and equity $ $ 150 400 50 600 $ $ 100 200 300 600
Can Enterprise A report VIE 1s assets and liabilities in its consolidated financial statements at its net asset value of $50? Alternatively, can Enterprise A aggregate VIE 1s assets and liabilities separately and present its total assets at $600 and its total liabilities at $550? No. The Variable Interest Model permits aggregation of disclosures for similar entities in situations in which separate reporting would not provide information that is more useful to financial statement users. While we believe that aggregation of similar assets and liabilities of consolidated VIEs may be appropriate (as discussed in Question 19.1), we do not believe that a net presentation for a VIEs assets and liabilities as one line item would be acceptable. As such, Enterprise A should not present VIE 1s assets and liabilities as a single line item in its financial statements at $50. In addition, we believe that presenting VIE 1s aggregate assets and aggregate liabilities as suggested above ($600 and $550, respectively) also is inconsistent with the separate presentation requirements in ASC 810-10-45-25.
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As noted above, the Variable Interest Model does not provide detailed implementation guidance with respect to separate presentation. As a result, enterprises may choose different approaches to satisfy the separate presentation requirements. Using the above example, Enterprise A may choose to present a separate line item for accounts receivable for VIE 1 or it may choose to include the receivables of VIE 1 within its consolidated accounts receivable amount and parenthetically disclose the accounts receivable for VIE 1. Other presentation alternatives may be acceptable.
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Disclosures
Consolidation Overall Disclosure All Entities within the Scope of Subtopic 810-10-50-2AA The principal objectives of this Subsections required disclosures are to provide financial statement users with an understanding of all of the following: a. The significant judgments and assumptions made by a reporting entity in determining whether it must do any of the following: 1. 2. b. c. d. Consolidate a variable interest entity (VIE) Disclose information about its involvement in a VIE.
The nature of restrictions on a consolidated VIEs assets reported by a reporting entity in its statement of financial position, including the carrying amounts of such assets and liabilities. The nature of, and changes in, the risks associated with a reporting entitys involvement with the VIE. How a reporting entitys involvement with the VIE affects the reporting entitys financial position, financial performance, and cash flows.
810-10-50-2AB A reporting entity shall consider the overall objectives in the preceding paragraph in providing the disclosures required by this Subsection. To achieve those objectives, a reporting entity may need to supplement the disclosures otherwise required by this Subsection, depending on the facts and circumstances surrounding the VIE and a reporting entitys interest in that VIE. 810-10-50-2AC The disclosures required by this Subsection may be provided in more than one note to the financial statements, as long as the objectives in paragraph 810-10-50-2AA are met. If the disclosures are provided in more than one note to the financial statements, the reporting entity shall provide a cross reference to the other notes to the financial statements that provide the disclosures prescribed in this Subsection for similar entities. Primary Beneficiary of a VIE 810-10-50-3 The primary beneficiary of a VIE that is a business shall provide the disclosures required by other guidance. The primary beneficiary of a VIE that is not a business shall disclose the amount of gain or loss recognized on the initial consolidation of the VIE. In addition to disclosures required elsewhere in this Topic, the primary beneficiary of a VIE shall disclose all of the following (unless the primary beneficiary also holds a majority voting interest): a. [Subparagraph superseded by Accounting Standards Update No. 2009-17]
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b.
[Subparagraph superseded by Accounting Standards Update No. 2009-17]
bb. The carrying amounts and classification of the VIEs assets and liabilities in the statement of financial position that are consolidated in accordance with the Variable Interest Entities Subsections, including qualitative information about the relationship(s) between those assets and liabilities. For example, if the VIEs assets can be used only to settle obligations of the VIE, the reporting entity shall disclose qualitative information about the nature of the restrictions on those assets. c. d. Lack of recourse if creditors (or beneficial interest holders) of a consolidated VIE have no recourse to the general credit of the primary beneficiary Terms of arrangements, giving consideration to both explicit arrangements and implicit variable interests that could require the reporting entity to provide financial support (for example, liquidity arrangements and obligations to purchase assets) to the VIE, including events or circumstances that could expose the reporting entity to a loss.
A VIE may issue voting equity interests, and the entity that holds a majority voting interest also may be the primary beneficiary of the VIE. If so, and if the VIE meets the definition of a business and the VIEs assets can be used for purposes other than the settlement of the VIEs obligations, the disclosures in this paragraph are not required. Nonprimary Beneficiary Holder of Variable Interest in a VIE 810-10-50-4 In addition to disclosures required by other guidance, a reporting entity that holds a variable interest in a VIE, but is not the VIEs primary beneficiary, shall disclose: a. b. The carrying amounts and classification of the assets and liabilities in the reporting entitys statement of financial position that relate to the reporting entitys variable interest in the VIE. The reporting entitys maximum exposure to loss as a result of its involvement with the VIE, including how the maximum exposure is determined and the significant sources of the reporting entitys exposure to the VIE. If the reporting entitys maximum exposure to loss as a result of its involvement with the VIE cannot be quantified, that fact shall be disclosed. A tabular comparison of the carrying amounts of the assets and liabilities, as required by (a) above, and the reporting entitys maximum exposure to loss, as required by (b) above. A reporting entity shall provide qualitative and quantitative information to allow financial statement users to understand the differences between the two amounts. That discussion shall include, but is not limited to, the terms of arrangements, giving consideration to both explicit arrangements and implicit variable interests, that could require the reporting entity to provide financial support (for example, liquidity arrangements and obligations to purchase assets) to the VIE, including events or circumstances that could expose the reporting entity to a loss. Information about any liquidity arrangements, guarantees, and/or other commitments by third parties that may affect the fair value or risk of the reporting entitys variable interest in the VIE is encouraged. If applicable, significant factors considered and judgments made in determining that the power to direct the activities of a VIE that most significantly impact the VIEs economic performance is shared in accordance with the guidance in paragraph 810-10-25-38D.
c.
d.
e.
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Primary Beneficiaries or Other Holders of Interests in VIEs 810-10-50-5A A reporting entity that is a primary beneficiary of a VIE or a reporting entity that holds a variable interest in a VIE but is not the entitys primary beneficiary shall disclose all of the following: a. Its methodology for determining whether the reporting entity is the primary beneficiary of a VIE, including, but not limited to, significant judgments and assumptions made. One way to meet this disclosure requirement would be to provide information about the types of involvements a reporting entity considers significant, supplemented with information about how the significant involvements were considered in determining whether the reporting entity is the primary beneficiary. If facts and circumstances change such that the conclusion to consolidate a VIE has changed in the most recent financial statements (for example, the VIE was previously consolidated and is not currently consolidated), the primary factors that caused the change and the effect on the reporting entitys financial statements. Whether the reporting entity has provided financial or other support (explicitly or implicitly) during the periods presented to the VIE that it was not previously contractually required to provide or whether the reporting entity intends to provide that support, including both of the following: 1. 2. d. The type and amount of support, including situations in which the reporting entity assisted the VIE in obtaining another type of support The primary reasons for providing the support.
b.
c.
Qualitative and quantitative information about the reporting entitys involvement (giving consideration to both explicit arrangements and implicit variable interests) with the VIE, including, but not limited to, the nature, purpose, size, and activities of the VIE, including how the VIE is financed. Paragraphs 810-10-25-48 through 25-54 and Example 4 (see paragraph 810-10-55-87) provide guidance on how to determine whether a reporting entity has an implicit variable interest in a VIE.
810-10-50-5B A VIE may issue voting equity interests, and the entity that holds a majority voting interest also may be the primary beneficiary of the VIE. If so, and if the VIE meets the definition of a business and the VIEs assets can be used for purposes other than the settlement of the VIEs obligations, the disclosures in the preceding paragraph are not required. Scope-Related Disclosures 810-10-50-6 A reporting entity that does not apply the guidance in the Variable Interest Entities Subsections to one or more VIEs or potential VIEs because of the condition described in paragraph 810-10-15-17(c) shall disclose all the following information: a. The number of legal entities to which the guidance in the Variable Interest Entities Subsections is not being applied and the reason why the information required to apply this guidance is not available The nature, purpose, size (if available), and activities of the legal entities and the nature of the reporting entitys involvement with the legal entities
b.
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c. d.
The reporting entitys maximum exposure to loss because of its involvement with the legal entities The amount of income, expense, purchases, sales, or other measure of activity between the reporting entity and the legal entities for all periods presented. However, if it is not practicable to present that information for prior periods that are presented in the first set of financial statements for which this requirement applies, the information for those prior periods is not required.
Aggregation of Certain Disclosures 810-10-50-9 Disclosures about VIEs may be reported in the aggregate for similar entities if separate reporting would not provide more useful information to financial statement users. A reporting entity shall disclose how similar entities are aggregated and shall distinguish between: a. b. VIEs that are not consolidated because the reporting entity is not the primary beneficiary but has a variable interest VIEs that are consolidated.
In determining whether to aggregate VIEs, the reporting entity shall consider quantitative and qualitative information about the different risk and reward characteristics of each VIE and the significance of each VIE to the entity. The disclosures shall be presented in a manner that clearly explains to financial statement users the nature and extent of an entitys involvement with VIEs. 810-10-50-10 A reporting entity shall determine, in light of the facts and circumstances, how much detail it shall provide to satisfy the requirements of the Variable Interest Entities Subsections. A reporting entity shall also determine how it aggregates information to display its overall involvements with VIEs with different risk characteristics. The reporting entity must strike a balance between obscuring important information as a result of too much aggregation and overburdening financial statements with excessive detail that may not assist financial statement users to understand the reporting entitys financial position. For example, a reporting entity shall not obscure important information by including it with a large amount of insignificant detail. Similarly, a reporting entity shall not disclose information that is so aggregated that it obscures important differences between the types of involvement or associated risks.
20.1
In general, Statement 167 retains the disclosure requirements in the Variable Interest Model previously applicable to public enterprises with only minor editorial changes. Additionally, the Variable Interest Model requires disclosures in situations in which an enterprise determines that it shares the power over a VIE. As nonpublic enterprises previously were not required to apply all of the provisions in the Variable Interest Model, the adoption of Statement 167 will significantly expand the disclosure requirements for those enterprises as the Variable Interest Model will no longer provide an exception for these enterprises. In response to financial statement users concerns over the transparency of entities involvement with VIEs, Statement 167s amendments to the Variable Interest Model will require expanded disclosures in the following areas: The significant judgments and assumptions considered by the enterprise in determining whether it must consolidate a VIE or disclose information about its involvement with a VIE
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The nature of restrictions on a consolidated VIEs assets and on the settlement of its liabilities reported by the enterprise in its statement of financial position, including the carrying amounts of such assets and liabilities The nature of, and changes in, the risks associated with the enterprises involvement in a VIE How an enterprises involvement with a VIE affects its financial position, financial performance and cash flows
An enterprise must consider these overall objectives in providing the disclosures required by the Variable Interest Model. To achieve these objectives, an enterprise may need to supplement the required disclosures, depending on the facts and circumstances surrounding the VIE and the enterprises interest in that entity. Accordingly, if the enterprises involvement with the VIE is not adequately described by any of the required disclosures, the enterprise should provide further information, as needed. The disclosure requirements are extensive and, for certain enterprises, obtaining the information to prepare these disclosures may present challenges. Many VIEs do not prepare financial statements on a timely basis, and the reporting enterprise may not have a legal or contractual right to obtain the information, particularly for those over which the enterprise does not have the power to direct the activities of a VIE that most significantly impact the entitys economic performance. As a result, variable interest holders should ensure that they have access to the necessary information and develop control procedures to be able to obtain and analyze the information in order to prepare the required disclosures. While we believe an enterprise that is the primary beneficiary may have access to the information necessary to comply with the disclosure requirements, the ability of the primary beneficiary to develop the systems and processes necessary to gather the data may prove challenging.
Questions and interpretative responses Public company MD&A disclosure requirements

Question 20.1 How do the Variable Interest Models disclosure requirements interact with those of FR-67? FR-67 requires a public company to provide disclosure in a separately captioned subsection of Managements Discussion and Analysis (MD&A) of off-balance sheet arrangements that had a material effect on the financial statements presented or that are reasonably likely to have a material future effect on the companys financial statements or financial outlook. We understand from the SEC Staff that the scope of these MD&A disclosures include obligations arising out of all variable interests held in any entity engaged in the activities specified in FR-67, even variable interests in an entity that is not subject to the consolidation guidance provided by the Variable Interest Model. For example, the scope of FR-67 can include obligations arising out of variable interests in an entity that is determined not to be a VIE after applying the provisions of the Variable Interest Model. Included within the definition of off-balance sheet arrangements in FR-67 are: Any retained or contingent interest in assets transferred to an unconsolidated entity. Any similar arrangement that serves as credit, liquidity or market risk support to such an unconsolidated entity for transferred assets. Obligations arising out of a material variable interest in an unconsolidated entity: That provides financing, liquidity, market risk or credit risk support to the company, or That engages in leasing, hedging or research and development services with the company.
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The definition of a variable interest, in this context, is intended to be consistent with the concept of a variable interest included in the Variable Interest Model.
Meaning of maximum exposure to loss

Question 20.2 Does the term maximum exposure to loss that must be disclosed pursuant to ASC 810-10-50-4(b) refer to economic risk or financial statement exposure? We believe that maximum exposure to loss refers to the maximum loss that an enterprise could be required to record in its income statement as a result of its involvement with a VIE. Further, this maximum potential loss must be disclosed regardless of the probability of such losses actually being incurred.
Aggregation
Question 20.3 What factors should an enterprise consider when aggregating disclosures about VIEs? In determining whether to aggregate disclosures with respect to multiple VIEs pursuant to ASC 810-10-50-9, the reporting enterprise should consider both quantitative and qualitative information about the different risk and reward characteristics of each VIE and the significance of each VIE to the enterprise. The disclosures must be presented in a manner that clearly explains to financial statement users the nature and extent of an enterprises involvement with VIEs. We believe that the qualitative information an enterprise may consider in determining whether VIEs are similar such that aggregating disclosures is appropriate may include, but is not limited to: The purpose and design of the VIE including the nature of the risks that the entity was designed to create. For example, the purpose and the design of a VIE may be to provide liquidity to the transferor of assets and to provide investors with the ability to invest in a pool of highly rated medium-term assets. Another VIEs purpose and design may be to provide the lessee with use of the property for a certain number of years with substantially all of the rights and obligations of ownership. We believe aggregating disclosures based on the purpose and design of a VIE as described herein is appropriate and, therefore, the assets and liabilities of these two VIEs should not be aggregated. The nature of the assets in the entity (e.g., residential mortgage vs. commercial mortgage). The type of involvement an enterprise may have with the VIEs. Examples of an involvement in an entity can vary and may relate to ones role (e.g., a special servicer, provider of guarantees or liquidity reserves) or to the types of interests one holds (e.g., equity vs. debt).
We believe that the objectives of the disclosure requirements are to provide more decision useful information to users. As such, the manner in which an enterprise applies the aggregation provisions should be consistent with these overall objectives, and an enterprise will be required to exercise judgment based upon its facts and circumstances in determining how much detail it must provide to satisfy the requirements of the Variable Interest Model. When considering whether to aggregate disclosures with respect to multiple VIEs, the enterprise should attempt to consider the disclosure alternatives from the perspective of a third party trying to understand the amount and nature of the enterprises exposure to the VIEs. That is, the reporting enterprise should consider whether the disclosures are more informative on an aggregated or disaggregated basis. While disaggregated information arguably is always more useful, that may not be true when it results in excessively lengthy disclosures. However, amounts relating to consolidated VIEs may never be aggregated with amounts relating to VIEs that are not consolidated.
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21
Effective date and transition

Consolidation Overall Transition and Open Effective Date Information 810-10-65-2 The following represents the transition and effective date information related to FASB Statement No. 167, Amendments to FASB Interpretation 46(R): a. Except as noted in item aa, the pending content that links to this paragraph is effective as of the beginning of each reporting entitys first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. aa. Except for the pending content in Section 810-10-50, the pending content that links to this paragraph shall not be applied to either of the following: 1. A reporting entitys interest in an entity if all of the following conditions are met: i. The entity either: 01. Has all of the attributes specified in paragraph 946-10-15-2(a) through (d) 02. Does not have all of the attributes specified in paragraph 946-10-15-2(a) through (d) but is an entity for which it is acceptable based on industry practice to apply measurement principles that are consistent with those in Topic 946 (including recognizing changes in fair value currently in the statement of operations) for financial reporting purposes. ii. The reporting entity does not have an explicit or implicit obligation to fund losses of the entity that could potentially be significant to the entity. This condition should be evaluated considering the legal structure of the reporting entitys interest, the purpose and design of the entity, and any guarantees provided by the reporting entitys related parties. The entity is not: 01. A securitization entity 02. An asset-backed financing entity 03. An entity that was formerly considered a qualifying special-purpose entity. Examples of entities that may meet the preceding conditions include a mutual fund, a hedge fund, a mortgage real estate investment fund, a private equity fund, and a venture capital fund. Examples of entities that do not meet the preceding conditions include structured investment vehicles, collateralized debt/loan obligations, commercial paper conduits, credit card securitization structures, residential or commercial mortgage-backed entities, and government sponsored mortgage entities.
iii.
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2.
A reporting entitys interest in an entity that is required to comply with or operate in accordance with requirements that are similar to those included in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. An entity that initially meets the deferral requirements in this subparagraph may subsequently cease to qualify for the deferral as a result of a change in facts and circumstances. In that situation, the pending content that links to this paragraph shall become effective for the entity. Accordingly, if the reporting entity is required to consolidate an entity because the entity no longer qualifies for the deferral, the reporting entity shall initially measure the assets, liabilities, and noncontrolling interests of the VIE in accordance with paragraphs 810-10-30-1 through 30-6, as of the date the entity ceases to qualify for the deferral.
aaa. Public and nonpublic entities shall provide the disclosures required by the pending content in paragraphs 810-10-50-1 through 50-19 that links to this paragraph for all variable interests in variable interest entities (VIEs). This includes variable interests in VIEs that qualify for the deferral in the preceding subparagraph but are considered VIEs under the provisions of the Variable Interest Entities Subsections of this Subtopic before the amendments in the pending content that links to this paragraph (that is, before the effects of Accounting Standards Updates 2009-17 and 2010-10). For public entities, in periods after initial adoption, comparative disclosures for those disclosures that were not previously required by paragraphs 810-10-50-7 through 50-19 are required only for periods after the effective date. Comparative information for disclosures previously required by those paragraphs that also are required by the pending content in the Variable Interest Entities Subsections shall be presented. For nonpublic entities, in periods after initial adoption, comparative disclosures for those disclosures that were not previously required are required only for periods after the effective date. Comparative information for disclosures previously required that also are required by the pending content in the Variable Interest Entities Subsections shall be presented. b. If a reporting entity is required to consolidate a VIE as a result of the initial application of the pending content that links to this paragraph, the initial measurement of the assets, liabilities, and noncontrolling interests of the VIE depends on whether the determination of their carrying amounts is practicable. In this context, carrying amounts refers to the amounts at which the assets, liabilities, and noncontrolling interests would have been carried in the consolidated financial statements if the requirements of the pending content that links to this paragraph had been effective when the reporting entity first met the conditions to be the primary beneficiary. 1. If determining the carrying amounts is practicable, the consolidating entity shall initially measure the assets, liabilities, and noncontrolling interests of the VIE at their carrying amounts at the date the requirements of the pending content that links to this paragraph first apply. If determining the carrying amounts is not practicable, the assets, liabilities, and noncontrolling interests of the VIE shall be measured at fair value at the date the pending content that links to this paragraph first applies. However, as an alternative to this fair value measurement requirement, the assets and liabilities of the VIE may be measured at their unpaid principal balances at the date the pending content that links to this paragraph first applies if both of the following conditions are met: i. The activities of the VIE are primarily related to securitizations or other forms of asset-backed financings.
2.
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ii.
The assets of the VIE can be used only to settle obligations of the entity.
This measurement alternative does not obviate the need for the primary beneficiary to recognize any accrued interest, an allowance for credit losses, or other-than-temporary impairment, as appropriate. Other assets, liabilities, or noncontrolling interests, if any, that do not have an unpaid principal balance, and any items that are required to be carried at fair value under other applicable standards, shall be measured at fair value. c. Any difference between the net amount added to the balance sheet of the consolidating entity and the amount of any previously recognized interest in the newly consolidated VIE shall be recognized as a cumulative effect adjustment to retained earnings. A reporting entity shall describe the transition method(s) applied and shall disclose the amount and classification in its statement of financial position of the consolidated assets or liabilities by the transition method(s) applied. A reporting entity that is required to consolidate a VIE as a result of the initial application of the pending content in the Variable Interest Entities Subsections may elect the fair value option provided by the Fair Value Option Subsections of Subtopic 825-10, only if the reporting entity elects the option for all financial assets and financial liabilities of that VIE that are eligible for this option under those Fair Value Option Subsections. This election shall be made on a VIE-by-VIE basis. Along with the disclosures required in those Fair Value Option Subsections, the consolidating reporting entity shall disclose all of the following: 1. 2. 3. Managements reasons for electing the fair value option for a particular VIE or group of VIEs The reasons for different elections if the fair value option is elected for some VIEs and not others Quantitative information by line item in the statement of financial position indicating the related effect on the cumulative-effect adjustment to retained earnings of electing the fair value option for a VIE.
d.
e.
If a reporting entity is required to deconsolidate a VIE as a result of the initial application of the pending content in the Variable Interest Entities Subsections, the deconsolidating reporting entity shall initially measure any retained interest in the deconsolidated subsidiary at its carrying amount at the date the requirements of the pending content in the Variable Interest Entities Subsections first apply. In this context, carrying amount refers to the amount at which any retained interest would have been carried in the reporting entitys financial statements if the pending content in the Variable Interest Entities Subsections had been effective when the reporting entity became involved with the VIE or no longer met the conditions to be the primary beneficiary. Any difference between the net amount removed from the balance sheet of the deconsolidating reporting entity and the amount of any retained interest in the newly deconsolidated VIE shall be recognized as a cumulative-effect adjustment to retained earnings. The amount of any cumulative-effect adjustment related to deconsolidation shall be disclosed separately from any cumulative-effect adjustment related to consolidation of VIEs. The determinations of whether a legal entity is a VIE and which reporting entity, if any, is a VIEs primary beneficiary shall be made as of the date the reporting entity became involved with the legal entity or if events requiring reconsideration of the legal entitys status or the status of its variable interest holders have occurred, as of the most recent date at which the pending content in the Variable Interest Entities Subsections would have required consideration.
f.
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g.
If at transition it is not practicable for a reporting entity to obtain the information necessary to make the determinations in (f) above as of the date the reporting entity became involved with a legal entity or at the most recent reconsideration date, the reporting entity should make the determinations as of the date on which the pending content in the Variable Interest Entities Subsections is first applied. If the VIE and primary beneficiary determinations are made in accordance with subparagraphs (f) and (g) above, then the primary beneficiary shall measure the assets, liabilities, and noncontrolling interests of the VIE at fair value as of the date on which the pending content in the Variable Interest Entities Subsections is first applied. However, if the activities of the VIE are primarily related to securitizations or other forms of asset-backed financings and the assets of the VIE can be used only to settle obligations of the VIE, then the assets and liabilities of the VIE may be measured at their unpaid principal balances (as an alternative to a fair value measurement) at the date the pending content in the Variable Interest Entities Subsections first applies. This measurement alternative does not obviate the need for the primary beneficiary to recognize any accrued interest, an allowance for credit losses, or other-than-temporary impairment, as appropriate. Other assets, liabilities, or noncontrolling interests, if any, that do not have an unpaid principal balance, and any items that are required to be carried at fair value under other applicable standards, shall be measured at fair value. The pending content in the Variable Interest Entities Subsections may be applied retrospectively in previously issued financial statements for one or more years with a cumulative-effect adjustment to retained earnings as of the beginning of the first year restated. The pending content linked to this paragraph may amend or supersede either nonpending content or other pending content with different or the same effective dates. If a paragraph contains multiple pending content versions of that paragraph, it may be necessary to refer to the transition paragraphs of all such pending content to determine the paragraph that is applicable to a particular fact pattern.
h.
i.
j.
21.1
Note: In February 2010, the FASB issued an Accounting Standards Update (ASU) primarily to address concerns with the application of Statement 167 for reporting enterprises in the asset management industry by deferring the effective date of Statement 167 for certain investment funds. See additional discussion of this ASU later in this chapter. The FASB currently has a project on its agenda that would eliminate the deferral discussed above. In addition, the FASBs tentative decisions would modify the Variable Interest Models provisions for evaluating an enterprise as a principal or an agent (see Chapter 6) and the provisions for evaluating the substance of kick-out rights and participating rights (see Chapters 9 and 14), among other things. Readers should monitor developments in this area closely. Effective date Statement 167 is effective as of the beginning of an enterprises first annual reporting period that begins after 15 November 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter, with earlier application prohibited. For example, Statement 167 is effective for calendar year-end companies beginning on 1 January 2010.
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Disclosures In periods after the initial adoption, comparative information for disclosures previously required for nonpublic enterprises or for public enterprises is required. In periods after initial adoption, comparative disclosures for those disclosures that were not previously required for nonpublic enterprises or public enterprises only are required for periods subsequent to the effective date. That is, disclosures need not be provided for periods prior to the effective date unless those disclosures had been required when financial statements for those periods were originally prepared. Transition It is important to note that the amendments to the Variable Interest Model are applicable to all enterprises and to all entities with which those enterprises are involved, regardless of when that involvement arose. Therefore, upon adoption of Statement 167, all enterprises must reconsider their consolidation conclusions for all entities with which they are involved. Recognition Upon transition, an enterprise may be required to consolidate entities that it did not consolidate prior to the adoption of Statement 167. Conversely, an enterprise may be required to deconsolidate entities that it consolidated prior to the adoption of Statement 167. In evaluating the effects of Statement 167, an enterprise should assume that Statement 167s requirements always have been effective. The determination of whether an entity is a VIE and which enterprise, if any, is the VIEs primary beneficiary should be made as of the date the enterprise first became involved with the entity. That conclusion should then be reevaluated when events requiring reconsideration of the entitys status as a VIE or when a change in the primary beneficiary would have occurred under Statement 167. However, only if the enterprise would be a VIEs primary beneficiary at the adoption date if Statement 167s provisions had always been applied, should a VIE be consolidated by the enterprise on the adoption date. Alternatively, if the enterprise would not be an entitys primary beneficiary at the adoption date if Statement 167 had always been applied, the entity should not be consolidated by the enterprise on the adoption date. Situations may arise in which it is not practicable for an enterprise to determine whether an entity would have been a VIE or whether the enterprise would have been the primary beneficiary had Statement 167s provisions always been effective. That is, it may not be practicable for an enterprise to determine whether an entity is a VIE or whether the enterprise is the primary beneficiary from the date the enterprise first became involved with an entity, or if a reconsideration has occurred, at the most recent reconsideration date. In these instances, the enterprise should make the determination of whether it should consolidate an entity as of the effective date of the Statement 167. That is, an enterprise that takes the practicability exception performs the VIE and primary beneficiary analysis as of different date (the adoption date). Measurement If an enterprise is required to consolidate a VIE upon the implementation of Statement 167, the enterprise initially will measure and recognize all assets, liabilities and noncontrolling interests of the VIE at their carrying amounts at the date of adoption. Carrying amounts are the amounts at which the assets, liabilities and noncontrolling interests would have been carried in the consolidated financial statements if Statement 167 was effective when the enterprise first would have met the conditions to be the primary beneficiary under Statement 167. Any differences between the net amounts added to the balance sheet upon initial consolidation and the amount of any previously recognized interest in the newly consolidated VIE should be recognized as a cumulative effect adjustment to retained earnings.
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The Variable Interest Model generally requires that accounting subsequent to initial measurement follow the same accounting for a consolidated voting interest entity. Subsequent accounting may include, but would not be limited to, the elimination of intercompany transactions and balances, asset valuations (including analysis of asset impairments) and depreciation and amortization. Refer to Chapter 17 for further discussion regarding initial measurement and consolidation considerations. To illustrate, assume an enterprise determines upon the adoption of Statement 167 that it is the primary beneficiary of a VIE that was not consolidated previously. The enterprise determines it first met the conditions to be the primary beneficiary under Statement 167 on 1 January 2005. The enterprise also determines that the entity would have remained a VIE and that it would have remained the primary beneficiary under Statement 167 through the date of adoption. Therefore, the enterprise initially calculates the values of all assets, liabilities and noncontrolling interests of the VIE at the date the enterprise first met the conditions to be the primary beneficiary under Statement 167. The enterprise then subsequently adjusts those assets, liabilities and noncontrolling interests as if the entity was a consolidated subsidiary from 1 January 2005 to the date of adoption. The resulting amounts are recognized in consolidation at the date of adoption, with the difference between those amounts recognized as a cumulative effect adjustment to retained earnings. Assume now that VIE reconsideration events occurred on 1 May 2006 and on 1 August 2008. The VIE would have been deconsolidated as of 1 May 2006 as power and benefits were lost and then consolidated as of 1 August 2008 as power and benefits were re-gained. In this scenario, the determination of the carrying amounts upon adoption of Statement 167 would be made starting with 1 August 2008. If the VIE and primary beneficiary determinations are made as of the effective date of Statement 167 (in accordance with the practicability exception discussed above with respect to recognition), then the primary beneficiary should measure the assets, liabilities and noncontrolling interests of the VIE at fair value on the adoption date. However, certain exceptions (as described more fully below) related to securitization vehicles, transfers between entities under common control and transfers shortly before, in connection with, or shortly after becoming the VIEs primary beneficiary, would apply. In addition to the situations in which the VIE and primary beneficiary determinations are made as of the effective date of the Statement 167, there may be circumstances in which it is not practicable to determine carrying amounts. In those circumstances, the assets, liabilities and noncontrolling interests of the VIE should be measured at fair value at the date of adoption. However, if a VIEs primary beneficiary changes between entities that are under common control, we believe that the new primary beneficiary initially should measure the assets, liabilities and noncontrolling interests of the VIE at carryover basis.34 In addition, we believe that when an enterprise transfers assets and liabilities to a VIE shortly before, in connection with, or shortly after becoming the VIEs primary beneficiary, the primary beneficiary initially should measure those assets and liabilities transferred to the VIE at the same amounts at which the assets and liabilities would have been measured had they not been transferred. Refer to Chapter 17 for further discussion regarding initial measurement and consolidation considerations. In the circumstances in which determining the carrying amounts of assets, liabilities and noncontrolling interests is not practicable, Statement 167 provides an additional measurement alternative for certain assets. In the circumstances in which the activities of the VIE are primarily related to securitizations or other forms of asset-backed financings, and the assets of the VIE can be used only to settle obligations of the VIE, the enterprise upon adoption may choose to measure the assets and liabilities of the VIE at their
34
Carryover basis is the amount at which the assets, liabilities and noncontrolling interests were carried in the accounts of the enterprise that formerly controlled the VIE (i.e., carryover basis should be used with no adjustment to current fair values, and no gain or loss should be recognized). 291
unpaid principal balance. The primary beneficiary also must consider the need to recognize accrued interest, allowances for credit losses or other-than-temporary impairments, as appropriate, under this measurement alternative. It is important to note that in these circumstances, other assets, liabilities or noncontrolling interests, if any, that do not have an unpaid principal balance, and any items that are required to be carried at fair value under other applicable standards, should be measured at fair value. The FASB intends for the additional transition measurement alternative to be available in situations in which an enterprise would need to incur an excessive amount of cost and effort to determine carrying amounts of a consolidated entitys assets, liabilities and noncontrolling interests. If an enterprise is required to deconsolidate an entity upon the adoption of Statement 167, the deconsolidating enterprise initially should measure any retained interest in the deconsolidated entity at its carrying amount upon adoption. Carrying amount refers to the amount at which any retained interest would have been carried in the enterprises financial statements if Statement 167 had been effective when the enterprise became involved with the entity or no longer met the conditions to be the primary beneficiary (as defined by the Variable Interest Model). Any difference between the net amount removed from the balance sheet of the deconsolidating enterprise and the amount of any retained interest in the deconsolidated entity should be recognized as a cumulative effect adjustment to retained earnings. The amount of any cumulative effect adjustment related to deconsolidation should be disclosed separately from cumulative effect adjustments related to consolidation. To illustrate, assume an enterprise determines upon the adoption of Statement 167 that it is not the primary beneficiary of an entity that was previously consolidated. The enterprise became involved with the entity on 1 January 2005. In considering Statement 167, the entity concludes that it would have accounted for its initial investment under the equity method in accordance with ASC 323-10. Therefore, the enterprise calculates its initial investment at cost in accordance with the equity method of accounting on 1 January 2005. The enterprise then subsequently adjusts the investment balance in accordance with the equity method of accounting to the date of adoption of Statement 167. The amount resulting from these calculations through the adoption date is recognized on the enterprises balance sheet at the date of adoption, all assets and liabilities previously recognized through consolidation of the entity are derecognized, and the difference is recognized as a cumulative effect adjustment to retained earnings. Fair value option An enterprise that is required to consolidate a VIE as result of Statement 167 may elect the fair value option for qualifying assets and liabilities of a newly consolidated VIE pursuant to ASC 825-10 but only as of the date that Statement 167 becomes effective (i.e., the adoption date). An enterprise may elect the fair value option for items of a VIE that are eligible for this option so long as the election is applied to all eligible items within the VIE. While ASC 825-10 allows entities to elect the fair value option for individual qualifying financial instruments without regard to consistency, the FASB was concerned that allowing the fair value option on an instrument-by-instrument basis upon adoption of Statement 167 may result in enterprises electing the option to achieve accounting results that are inconsistent with the objectives of ASC 825-10. However, enterprises may elect the fair value option on an entity-by-entity basis. Subsequent to transition, an enterprise should follow the provisions of ASC 825-10 for newly consolidated VIEs. That is, for VIEs consolidated after the initial adoption of Statement 167, the fair value option may be elected on an item-by-item basis and need not be consistently applied to all qualifying assets and liabilities of the newly consolidated VIE. An enterprise electing the fair value option should disclose its rationale for electing the option for certain entities. If the fair value option is elected for some entities and not others, the reasons for those elections must be disclosed. Additionally, the consolidating enterprise must disclose quantitative information by line item in the statement of financial position indicating the related effect on the cumulative effect adjustment
of electing the fair value option for an entity. Thus, an enterprise must compare the amounts of the line items for which the fair value option was elected to the carrying amounts of the same line items (assuming determining carrying amounts is practical). Subsequent to transition, an enterprise will continue to be subject to the ongoing disclosure requirements of ASC 825-10. Retrospective application Statement 167 may be applied retrospectively in previously issued financial statements for one or more years with a cumulative effect adjustment to retained earnings as of the beginning of the first year restated. If an entity restates its financial statements, we believe the restatement should include the effects of all entities for which the enterprise had involvement during the restated period. Additionally, we believe that by restating and promoting comparability between periods, an enterprise should consider the appropriateness of providing the disclosures required by ASC 250.
Effect of prior period VIE reconsideration events on initial measurement

Question 21.1 How do VIE reconsideration events affect the initial measurement of a VIE upon adoption of Statement 167? Consider the following illustration: Illustration 21-1: Effect of prior period VIE reconsideration events on initial measurement
Under Statement 167, Company A would have been the primary beneficiary of a VIE from inception on 1 January 2005. On 31 July 2008, an event occurred that would have required a reconsideration of the status of the entity as a VIE. After reconsideration, the entity is a VIE, and Company A remains the primary beneficiary. In accordance with the transition provisions of Statement 167, the determinations of whether an entity is a VIE and which enterprise, if any, is a VIEs primary beneficiary is made as of (a) the date the enterprise became involved with the entity or (b) if a reconsideration has occurred that would change the determination of whether the entity is a VIE or the enterprise is the primary beneficiary, at the most recent reconsideration date. Assuming that the entity is a VIE, and Company A is the primary beneficiary under Statement 167, Company A would not adjust the measurement of any of VIEs assets, liabilities or noncontrolling interests as a result of the reconsideration event (i.e., in this scenario, the reconsideration event does not affect the measurement of assets, liabilities and noncontrolling interests previously recognized). Assume now that certain events occurred that would have required reconsideration of the entitys VIE status on 1 May 2006 and on 1 August 2008 under Statement 167. Pursuant to Statement 167, the VIE would have been deconsolidated as of 1 May 2006 and then consolidated as of 1 August 2008. In this scenario, the determination of the carrying amounts upon adoption of Statement 167 would be made starting with the reconsolidation on 1 August 2008. Company A initially measures the VIEs assets, liabilities and noncontrolling interests as of 1 August 2008 and rolls them forward to 1 January 2010 to determine the carrying amounts upon adoption of Statement 167. The fact that Company A was the primary beneficiary prior to 1 May 2006 does not affect the requirement for Company A initially to measure the VIEs assets, liabilities and noncontrolling interests as of 1 August 2008 for the purpose of determining the carrying amounts upon adoption of Statement 167.
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Transition for an enterprise that is not the primary beneficiary on the adoption date but would have been in prior periods presented if Statement 167 had applied
Question 21.2 Assume Company C, which has a calendar year-end, determines pursuant to Statement 167 that it would have been the primary beneficiary of a collateralized debt obligation (CDO) when the CDO was created on 31 July 2005. Company C sells its only variable interest in the CDO on 1 December 2009 and concludes that it would no longer be the CDOs primary beneficiary if Statement 167 were adopted. No other events triggering reconsideration have occurred. Even though Company C is not the primary beneficiary of the CDO on the date of adoption, since it would have been the primary beneficiary of the CDO under Statement 167 during the years for which the financial statements are presented, does Company C have to apply the transition provisions of Statement 167 to the CDO? No. Upon adoption of Statement 167 on 1 January 2010, Company C would not consolidate the CDO as it was not the primary beneficiary on 31 December 2009 under Statement 167 (it would have deconsolidated the CDO under Statement 167 at the time it sold its interest). However, if Company C were to elect to retrospectively apply the provisions of Statement 167, it would consolidate the CDO in the financial statements until the sale of its interest.
Practicability exception for measurement available on an entity-by-entity basis

Question 21.3 Is the practicability exception with respect to measurement of assets, liabilities and noncontrolling interests available on an entity-by-entity basis? Yes. We believe the practicability exception with respect to measurement can be applied on an entity-byentity basis. For example, assume upon adoption of Statement 167, Company A determines it is required to consolidate three VIEs (VIE 1, VIE 2 and VIE 3) it has not previously consolidated. Company A became involved with VIEs 1, 2 and 3 on 1 January 2006, 1 July 2007 and 15 May 2009, respectively. Company A further concludes that it can determine the carrying amounts for VIE 3, but it is not practicable to do so for VIEs 1 and 2. Under this scenario, Company A initially will measure the assets, liabilities and noncontrolling interests of VIE 3 as of 15 May 2009. Company A then would rollforward to the adoption date the carrying amounts of the assets, liabilities and noncontrolling interests of VIE 3. With respect to VIE 1 and VIE 2, Company A initially will measure the assets, liabilities and noncontrolling interests at fair value at the date of adoption (if the VIEs activities are primarily related to securitizations or other forms of asset-backed financings, refer to Question 21.4). Company A recognizes any differences between the net amounts added to the balance sheet upon initial consolidation and the amount of any previously recognized interests in the newly consolidated VIEs as a cumulative effect adjustment to retained earnings.
Practicability exception for measurement when the activities of the entity are primarily related to securitizations or other forms of asset-backed financings
Question 21.4 If the activities of the entity are primarily related to securitizations or other forms of asset-backed financings, and the assets of the entity can be used only to settle obligations of the entity, can an enterprise measure the assets and liabilities of the entity at their unpaid principal balances in all circumstances? Before the enterprise can elect to measure the eligible assets, liabilities and noncontrolling interests at their unpaid principal balances, the enterprise needs first to establish that it is not practicable to measure the assets, liabilities and noncontrolling interests of the VIE at their carrying amounts.
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It is important to note that the primary beneficiary also must consider the need to recognize accrued interest, allowances for credit losses or other-than-temporary impairments, as appropriate, under this measurement alternative. In addition, other assets, liabilities or noncontrolling interests, if any, that do not have an unpaid principal balance, and any items that are required to be carried at fair value under other applicable standards, must be measured at fair value.
Practicability exception general

Question 21.5 How should an enterprise evaluate whether it is not practicable to apply the recognition or measurement provisions in Statement 167? Statement 167 provides for practicability exceptions in applying its consolidation transition provisions with respect to both (a) recognition and (b) initial measurement, as discussed above. However, the Variable Interest Model does not define not practicable. We believe the following factors should be considered in assessing whether it is impracticable to apply Statement 167s transition provisions: Whether data was collected in prior periods in a way that allows retrospective application. If not, whether it is impracticable to recreate the data in a manner that supports retrospective application Whether applying the provisions of Statement 167 requires the use of hindsight on the part of management, either in making assumptions about what managements intentions would have been in a prior period or estimating the amounts recognized, measured or disclosed (e.g., an estimate of fair value based on inputs that are not derived from observable market sources and were not used for other accounting measurements at that time) Whether in light of the expected costs and perceived benefits, retrospective application would involve undue cost and effort
Given the challenges that some may face in applying Statement 167s transition provisions, we believe that the use of Statement 167s practicability exceptions may not be uncommon. If an entity concludes that applying Statement 167s transition provisions are impracticable, we would expect that this conclusion would be supported by a thoroughly documented analysis.
Determining fair value in arriving at carrying amounts upon transition

Question 21.6 Should an enterprise use the concepts in Statement 141(R) (codified in ASC 805), Statement 141 (codified in ASC 805) or fair value (with no exceptions) for purposes of the initial measurement that is rolled forward to arrive at carrying amounts upon transition? Statement 167 does not provide detailed implementation guidance on the determination of the initial measurement in computing carrying amounts upon adoption. We note that ASC 810-10-30-1 through 30-4 require that an enterprise initially measure the assets, liabilities and noncontrolling interests of a VIE: At the amounts at which they were carried in the accounts of the enterprise that controls the VIE if the primary beneficiary of a VIE and the VIE are under common control; Pursuant to Statement 141(R) if the VIE is a business; or Pursuant to 141(R) (except for the recognition of goodwill) for a VIE that is not a business.
However, assets and liabilities transferred shortly before or after the date the enterprise became the primary beneficiary are measured at the same amounts at which those assets and liabilities would have been measured had the transfer not occurred (i.e., no gain or loss is recorded by the transferor).
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Given that an enterprise is required to calculate carrying amounts from the date the enterprise first would have met the conditions to be the primary beneficiary under Statement 167, the initial measurement date could be prior to the effective date of Statement 141(R). We note that prior to the incorporation of Statement 141(R)s provisions, FIN 46(R) required initial measurement of assets, liabilities and noncontrolling interests at fair value. As such, we believe an approach to measure assets, liabilities and noncontrolling interests initially at fair value prior to Statement 141(R)s effective date would be appropriate. In addition, Statement 167 clearly states that Statement 141(R) should be followed in circumstances in which the basis of initial measurement would be fair value. Therefore, as an alternative, we believe that applying the provisions of Statement 141(R) would be acceptable even if an enterprise first would have met the conditions to be the primary beneficiary under Statement 167 prior to the effective date of Statement 141(R). Given that the measurement approaches in both Statement 141(R) and FIN 46(R)s original approach to initial measurement are based principally upon fair value, the differences in valuation approaches often will not be significant. However, we believe the initial measurement of newly recognized assets, liabilities and noncontrolling interests based upon Statement 141 would be inappropriate since the Variable Interest Model has never permitted the use of Statement 141 as a basis for initial measurement.
Determining initial carrying amounts when involvement precedes the effective date of current accounting standards
Question 21.7 Should Statement 160 (codified in ASC 810-10) (or other accounting standards that may not have been effective when an enterprise first became involved with an entity or no longer met the conditions to be the primary beneficiary) be applied in determining carrying amounts upon transition to Statement 167? Statement 167 does not provide detailed implementation guidance on the determination of initial measurement and subsequent accounting in computing carrying amounts upon adoption. Given that an enterprise is required to calculate carrying amounts from the date the enterprise first would have been the primary beneficiary (or from the date the enterprise was no longer the primary beneficiary), initial and subsequent accounting for purposes of determining carrying amounts may occur for periods prior to the effective date of Statement 160. Additionally, certain other accounting standards may not have been effective at the date an enterprise first became involved with an entity or no longer met the conditions to be the primary beneficiary. We do not believe it was the FASBs intent to require the adoption of accounting standards prior to their effective date in rolling forward the carrying amounts or initial measurement of deconsolidated VIEs. Refer to Question 21.6 for initial measurement for consolidated VIEs. Therefore, we believe that in the circumstances in which an enterprise is required to determine carrying amounts, it should apply new accounting standards in rolling forward carrying amounts from the date at which the new accounting standards would have been effective.
Application of accounting standards that require an assessment of managements intent or application of judgment retrospectively
Question 21.8 How should an enterprise apply accounting standards that require an assessment of managements intent or application of judgment retrospectively in the determination of carrying amounts? Statement 167 requires an enterprise upon initial adoption to determine the carrying amounts of the assets, liabilities and noncontrolling interests of a newly consolidated entity, or the carrying amount of an investment in an entity that is no longer consolidated, as if it always had applied the provisions of
Statement 167. This requires calculating the initial carrying amounts and subsequent changes in those carrying amounts as if Statement 167always had been applied. Statement 167 does not provide detailed implementation guidance regarding the determination of subsequent accounting in computing carrying amounts upon adoption. Therefore, application of standards that require judgment or an assessment of managements intent will require careful consideration in rolling forward initial carrying amounts for the purpose of determining the cumulative effect adjustment. For example, assume an enterprise determines upon the adoption of Statement 167 that it is not the primary beneficiary of an entity that was consolidated previously. The enterprise became involved with the entity on 1 January 2005. In considering Statement 167, the entity concludes that it would have accounted for its initial investment under the equity method in accordance with ASC 323. Therefore, the enterprise calculates its initial investment at cost in accordance with the equity method of accounting on 1 January 2005. The enterprise is required subsequently to adjust the initial investment balance in accordance with the equity method of accounting to the date of adoption of Statement 167. In subsequently adjusting the investment balance in accordance with the equity method of accounting to the date of adoption of Statement 167, an enterprise may encounter circumstances that require judgment. For example, in rolling forward the initial investment balance, the enterprise may be required to evaluate whether the equity-method investment is other-than-temporarily impaired. An enterprise carefully should evaluate how accounting standards that require judgment or an assessment of managements intent should be applied in the determination of carrying amounts. Those judgments should be based on information that would have been available at the time judgments would have been required. For example, it would be inappropriate to recognize an impairment based solely on subsequent events that could not have been known on the impairment assessment date.
Practicability exception not available for deconsolidation

Question 21.9 Is there a practicability exception available in deconsolidating an entity upon adoption of Statement 167? No. Statement 167 does not provide for a practicability exception when an enterprise determines it is required to deconsolidate an entity upon transition to Statement 167. If an enterprise determines it is required to deconsolidate an entity pursuant to Statement 167, the enterprise will measure any retained interest(s) as of the date at which the entity should be deconsolidated as if Statement 167 always had been applied. The interest(s) in the entity then must be rolled forward to the adoption date. Statement 167 does not provide a practicability exception because it is anticipated that an enterprise that was previously consolidating an entity prior to Statement 167 will have the ability to measure the carrying value (as defined by Statement 167) of any retained interest(s) and appropriately roll them forward to the adoption date.
Retrospective application when an enterprise no longer consolidates a VIE at the date of adoption
Question 21.10 If an enterprise elects to retrospectively apply Statement 167, should the restatement include all VIEs for which the enterprise was the primary beneficiary during the restated period, even if it was not the primary beneficiary of the VIE at the date of adoption? Yes. We believe the restatement should include all VIEs of which the enterprise was the primary beneficiary during the restated period, even if it was not the primary beneficiary of the VIE at the date of adoption. For example, assume Company Y, a calendar year-end company, would have been the primary beneficiary of two VIEs when they were created in 2002 under Statement 167. Company Y determines at 1 January 2010 (the date of adoption) that it is still the primary beneficiary of VIE 1 under Statement 167 but, because of the sale of all of its variable interests in VIE 2 on 31 May 2009, it would no longer be VIE
2s primary beneficiary under Statement 167. If Company Y elects to retrospectively apply Statement 167 in previously issued financial statements with a cumulative effect adjustment at 1 January 2008, Company Ys financial statements should reflect the consolidation of VIE 1 for 2008 and 2009 and VIE 2 through 31 May 2009, the date at which Company Y is no longer the primary beneficiary.
SEC registration requirements following the adoption of Statement 167

Question 21.11 How should an enterprise consider the SEC registration requirements upon adoption of Statement 167? Specifically, what are the considerations when filing a registration statement (other than on Form S-8) that incorporates the most recent annual report on Form 10-K in addition to financial statements for a subsequent interim period that includes the adoption of Statement 167? The SEC staff has indicated that if a registrant elected to adopt Statement 167 retrospectively and has filed interim financial statements for a period that includes the date of adoption, that registrant must recast its prior period annual financial statements that are incorporated by reference in a registration statement (other than on Form S-8) to reflect a material retrospective application of Statement 167.35 However, we expect the SEC staff to be skeptical of a conclusion that a retrospective application of Statement 167 is not material. Given that retrospective application is not required and generally would require significant effort on the part of the enterprise, we would expect that the SEC staff would presume such a retroactive application is material or the registrant would not have elected to apply Statement 167 retrospectively.
Derivatives hedge designation for newly consolidated VIEs upon adoption of Statement 167
Question 21.12 Upon adoption of Statement 167, Enterprise A determines that it will consolidate VIE B. VIE B has never prepared financial statements in accordance with US GAAP. VIE B has a derivative that is an economic hedge on its fixed rate debt that VIE B had issued to an unrelated party prior to the Statement 167 adoption date. Because VIE B has never prepared US GAAP financial statements, it previously has not considered the provisions of ASC 815 inclusive of the documentation requirements. Under Statement 167, Enterprise A must determine the carrying amounts of VIE Bs assets and liabilities from the date Enterprise A originally would have been the primary beneficiary. In determining carrying amounts, can Enterprise A designate a hedge relationship for VIE B from the inception of the derivative? No. We believe that hedge accounting is available as of the date that the relationship is formally designated and documented. Thus, we believe that hedge accounting can be evaluated under ASC 815 from the date of adoption Statement 167. For further discussion of hedge designation and documentation, see our Financial reporting developments publication, Accounting for derivative instruments and hedging activities.
Accumulated other comprehensive income and carrying amounts

Question 21.13 How should an enterprise consider accumulated other comprehensive income (AOCI) in arriving at carrying amounts upon transition to Statement 167? If an enterprise is required to consolidate a VIE upon the implementation of Statement 167, the enterprise initially will measure and recognize all assets, liabilities and noncontrolling interests of the VIE at their carrying amounts at the date of adoption. Carrying amounts are the amounts at which the assets, liabilities and noncontrolling interests would have been carried in the consolidated financial statements if Statement 167 was effective when the enterprise first would have met the conditions to be the primary
35
The SEC staff shared this view with the Center for Audit Quality SEC Regulations Committee (CAQ Alert #2010-20 April 9, 2010). 298
beneficiary under Statement 167. While specifically not addressed in the transition guidance to Statement 167, we believe that an enterprise also should record any AOCI that would have been carried in the consolidated financial statements in the enterprises determination of carrying amounts at the adoption date. For example, we believe it would be appropriate to include AOCI amounts for any foreign currency translation adjustments that would have been recorded from the date the enterprise would have been the primary beneficiary of an entity newly consolidated under Statement 167 to the date of adoption.
Table of selected financial data in Form 10-K

Question 21.14 If an enterprise elects to retrospectively apply Statement 167, what considerations should be given in preparing the table of selected financial data in its Form 10-K? With respect to retrospective application, the SEC staff has indicated that a registrant should apply Statement 167 consistently in the financial statements and in the table of selected financial data. For example, if a calendar year-end registrant adopts Statement 167 on 1 January 2010 and elects to retrospectively apply Statement 167 to fiscal year 2009, it should apply Statement 167 beginning in 2009 in the table of selected financial data. However, if the registrant elects to retrospectively apply Statement 167 to fiscal years 2009 and 2008, the SEC staff indicated that the registrant may decide whether it also will apply Statement 167 to fiscal years 2006 and 2007 within the selected financial data table. In all cases, the SEC staff expects a registrant to disclose to which periods it has retrospectively applied Statement 167 and, if necessary, the fact that certain periods are not comparable to the periods for which the audited financial statements are provided. 36
Internal control over financial reporting requirements for an entity newly consolidated pursuant to the adoption Statement 167
Question 21.15 What are the internal control over financial reporting (ICFR) requirements for an entity newly consolidated pursuant to the adoption of Statement 167? The SEC staff has indicated that VIEs consolidated upon adoption of Statement 167 should be included in managements reports on ICFR. Because the criteria for consolidation of a VIE under the revised guidance are based on control, the SEC staff has indicated that a registrant would not be able to justify excluding consolidated VIEs from the scope of their internal control assessment. That is, registrants likely will have the right or authority to assess the internal controls of those VIEs. Furthermore, because the consolidation of VIEs under Statement 167 will occur as of the first day of the registrants fiscal year, the SEC staff believes the registrant will have sufficient time to perform that assessment and would be unable to rely on the temporary relief provided under FAQ #3 on Managements Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Period Reports (see also Section 4310.11(c) in the Division of Corporation Finance Financial Reporting Manual). FAQ #3 addresses a situation where a registrant acquires a business during a year but it is not possible to conduct an assessment of the acquired business internal controls during the period between the consummation date and year end. A registrant may exclude an acquired business from the scope of its internal control assessment in this situation. The SEC staff indicated a registrant may consider the guidance in FAQ #3 when evaluating whether it would be appropriate to exclude a newly consolidated VIE from the scope of its internal control assessment in periods after the adoption of Statement 167.37 We believe that FAQ #3 is expressly limited to situations in which a registrant acquires a business (as defined by the SEC).
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The SEC staff shared these views with the Center for Audit Quality SEC Regulations Committee (CAQ Alert #2010-20 April 9, 2010). The SEC staff shared these views with the Center for Audit Quality SEC Regulations Committee (CAQ Alert #2010-21 April 19, 2010). 299
21.2
Interpretative guidance Statement 167 deferral

Summary On 26 February 2010, the FASB issued Accounting Standards Update (ASU) 2010-10, Amendments for Certain Investment Funds (ASU 2010-10), primarily to address concerns with the application of Statement 167s consolidation guidance by reporting enterprises in the asset management industry. ASU 2010-10 deferred the effective date of the consolidation guidance of Statement 167 for certain investment funds. However, Statement 167s disclosure requirements will continue to apply to all entities. The deferral applies to certain investment funds until the completion of the joint FASB/IASB project on consolidation accounting. The deferral applies only in instances in which certain conditions are met, as discussed in more detail later. Additionally, ASU 2010-10 amended Statement 167 to defer its effective date for money market funds (MMFs) that are required to comply with or operate in accordance with guidance similar to the requirements in Rule 2a-7 of the Investment Company Act of 1940. ASU 2010-10 has the same effective date as Statement 167, which is effective for reporting enterprises in fiscal years, and interim periods within those fiscal years, beginning after 15 November 2009. Effective date deferral asset management funds Except for the disclosure requirements of Statement 167, ASU 2010-10 deferred Statement 167s effective date for reporting enterprises that have an interest in an entity (regardless of the size of such interest) if all of the following conditions are met: The entity has all of the attributes specified in ASC 946-10-15-2(a) through (d),38 or it does not have all of the attributes specified in ASC 946-10-15-2(a) through (d) but is an entity for which it is acceptable based on industry practice to apply measurement principles that are consistent with those in ASC 946 for financial reporting purposes. Those measurement principles, among other things, generally provide for the remeasurement of investments at fair value with changes in fair value recognized in the statement of operations. The reporting entity does not have an explicit or implicit obligation to fund losses of the entity that could potentially be significant to the entity. This condition should be evaluated considering the legal structure of the reporting entitys interest, the purpose and design of the entity, and any guarantees provided by the reporting entitys related parties. The entity is not a securitization entity, an asset-backed financing entity or an entity that was formerly considered a qualifying special-purpose entity (QSPE).
ASU 2010-10 indicates that entities that may meet the conditions for the deferral include mutual funds, hedge funds, mortgage real estate investment funds, private equity funds and venture capital funds.
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ASC 946-10-15-2(a) through (d) describe the attributes of investment companies as follows: (a) Investment activity: the investment companys primary business activity involves investing its assets, usually in the securities of other entities not under common management, for current income, appreciation, or both, (b) Unit ownership: ownership in the investment company is represented by units of investments, such as shares of stock or partnership interests, to which proportionate shares of net assets can be attributed, (c) Pooling of funds: the funds of the investment companys owners are pooled to avail owners of professional investment management and (d) Reporting entity: the investment company is the primary reporting entity. 300
Attributes of an investment company In addition to those entities subject to ASC 946, the FASB recognized that there are investment funds that are (a) not subject to US GAAP or (b) not included in the scope of ASC 946 but have the same characteristics as those entities. An example of an entity that could meet these conditions includes a non-US registered fund (e.g., a foreign fund registered within its local jurisdiction) that is not subject to US GAAP but may have the same characteristics as those entities in the scope of ASC 946. The FASB concluded that those entities should be eligible for the deferral. In ASC 810-10-65-2(aa), the FASB clarified that examples of entities to which this deferral should not apply include structured investment vehicles, collateralized debt and loan obligations, commercial paper conduits, credit card securitization structures, residential or commercial mortgage-backed entities and government sponsored mortgage entities. In addition, in its Basis for Conclusions, the FASB provided further that the deferral should not apply to entities including, but not limited to, securitization entities, asset-backed financing entities, or entities that were formerly considered qualifying special-purpose entities, even if practice considers those entities to have characteristics similar to those of an investment company, as defined in Topic 946, or for which it is industry practice to apply the measurement principles for financial reporting purposes that are consistent with that Topic. The FASB considers entities with multiple levels of subordinated investors (such as those noted above) to be asset-backed financing entities rather than investment companies. Obligation to fund losses One of the conditions for the deferral specifies that the reporting enterprise does not have the obligation to fund losses of the entity that could potentially be significant to the entity. The FASB noted that if a reporting enterprises exposure to the obligations of an investment fund such as a partnership is limited based on the legal structure of its interest, the entity may qualify for the deferral. For example, ASU 2010-10s Basis for Conclusions states that a general partners unlimited liability with respect to its interest in a limited partnership that has general recourse debt obligations would not be deemed to expose the reporting entity (general partners investor) to losses of the partnership that could potentially be significant to the partnership, if the general partner has no assets other than its interest in the limited partnership and the partnerships creditors have no recourse to assets of the financial reporting entity (general partners investor). Under such a circumstance, the reporting enterprises exposure to the obligations of the partnership may be limited, and it may qualify for the deferral. Additionally, even if the reporting enterprise had a general partner interest directly in a limited partnership (versus through an entity that would act as a general partner such as a limited liability company) and was not legally insulated from the liabilities of the partnership, the reporting enterprise may still qualify for the deferral in certain circumstances. Qualifying for the deferral will depend upon whether the reporting enterprise has an explicit, implicit or legal obligation to use consolidated assets to fund the losses of the partnership (e.g., the limited partnership is unlevered or if levered, the debt is truly non-recourse to the general partner). However, if the reporting enterprise guaranteed the returns of the assets of the partnership or could be obligated to repay significant liabilities of the partnership, the entity would not be eligible for the deferral. We believe the phrase that could potentially be significant contemplates all possible outcomes relevant to the entitys purpose and design. In other words, we believe that a consideration of the likelihood or probability of funding such losses is not relevant for this assessment. Accordingly, a reporting enterprise would not meet this criterion even if the events that would lead to the significant funding obligation are not expected.
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Entities subject to the deferral If an entity is subject to the deferral, it should continue to be evaluated under the consolidation literature in ASC 810 prior to Statement 167s amendments. However, the deferral only applies to the recognition and measurement requirements of Statement 167, and, therefore, a reporting enterprise with a variable interest in a variable interest entity (under FIN 46(R)) that qualifies for the deferral is still required to follow Statement 167s disclosure requirements (see Chapter 20 for further discussion of Statement 167s disclosure requirements). Continuous evaluation of the deferral A reporting enterprise that initially qualifies for the deferral should continually reevaluate its circumstances to ensure it continues to meet the conditions of the deferral. For example, if a reporting enterprise subsequently enters into an agreement to guarantee debt of the entity, it would no longer qualify for the deferral. Under such a circumstance, the reporting enterprise will need to apply the guidance in Statement 167 in evaluating whether its interest represents a variable interest, whether the entity is a variable interest entity and whether it is the primary beneficiary of such an entity. If the reporting enterprise determines that the entity is a variable interest entity and it is the primary beneficiary, the reporting enterprise should apply the initial measurement guidance in Statement 167 as of the date of the change in assessment as if it had become newly involved with the variable interest entity (see discussion in Chapter 17). Consequently, the transition provisions of Statement 167 should not be applied in such a situation. Effective date deferral money market funds (MMF) The FASB also deferred the provisions of Statement 167 for MMFs. This deferral applies to a reporting enterprises interest in an MMF that is required to comply with or operate in accordance with requirements that are similar to those included in Rule 2a-7 of the Investment Company Act of 1940 (the 1940 Act) for registered money market funds. Given the restrictive requirements of the 1940 Act and the credit quality of the permitted assets held, the FASB reasoned that investment managers should not consolidate MMFs pursuant to Statement 167. The deferral for MMFs applies regardless of an asset managers involvement with the MMFs, including any potential obligation to provide additional funding. MMFs subject to the deferral should continue to be evaluated for consolidation under existing US GAAP, including the Variable Interest Model prior to Statement 167s amendments, but reporting enterprises holding variable interests in those entities are still required to follow Statement 167s disclosure provisions. This deferral also will be revisited as part of the joint FASB/IASB project.
Consolidation analysis for entities that qualify for the deferral

Question 21.16 If an entity is eligible to defer the application of Statement 167s amendments to the guidance in ASC 810, does the reporting enterprise still need to evaluate such an entity for consolidation? Yes. An entity that qualifies for the deferral should continue to be assessed for consolidation under the guidance in the Variable Interest Model that was in effect before Statement 167s amendments. That is, an enterprise should use the guidance in ASC 810 before Statement 167s amendments to identify variable interests, assess whether the entity is a VIE and determine which entity is the primary beneficiary. If it is determined the Variable Interest Model, before the Statement 167 amendments, does not apply, other consolidation guidance included in ASC 810 (e.g., the guidance for the consolidation of partnerships in ASC 810-20) should be considered.
Disclosures
Question 21.17 If an entity does qualify for the deferral, what disclosures should a reporting enterprise provide? ASU 2010-10 did not defer Statement 167s disclosure requirements. Therefore, regardless of whether the entity qualifies for the deferral, all reporting enterprises (both public and nonpublic) should provide all disclosures related to variable interests and VIEs as required by ASC 810, as amended by Statement 167. Illustration 21-2: Disclosure requirements
Assume that a reporting enterprise determines its interest in an entity qualifies for the deferral pursuant to ASU 2010-10 but concludes its interest would be deemed a variable interest in a VIE under the Variable Interest Model before the Statement 167 amendments (i.e., FIN 46(R)). In this scenario, even though the reporting enterprise does not apply the recognition and measurement guidance of Statement 167, it is still required to provide all disclosures required by ASC 810, as amended by Statement 167.
Foreign investment funds

Question 21.18 Can a reporting enterprises interest in a foreign investment fund that is not subject to US GAAP qualify for the deferral? Yes. ASU 2010-10s Basis for Conclusions notes that the FASB recognized that there are investments funds that are (a) not subject to US GAAP or (b) are not included in the scope of ASC 946 but have the same characteristics as those entities within the scope of ASC 946 that may be eligible for the deferral. An example of an entity that could meet these conditions above include a non-US registered fund (e.g., a foreign fund registered within its local jurisdiction) that is not subject to US GAAP but may have the same characteristics as those in the scope of ASC 946 and thus follows the measurement and recognition guidance of ASC 946.
Foreign money market funds

Question 21.19 Can a reporting enterprises interest in a money market fund that is not required to comply or operate in accordance with the 1940 Act qualify for the deferral? Yes, depending on the facts and circumstances. The Variable Interest Model, as amended by ASU 201010, indicates that the deferral applies to a reporting enterprises interest in an entity that is required to comply with or operate in accordance with requirements that are similar to those included in the 1940 Act. Therefore, a money market fund registered in a foreign jurisdiction that is legally and (or) contractually required to comply with or operate in accordance with requirements that are similar to those included in the 1940 Act may qualify for the deferral. In making this determination, we believe that careful consideration of facts and conditions and the use of professional judgment will be required. The facts to consider may include, but are not limited to: Limits on the maturities of investments Minimum required liquidity of the funds investments Requirements governing the credit quality of the funds investments Requirements related to the funds concentration of risk The nature of the regulation under which the foreign fund operates
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Subsequent loss of status to qualify for the deferral Recognition and measurement principle
Question 21.20 If an entity no longer qualifies for the deferral, what recognition and measurement principle should a reporting enterprise apply? If the reporting enterprise is required to consolidate an entity because the reporting enterprise or the entity no longer qualifies for the deferral, the reporting enterprise should initially recognize and measure the assets, liabilities and noncontrolling interests of the VIE in accordance with the initial measurement provisions of the Variable Interest Model. That is, assets, liabilities and noncontrolling interests of the newly-consolidated entity generally will be measured at their fair values. The initial measurement provisions should be applied as of the date the reporting enterprise or the entity ceases to qualify for the deferral. It is important to note that the transition guidance in Statement 167 does not apply in this circumstance.
Partnership obligation to fund losses

Question 21.21 Can a reporting enterprise serve as a general partner of a limited partnership and still qualify for the deferral? Yes, in some circumstances. The FASB believes that if a reporting enterprises exposure to the obligations of an investment fund such as a partnership is limited based on the legal structure of its interest, the entity may qualify for the deferral. ASU 2010-10s Basis for Conclusions further provides that a general partners unlimited liability with respect to its interest in a limited partnership that has general recourse debt obligations would not be deemed to expose the reporting entity (general partners investor) to losses of the partnership that could potentially be significant to the partnership, if the general partner has no assets other than its interest in the limited partnership and the partnerships creditors have no recourse to assets of the financial reporting entity (general partners investor). Under such a circumstance, the reporting enterprises exposure to the obligations of the partnership may be limited, and it may qualify for the deferral. Even if the reporting enterprise had a general partner interest directly in a limited partnership (as opposed to through another subsidiary such as a limited liability company which could legally limit any obligation) and therefore is not legally insulated from the liabilities of the partnership, the entity may still qualify for the deferral. In this circumstance, qualifying for the deferral will depend upon whether the reporting enterprise has an explicit, implicit or legal obligation to use consolidated assets to fund the losses of the partnership. For example, a reporting enterprises interest in an entity may qualify for the deferral when the limited partnership does not have substantive debt or other financial obligations (and the general partner has not incurred an obligation to fund losses on the partnerships assets). Even if the limited partnership were levered, a reporting enterprises interest in the entity may still qualify for the deferral if the limited partnerships obligations were truly non-recourse to the general partner. ASU 2010-10s Basis for Conclusions also provides that claw back arrangements, where an investment manager may be required to refund prior fee payments made by the entity up to the amount of fees previously received, would not result in a violation of the deferral criteria. Accordingly, even though the reporting enterprise may have an obligation to effectively fund a portion of the entitys future losses through a clawback arrangement, that arrangement will not disqualify the reporting enterprise from being eligible for the deferral if the obligation under the clawback arrangements could not exceed fees previously received by the reporting enterprise.
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Significance obligation to fund losses

Question 21.22 How should a reporting enterprise assess the significance of its obligation to fund losses of an entity? The evaluation of whether a reporting enterprise has an explicit or implicit obligation to fund losses of the entity that could potentially be significant to the entity necessarily requires consideration of the entitys purpose and design. For example, in a partnership structure, a general partner normally has an unlimited obligation to fund the partnerships losses that arise from events not related to the partnerships purpose and design (e.g., a potential lawsuit pertaining to a slip and fall accident). However, such an obligation may not be considered significant because it relates to a risk that the VIE was not designed to create and pass through to its variable interest holders. On the other hand, consider a typical general partner that has an obligation to fund the partnerships performance related losses. In this circumstance, even if the events that would lead to the significant funding obligation are not expected, the general partner would still be deemed to have the obligation to fund losses that could potentially be significant to the partnership because such performance losses would be contemplated in the purpose and design of the entity.
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Appendix A: Summary of important changes

The following highlights important changes to this Financial reporting developments publication since the March 2010 edition:
Chapter 1
Introduction
Section 1.2 was updated to reflect the current status of the standard-setting and convergence efforts of the FASB and IASB.
Chapter 4
Scope
Section 4.1 was updated to provide additional interpretative guidance for evaluating whether a structure meets the definition of a legal entity. Section 4.8 was updated to provide additional clarity for evaluating the scope exception for not-forprofit organizations. Question 4.25 was updated to provide additional clarity for evaluating the joint venture aspect of the business scope exception.
Chapter 5
Evaluation of variability and the variable interest determination

Question 5.1 was added to provide interpretative guidance for evaluating trust preferred securities arrangements.
Chapter 7
Silos
Section 7.1 and subsequent Questions were updated to provide additional clarity for identifying silos.
Chapter 9
Determining whether an entity is a variable interest entity

Question 9(b)(1).6 was updated to provide additional clarity for determining when a general partners at-risk equity investment is substantive. Question 9(b)(1).10 was added to provide interpretative guidance for evaluating affordable housing project arrangements.
Chapter 12
Reconsideration events
Section 12.1 was updated to provide additional clarity that the amendments to the Variable Interest Model could lead to more consolidation of borrowers by lenders. Question 12.5 was added to highlight SEC reporting considerations following a consolidation or deconsolidation event.
Chapter 14
Primary beneficiary determination

Section 14.1 was updated to highlight commentary provided by the SEC staff on the identification of significant activities of a VIE. Question 14.18 was added to provide additional interpretative guidance on the consideration of potential voting rights (e.g., call options, convertible instruments) when assessing power. Section 14.3 was updated to highlight commentary provided by the SEC staff on shared power.
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Appendix A: Summary of important changes
Chapter 15
Related parties and de facto agents

Question 15.5 was added to highlight guidance issued by the FASB on the consideration of separate accounts of life insurance enterprises as related parties.
Chapter 17
Initial measurement and consolidation

Question 17.1 was updated to provide the views of the SEC staff regarding Form 8-K and pro forma reporting requirements upon the initial adoption of Statement 167. Question 17.2 was updated to provide the views of the SEC staff regarding Form 8-K and SEC Regulation S-X Rules 3-05 and 3-14 reporting requirements upon the initial adoption of Statement 167.
Chapter 18
Accounting after initial measurement

Question 18.9 was added to provide interpretative guidance regarding the attribution of income/loss in an asset-backed financing entity.
Chapter 21
Effective date and transition

Question 21.14 was added to provide the views of the SEC staff regarding retrospective application of Statement 167 and the interaction with the table of selected financial data in a Form 10-K. Question 21.15 was added to provide the views of the SEC staff regarding internal control over financial reporting requirements for an entity newly consolidated pursuant to the adoption Statement 167.
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Appendix B: Abbreviations used in this publication

Abbreviation ASC 205-20 ASC 250 ASC 310 ASC 320 ASC 323 ASC 350 ASC 360 ASC 470 ASC 480 ASC 605 ASC 710 ASC 712 ASC 715 ASC 718 ASC 805 ASC 808 ASC 810 ASC 815 ASC 820 ASC 825 ASC 840 ASC 850 ASC 860 ASC 915 ASC 944 ASC 946 ASC 958 ASC 960 ASC 976 FASB Accounting Standards Codification
FASB ASC Topic 205-20, Discontinued Operations FASB ASC Topic 250, Accounting Changes and Error Corrections FASB ASC Topic 310, Receivables FASB ASC Topic 320, Investments Debt and Equity Securities FASB ASC Topic 323, Investments Equity Method and Joint Ventures FASB ASC Topic 350, Intangibles Goodwill and Other FASB ASC Topic 360, Property, Plant, and Equipment FASB ASC Topic 470, Debt FASB ASC Topic 480, Distinguishing Liabilities from Equity FASB ASC Topic 605, Revenue Recognition FASB ASC Topic 710, Compensation General FASB ASC Topic 712, Compensation Nonretirement Postemployment Benefits FASB ASC Topic 715, Compensation Retirement Benefits FASB ASC Topic 718, Compensation Stock Compensation FASB ASC Topic 805, Business Combinations FASB ASC Topic 808, Collaborative Arrangements FASB ASC Topic 810, Consolidation FASB ASC Topic 815, Derivatives and Hedging FASB ASC Topic 820, Fair Value Measurements and Disclosures FASB ASC Topic 825, Financial Instruments FASB ASC Topic 840, Leases FASB ASC Topic 850, Related Party Disclosures FASB ASC Topic 860, Transfers and Servicing FASB ASC Topic 915, Development Stage Entities FASB ASC Topic 944, Financial Services Insurance FASB ASC Topic 946, Financial Services Investment Companies FASB ASC Topic 958, Not-for-Profit Entities FASB ASC Topic 960, Plan Accounting Defined Benefit Pension Plans FASB ASC Topic 976, Real Estate Retail Land
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Appendix B: Abbreviations used in this publication
Abbreviation ASR 268 GASB 20
Other authoritative standards SEC Accounting Series Release No. 268, Presentation in Financial Statements of
Redeemable Preferred Stock Governmental Accounting Standards Board Statement No. 20, Accounting and Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund Accounting SEC Final Rule 67, Disclosure in Managements Discussion and Analysis about OffBalance Sheet Arrangements and Aggregate Contractual Obligations
FR-67
Abbreviation CON 7 FIN 46 FIN 46(R) FSP FIN 46(R)-3
Non-authoritative standards FASB Statement of Financial Accounting Concepts No. 7, Using Cash Flow
Information and Present Value in Accounting Measurements
FASB Interpretation No. 46, Consolidation of Variable Interest Entitiesan

interpretation of ARB No. 51 FASB Interpretation No. 46 (Revised), Consolidation of Variable Interest Entities an interpretation of ARB No. 51 FASB Staff Position FIN 46(R)-3, Evaluating Whether, as a Group, the Holders of the Equity Investment at Risk Lack the Direct or Indirect Ability to Make Decisions about an Entitys Activities through Voting Rights or Similar Rights under FASB Interpretation No. 46 Statement 133 Implementation Issue No. E22, Accounting for the Discontinuance of Hedging Relationships Arising from Changes in Consolidation Practices Related to Applying FASB Interpretation No. 46 or 46(R) FASB Statement No. 141, Business Combinations FASB Statement No. 141(R), Business Combinations FASB Statement No. 157, Fair Value Measurements FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB No. 51 FASB Statement No. 166, Accounting for Transfers of Financial Assetsan amendment of FASB Statement No. 140
Issue E22
Statement 141 Statement 141(R) Statement 157 Statement 160 Statement 166 Statement 167 SOP 07-1
FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R) AICPA Statement of Position 07-1, Clarification of the Scope of the Audit and
Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies
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Appendix C: Index of ASC references in this publication

ASC paragraph 810-10-05-8 810-10-05-8A 810-10-05-9 810-10-05-10 810-10-05-11 810-10-05-12 810-10-05-13 810-10-15-1 810-10-15-2 810-10-15-3 810-10-15-4 810-10-15-6 810-10-15-8 810-10-15-9 810-10-15-11 810-10-15-12 810-10-15-13 810-10-15-13A 810-10-15-13B 810-10-15-14 810-10-15-15 810-10-15-16 810-10-15-17 810-10-25-21 810-10-25-22 810-10-25-23 810-10-25-24 810-10-25-25 Section Chapter 1 Chapter 1 Chapter 1 Chapter 1 Chapter 1 Chapter 1 Chapter 1 Chapter 4 Chapter 4 Chapter 4 Chapter 4 Chapter 4 Chapter 4 Chapter 4 Chapter 4 Chapter 4 Chapter 4 Chapter 3 Chapter 3 Chapter 9 Chapter 4 Chapter 13 Chapter 4 Chapter 5 Chapter 5 Chapter 5 Chapter 5 Chapter 5 Introduction Introduction Introduction Introduction Introduction Introduction Introduction Scope Scope Scope Scope Scope Scope Scope Scope Scope Scope exceptions Scope Scope exceptions Consideration of substantive terms, transactions and arrangements Consideration of substantive terms, transactions and arrangements Determining whether an entity is a variable interest entity Scope Development stage enterprises Scope Scope exceptions Evaluation of variability and the variable interest determination Evaluation of variability and the variable interest determination Evaluation of variability and the variable interest determination Evaluation of variability and the variable interest determination Evaluation of variability and the variable interest determination
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ASC paragraph 810-10-25-26 810-10-25-27 810-10-25-29 810-10-25-31 810-10-25-32 810-10-25-33 810-10-25-34 810-10-25-35 810-10-25-36 810-10-25-37 810-10-25-38 810-10-25-38A 810-10-25-38B 810-10-25-38C 810-10-25-38D 810-10-25-38E 810-10-25-38F 810-10-25-38G 810-10-25-42 810-10-25-43 810-10-25-44 810-10-25-45
Section Chapter 5 Chapter 5 Chapter 5 Chapter 5 Chapter 5 Chapter 5 Chapter 5 Chapter 5 Chapter 5 Chapter 11 Chapter 14 Chapter 14 Chapter 14 Chapter 14 Chapter 14 Chapter 14 Chapter 14 Chapter 14 Chapter 15 Chapter 15 Chapter 16 Chapter 9 Evaluation of variability and the variable interest determination Evaluation of variability and the variable interest determination Evaluation of variability and the variable interest determination Evaluation of variability and the variable interest determination Term of interests issued Evaluation of variability and the variable interest determination Subordination Evaluation of variability and the variable interest determination Certain interest rate risk Evaluation of variability and the variable interest determination Certain derivative instruments Evaluation of variability and the variable interest determination Certain derivative instruments Evaluation of variability and the variable interest determination Certain derivative instruments Initial determination of VIE status Primary beneficiary determination Primary beneficiary determination Primary beneficiary determination Primary beneficiary determination Primary beneficiary determination Primary beneficiary determination Primary beneficiary determination Primary beneficiary determination Related parties and de facto agents Related parties and de facto agents Determining the primary beneficiary from a related party group Determining whether an entity is a variable interest entity Interpretative guidance Equity investment at risk (ASC 810-10-15-14(a)) Determining whether an entity is a variable interest entity Interpretative guidance Equity investment at risk (ASC 810-10-15-14(a)) Determining whether an entity is a variable interest entity Interpretative guidance Equity investment at risk (ASC 810-10-15-14(a)) Implicit variable interests Implicit variable interests Implicit variable interests Implicit variable interests Implicit variable interests
311
810-10-25-46
Chapter 9
810-10-25-47
Chapter 9
810-10-25-48 810-10-25-49 810-10-25-50 810-10-25-51 810-10-25-52
Question 5-18 Question 5-18 Question 5-18 Question 5-18 Question 5-18
ASC paragraph 810-10-25-53 810-10-25-54 810-10-25-55 810-10-25-56 810-10-25-57 810-10-25-58 810-10-30-1 810-10-30-2 810-10-30-3 810-10-30-4 810-10-35-3 810-10-35-4 810-10-45-25 810-10-50-2AA 810-10-50-2AB 810-10-50-2AC 810-10-50-3 810-10-50-4 810-10-50-5A 810-10-50-5B 810-10-50-6 810-10-50-9 810-10-50-10 810-10-55-17 810-10-55-18 810-10-55-19 810-10-55-20 810-10-55-21 810-10-55-22 810-10-55-23 810-10-55-24 810-10-55-25 810-10-55-26 810-10-55-27
Section Question 5-18 Question 5-18 Chapter 8 Chapter 8 Chapter 7 Chapter 7 Chapter 17 Chapter 17 Chapter 17 Chapter 17 Chapter 18 Chapter 12 Chapter 19 Chapter 20 Chapter 20 Chapter 20 Chapter 20 Chapter 20 Chapter 20 Chapter 20 Chapter 20 Chapter 20 Chapter 20 Chapter 5 Chapter 5 Chapter 5 Chapter 5 Chapter 5 Chapter 5 Chapter 5 Chapter 5 Question 5-11 Question 5-11 Chapter 5 Implicit variable interests Implicit variable interests Variable interests interests in specified assets Variable interests interests in specified assets Silos Silos Initial measurement and consolidation Initial measurement and consolidation Initial measurement and consolidation Initial measurement and consolidation Accounting after initial measurement Reconsideration events Presentation Disclosures Disclosures Disclosures Disclosures Disclosures Disclosures Disclosures Disclosures Disclosures Disclosures Evaluation of variability and the variable interest determination Interpretative guidance Evaluation of variability and the variable interest determination Interpretative guidance Evaluation of variability and the variable interest determination Interpretative guidance Evaluation of variability and the variable interest determination Interpretative guidance Evaluation of variability and the variable interest determination Interpretative guidance Evaluation of variability and the variable interest determination Interpretative guidance Evaluation of variability and the variable interest determination Interpretative guidance Evaluation of variability and the variable interest determination Interpretative guidance Financial guarantees as variable interests Financial guarantees as variable interests Evaluation of variability and the variable interest determination Certain derivative instruments
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ASC paragraph 810-10-55-28 810-10-55-29 810-10-55-30 810-10-55-31 810-10-55-37 810-10-55-37A 810-10-55-38 810-10-55-39 810-10-55-87 810-10-55-88 810-10-55-89 810-10-65-2
Section Chapter 5 Chapter 5 Chapter 5 Chapter 5 Chapter 6 Chapter 6 Chapter 6 Question 5-13 Question 5-18 Question 5-18 Question 5-18 Chapter 21 Evaluation of variability and the variable interest determination Certain derivative instruments Evaluation of variability and the variable interest determination Certain derivative instruments Evaluation of variability and the variable interest determination Certain derivative instruments Evaluation of variability and the variable interest determination Certain derivative instruments Variable interests fees paid to decision makers or service providers Variable interests fees paid to decision makers or service providers Variable interests fees paid to decision makers or service providers Operating leases as variable interests Implicit variable interests Implicit variable interests Implicit variable interests Effective date and transition
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Appendix D: Step-by-step guide to applying the Variable Interest Model

Step 1: Does the entity or arrangement being evaluated qualify for a scope exception? (Chapter 4) No Step 2: Does the enterprise have a variable interest in the entity being evaluated for consolidation? 2 (Chapters 5 & 6) Yes Step 3: Are there silos? (Chapter 7) Yes No If entity is a VIE, evaluate each silo separately for consolidation 3 Do not apply the Variable Interest Model Apply other GAAP 1 Yes
No
Step 4:
Do the interests or other contractual arrangements of the entity (excluding interests in silos) qualify as variable interests in the entity as a whole? (Chapter 8) Yes
No
Apply other GAAP to those interests
Step 5:
Qualitatively or quantitatively determine expected losses of the entity. These should exclude expected losses related to (1) variable interests in specified assets and (2) interests in silos. (Chapter 9)
Step 6:
Is the total equity investment at risk sufficient and as a group, do their holders have the characteristics of a controlling financial interest? (Chapter 9) No
Apply other GAAP 1 Yes
Step 7:
Entity is a variable interest entity (VIE) (Chapter 9)
Step 8:
Determine whether the VIE has a primary beneficiary. A variable interest holder in a VIE assesses whether it is the VIEs primary beneficiary by reference to the power and benefits principle. (Chapter 14)4
Step 9:
If no party meets the primary beneficiary criteria under the power and benefits principle, an enterprise should consider the related party provisions (Chapters 15 and 16) if its related parties and de facto agents have power and benefits.
Notes: 1. Including other GAAP consolidation guidance. 2. Consider the risks the entity was designed to create and distribute and whether the instrument absorbs that variability (Chapter 5). 3. A silo is not to be treated as a separate entity for purposes of applying the Variable Interest Model unless the host entity is a VIE. If this silo is deemed to be treated as a separate entity, perform steps 5-9 for the silo. 4. The primary beneficiary should consolidate the VIE. Other holders of variable interests should make the disclosures required by the Variable Interest Model. Financial reporting developments Consolidation of variable interest entities 314
Appendix E: Variable Interest Entity identifier tool

Instructions and explanatory comments 1. The purpose of the Variable Interest Entity Identifier Tool is to assist in the identification of variable interest entities, as that term is defined in ASC 810-10. Using the criteria in ASC 810-10, this tool provides a summary of the common attributes of a variable interest entity and also provides Interpretative guidance. This document does not assist in the determination of whether an enterprise1 has a variable interest in an entity or who is the primary beneficiary of a variable interest entity. An entitys terms should be carefully understood before determining whether that entity is a variable interest entity. 2. Variable interests are contractual, ownership or other pecuniary interests in a variable interest entity whose values change with changes (exclusive of variable interests) in the fair value of the entitys net assets. Common examples of variable interests include (this list is not all inclusive): Investments in common stock Investments in preferred stock Loans or notes receivable Guarantees or insurance contracts Derivative contracts Management and other service contracts Leases
3. Any legal structure used to conduct activities or to hold assets is in the scope of ASC 810-10s variable interest consolidation model (the Variable Interest Model)2 with limited exceptions as follows: Not-for profit organizations3 Governmental organizations Separate accounts of life insurance companies4 Employee benefit plans5 Investments accounted for at fair value in accordance with ASC 946 An entity deemed to be a business (in certain circumstances)
When we use the term enterprise in this publication, we refer to the enterprise that is evaluating its potential variable interest in a potential VIE for purposes of determining whether it must consolidate that entity or to the enterprise that consolidates a VIE. When we use the term entity, we refer to the potential VIE or to the VIE. That is, the purpose of the Variable Interest Model is to determine whether the enterprise is the party that must consolidate an entity that is a VIE. Generally, ASC 810-10 includes guidance with respect to the consolidation considerations for voting interest entities and variable interest entities for each of ASC 810-10s sections. In each of ASC 810-10s sections there is a General subsection with respect to the consolidation model. This guidance applies to voting interest entities and also may apply to variable interest entities in certain circumstances. The Variable Interest Entities subsection within each of ASC 810-10s sections contains considerations with respect to variable interest entities. In referring to the Variable Interest Model in ASC 810-10, we are referring to the guidance applicable to variable interest entities in each of ASC 810-10s sections. However, if the not-for-profit entity is used in a manner similar to a variable interest entity in an effort to circumvent the Variable Interest Model, then that not-for-profit entity is subject to the scope of the Variable Interest Model. For the separate account investors evaluation only. For the employers evaluation only. 315
4 5
4. Although expected to be very infrequent, an enterprise is not required to apply the Variable Interest Model if the entity subject to evaluation was created before 31 December 2003 and if the enterprise is unable to obtain information necessary to (1) determine whether the entity is a variable interest entity, (2) determine whether the enterprise is the variable interest entitys primary beneficiary or (3) perform the accounting required to consolidate the variable interest entity for which it is determined to be the primary beneficiary. The left hand column of this tool asks a question about the feature of the entity being evaluated. A No response indicates that the entity is a variable interest entity. The right-hand column provides background for the question and the implications of the answer. Refer to Chapter 9 for additional discussion.
Sufficiency of the equity investment at risk 1. Is the total equity investment at risk sufficient to permit the legal entity to finance its activities without additional subordinated financial support provided by any parties, including equity holders? (Refer to Question 1(a) for what constitutes an equity investment at risk.) (ASC 810-10-15-14(a)) Interpretative guidance An entity may not have enough equity to induce lenders or other investors to provide the funds necessary for the entity to conduct its activities, in which case it would be a variable interest entity. We expect that in many instances it will be difficult to establish that the equity investment is sufficient without calculating expected losses (Method 3). Entities with a capital structure more complex than senior debt with a market-based interest rate and common stock will likely be unable to conclude that the entity has a sufficient amount of equity at risk under Method 1. Examples of an entitys features that indicate Method 1 should not be used to determine the sufficiency of the equity include (1) the entity has preferred stock that is classified as a liability, (2) the entity issues multiple classes of debt with different priorities of payment, (3) the owners of the entity or others guarantee the entitys debt. To determine whether an entity is comparable pursuant to Method 2:
The legal entity has demonstrated that it can finance its activities without additional subordinated financial support (Method 1) The legal entity has at least as much equity invested as other entities that hold only similar assets of similar quality in similar amounts and operate with no additional subordinated financial support (Method 2) The amount of equity invested in the legal entity exceeds the estimate of the legal entitys expected losses based on reasonable quantitative evidence (Method 3) Yes No
Response:
If yes, describe:
The size and composition of the entitys assets should be similar, The type and amount of the entitys liabilities, including maturities and interest rates should be similar, The type and amount of capital used to finance the entity should be similar, The nature of the entitys operations should be similar (product lines, service lines, markets, etc.), and The comparable entity should not have any of the features that would prohibit the use of Method 1 described previously.
We believe that, generally, it will be infrequent that entities are capable of demonstrating the sufficiency of the equity investment at risk through Method 2. Regulatory capital requirements (e.g., risk-based capital) may be considered, in part, in determining whether an entity has sufficient equity for purposes of applying Method 1 or Method 2.
Equity investment at risk 1(a). The equity investment at risk under evaluation in Question 1 must:
Interpretative guidance If Method 3 is used to answer Question 1, the equity investment at risk is compared to the entitys expected losses to determine the sufficiency of the equity. Equity investments in an entity are interests that are required to be reported as equity in that entitys GAAP financial statements. Certain portions of that amount may not be considered an equity investment at risk for purposes of comparison to the entitys expected losses. An equity investment at risk must participate significantly in profits and losses. Examples of instruments that do not participate significantly in profits and losses are:
Exclude equity instruments that do not participate significantly in profits and losses (even if those investments do not carry voting rights) (ASC 810-10-15-14(a)(1))
Explain whether equity investments meet this criterion:
Equity that may be put to the entity or to other parties involved with the entity at a price that does not allow for the potential of a significant loss of the investment. Equity that may be callable by the entity or by other parties involved with the entity at a price that does not allow for a significant participation in the entitys profits. Preferred stock that has no or a small coupon that results in an insignificant participation in the entitys profits. Convertible preferred stock may participate significantly in the entitys profits depending on the conversion price relative to the market price at its issuance date.
Exclude equity interests that the legal entity issued in exchange for subordinated interests in other VIEs (ASC 810-10-15-14(a)(2))
The Variable Interest Model precludes the same equity investment from being used to capitalize multiple entities. For example, if Investor X invests $10 in VIE 1, in exchange for VIE 1s common stock, and then contributes that investment to VIE 2 in exchange for VIE 2s common stock, the investment by Investor X should be excluded in analyzing the sufficiency of the equity in VIE 2 because the same equity is capitalizing two variable interest entities and, thus, is not considered to be equity at risk for VIE 2.
Exclude amounts provided to the equity investor directly or indirectly by the legal entity or by other parties involved with the legal entity, unless the provider is a parent, subsidiary or affiliate of the investor that is required to be included in the same set of consolidated financial statements as the investor (ASC 810-10-1514(a)(3))
An equity investment obtained directly or indirectly through fees, charitable contributions or other means should not be included in the equity sufficiency test. We believe that any type of fee, including fees for other services that are market-based, that the recipient has received or is unconditionally entitled to receive at inception should reduce that recipients equity investment at risk. If fees are to be paid over time, the present value of the amount that the recipient is entitled to at inception in the event it
317
terminates its relationship with the entity is to be subtracted from that recipients equity investment at risk for purposes of the sufficiency test.
Exclude amounts financed for the equity investor directly by the legal entity or by other parties involved with the legal entity, unless the provider is a parent, subsidiary or affiliate of the investor that is required to be included in the same set of consolidated financial statements as the investor (ASC 810-10-15-14(a)(4))
Any amounts financed for the equity investor pursuant to this criterion are to be excluded from the equity sufficiency test. We believe, however, that amounts financed for the equity investor by a party that is not related to the other parties involved with the entity qualify as an equity investment at risk. Additionally, we believe that the holders of the equity investments at risk may hedge the risks in their investment with parties not involved with the entity being evaluated.
Power 2. As a group, do the holders of the equity investments at risk (identified in Question 1) have the power, through voting rights or similar rights, to direct the activities of the legal entity that most significantly impact the entitys economic performance? The investors do not have that power through voting rights or similar rights if no owners hold voting rights or similar rights (such as those of a common shareholder in a corporation or a general partner in a partnership). Kick-out rights or participating rights held by the holders of the equity investment at risk do not prevent interests other than the equity investment from having this characteristic unless a single equity holder (including its related parties and de facto agents) has the unilateral ability to exercise such rights. Alternatively, interests other than the equity investment at risk that provide the holders of those interests with kick-out rights or participating rights do not prevent the equity holders from having this characteristic unless a single enterprise (including its related parties and de facto agents) has the unilateral ability to exercise those rights. A decision maker also shall not prevent the holders from having this characteristic unless the fees paid to the decision maker represent a variable interest based on ASC 810-10-55-37 and 55-38. (ASC 810-10-15-14(b)(1))
Interpretative guidance For an entity not to be a VIE, the Variable Interest Model requires that, as a group, the holders of the equity investment at risk must have the power to direct the activities of an entity that most significantly impact the entitys economic performance through voting or similar rights, embodied in the equity instruments they hold. This power must be able to have a significant effect on the success of the entity, because as the decisions to be made by the equity holders become less significant in nature, a model that bases consolidation on ownership of voting interests becomes less relevant. Professional judgment will be required to determine whether the at-risk equity holders have sufficient decision making ability. Kick-out rights or participating rights held by the owners of the equity investment at risk should not be considered in determining whether the at-risk equity investors have the power to direct the activities of an entity that most significantly impact the entitys economic performance unless a single enterprise (including its related parties and de facto agents) has the unilateral ability to exercise those rights. This is consistent with how kick-out rights are considered when determining the primary beneficiary. Alternatively, interests other than the equity investment at risk that provide the holders of those
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Response: Describe:
Yes
No
interests with kick-out rights or participating rights do not prevent the equity holders from having the characteristic in criterion ASC 810-10-1514(b)(1) unless a single enterprise (including its related parties and de facto agents) has the unilateral ability to exercise such rights. However, many structures do not provide for interests other than the equity investment at risk to hold kick-out rights or participating rights. If an interest other than the equity investment at risk provides the holder of that interest with power, but the interest does not represent a variable interest, that interest does not make the entity a VIE. The FASB reasoned that such a decision maker would never be the primary beneficiary of the VIE because it would not hold a variable interest. Additionally, such an interest would typically indicate that the decision maker was acting as a fiduciary, and the FASB observed that this fact alone should not lead to a conclusion that entity is a VIE (see Interpretative guidance and Questions in Chapters 5-6 for evaluating whether a party has a variable interest in an entity).
Anti-abuse provisions 2(a). If the voting rights of all investors are not proportional to their obligations to absorb the legal entitys expected losses or the rights to receive its expected residual returns, or both (considering all of the equity investors interests in the entity, not only its equity investment at risk), are substantially all of the legal entitys activities not involved with or conducted on behalf of an investor that has disproportionately few voting rights? (ASC 810-1015-14(c)) NOTE: Activities that involve or are conducted on behalf of the related parties of an investor with disproportionately few voting rights should be treated as if they involve or are conducted on behalf of that investor. Related parties refers to all related parties identified in ASC 810-10-25-43, except de facto agents under ASC 810-10-25-43(d). Response: Yes No
Interpretative guidance Whenever expected losses and expected residual returns are not allocated based exactly on the investors voting rights or are allocated through instruments without voting rights (e.g., a loan), the substantially all condition under ASC 810-10-1514(c)(2) must be evaluated. The following is an example of a situation in which profits and losses are not allocated proportionately. Investor A and Investor B form a partnership by each contributing an equal amount of capital. Profits and losses are allocated based upon voting rights until Investor A has received a return of 15% on its investment, at which point Investor A and Investor B receive 35% and 65%, respectively, of the entitys profits. In this instance, the allocation of profits and losses is not proportional to the investors voting rights. Determining if substantially all of an entitys activities are on behalf of an investor with disproportionately few voting rights will require consideration of all of the facts and circumstances. The determination should be based on a comparison of the activities to those of the investor, and the substantially all test should not be based solely on the relative size of the investors investments or the allocation of the entitys economic benefits. For example, in a partnership with a single general partner (GP) with a 1% interest and a limited partner (LP) with a 99% non-voting interest (the LP interest has disproportionately few voting rights)
If yes, describe:
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consideration must be given as to whether the activities of the partnership are clearly or closely related to the activities of the LP. If the partnership manufactures cars and if the LP is an investment bank providing financing to the entity and the GP is the strategic partner, the activities of the entity (making cars) would be compared to the investment banks activities (because it, as the LP, has disproportionately few voting rights). If the activities were determined to be dissimilar, as in this example, the anti-abuse provision would not be applicable. Obligation to absorb entitys expected losses 3. As a group, do the holders of the equity investment at risk have the obligation to absorb the legal entitys expected losses? (ASC 810-10-15-14(b)(2)) Response: Yes If no, describe: No Interpretative guidance An entity is a VIE if, by design, the holders of the equity investment at risk are directly or indirectly protected from expected losses or are guaranteed a return by the entity itself or by other parties involved with the entity. Instruments that may directly or indirectly protect the holders from the entitys expected losses include, among others:
Purchased put options Purchased guarantees Total return swaps
If exposure to losses is shared with holders that do not have an equity investment at risk, or allocated to the holders of the equity investment at risk through instruments other than equity investments, the entity is a VIE. Guarantees and other arrangements that protect lenders to the entity after the holders of the equity investments at risk have suffered a total loss of their investment are permitted. The allocation of losses (including allocations disproportionate to ownership or voting percentages) among the holders of the equity investment at risk does not result in the entity being a VIE as long as the equity owners, as a group, are exposed to first dollar risk of loss in the entity.6 Losses may not be shared by a holder of an instrument that is not an equity investment at risk until the equity investment at risk has been exhausted. Guarantees on a portion of an entitys assets may be permitted if that asset is less than half of the total fair value of the entitys assets or is a siloed asset (see Interpretative guidance and Questions in Chapters 7 and 8).
In situations in which the allocation of profits and losses among the equity holders is disproportionate to their voting interests, the anti-abuse provisions (described in Question 2(a)) should be carefully evaluated. 320
Right to receive entitys expected residual returns 4. As a group, do the holders of the equity investments at risk have the right to receive the legal entitys expected returns? (ASC 810-10-15-14(b)(3)) Response: Yes If no, describe: No
Interpretative guidance As a group, the holders of the equity investments at risk cannot have their returns capped (1) through arrangements with the entity or with other variable interest holders, (2) through the allocation of profits to instruments that are not equity investments at risk (even if held by an equity investor) or (3) by the entitys governing documents. Instruments that may directly or indirectly limit the equity holders from receiving the entitys expected residual returns include, among others:
Written call options Total return swaps
The allocation of profits among the holders of the equity investments at risk does not result in the entity being a VIE as long as the holders of the equity investments at risk, as a group, receive the entitys profits, even if the allocation is disproportionate to ownership or voting percentages.6 Profits may be shared through instruments that are not equity investments at risk as long as that sharing does not directly or indirectly cap the equity holders returns. An example of such a cap would be when an investment manager (that does not hold an equity investment at risk) keeps all profits of the entity after the investors receive a stated return. That arrangement would cap those holders return and the entity would be a VIE. Certain instruments that cap the return of a portion of an entitys assets may be permitted if that asset is less than half of the total fair value of the entitys assets or a silo (see the Interpretative guidance and Questions in Chapters 7 and 8).
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Appendix F: Example VIE analysis

F.1 Assumptions
A limited liability company (the LLC) is formed by Manage Co. and Passive Co. to acquire and operate commercial real estate (office buildings). The LLC is to be liquidated at the end of five years. The interest rate on a five-year default-risk-free investment at the date of formation of the LLC is 5%. Manage Co. and Passive Co. make a cash equity contribution to the LLC of $6,000,000 and $4,000,000, respectively, in exchange for a 60% and 40% ownership interest in the LLC. The contributions were not financed by any other parties involved in the LLC. Each party votes on matters affecting the LLC in proportion to its ownership interest. The LLC acquires three buildings upon its formation, as follows: Big Building is acquired for $68,700,000. The acquisition of Big Building is partially financed with $63,000,000 of debt from Lender A. Lender A has recourse only to the cash flows from the lease and sale of Big Building for the payment of interest and principal due. Little Building is acquired for $29,500,000. Lender B partially finances the acquisition of Little Building with debt of $27,000,000. Lender B has recourse only to the cash flows from the lease and sale of Little Building for the payment of interest and principal due. A third building (Building Three) is acquired for $45,000,000. Lender C finances the acquisition of Building Three in its entirety. Lender C has recourse only to the cash flows from the lease and sale of Building Three for the payment of interest and principal due.
Each note receives interest only payments (at a rate of 5.0% per annum) during the five-year life of the LLC, and the principal is to be repaid when the buildings are sold at the end of five years. (We have assumed that the interest rates on the loans are equal to the interest rate on a five-year default-risk-free investment to simplify the example calculations included in this Appendix.) Under the terms of the debt agreements, Big Building cannot be sold prior to the end of the five-year term of the LLC without the approval of Lender A. Additionally, under the terms of the debt agreement, Little Building also cannot be sold prior to the end of the five-year term of the LLC without the approval of both Lender A and Lender B (collectively, the Lenders). Furthermore, the Lenders must approve all tenants, and related lease terms, of Big Building and Little Building (Lender A for Big Building, and Lender A and Lender B for Little Building) and the LLCs annual operating budgets. In connection with the debt financing, Lender A requires that the LLC acquire a guarantee that the value of Big Building will not be less than $63,000,000 in five years from Guarantor A for a premium of $1,300,000. Lender B requires that the LLC acquire a guarantee from Guarantor B that the value of Little Building will not be less than $27,000,000 in five years for a premium of $500,000. The LLC has no employees but has engaged Manage Co. to actively manage Big Building and Little Building. In this role, Manage Co. makes decisions regarding the selection of tenants, negotiation of lease terms, setting of rental rates, capital expenditures and repairs and maintenance, among other
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things. For these services, Manage Co. will receive fees equal to 10% of the annual net rental revenue of each building per year. Lease terms with the tenants of Big Building and Little Building are consistent with market terms for such leases at the date of inception of the leases and contain no fixed price purchase options, residual value guarantees or similar features. At its acquisition date, Building Three is leased to one tenant for a five-year term. Upon expiration of the lease term, the lessee must either purchase Building Three for $45,000,000, or arrange for the sale of the building to a third party. If the sale option is elected, the Lessee is required to pay any shortfall between the sales proceeds and $45,000,000. If the sales proceeds are more than the Purchase Price, the lessee is entitled to such excess. Upon sale of the buildings, the LLC will pay off the debt and distribute any remaining proceeds to Manage Co. and Passive Co. based on their respective ownership interests.
The sources and uses of the LLCs financing can be summarized as follows:
Sources of funds: Manage Co. Equity Passive Co. Equity Lender A Loan Lender B Loan Lender C Loan $ $ 6,000,000 4,000,000 63,000,000 27,000,000 45,000,000 145,000,000 Uses of funds: Big Building Purchase Little Building Purchase Building Three Purchase Guarantee Fees Big Building Little Building $ 1,300,000 500,000 145,000,000 $ 68,700,000 29,500,000 45,000,000
The related fair values of the assets of the LLC are as summarized in Table A below. The fair values of each building and the guarantee are allocated to Manage Co. and Passive Co. in proportion to their relative ownership in the LLC (60% to Manage Co. and 40% to Passive Co., respectively). The fair values of the assets are allocated to the lenders based on the principal amounts loaned to the LLC. In some cases, it may not be necessary to allocate the fair value of an entitys individual assets (e.g., because all variable interests are considered to be variable interests in the entity and there are no silos).
Table A Fair value of the LLCs assets Manage Co. Big Building Building Guarantee Total Little Building Building Guarantee Total Passive Co. Lender A Lender B N/A N/A Lender C Total fair value
$ 3,420,000 $ 2,280,000 $63,000,000 780,000 520,000 4,200,000 2,800,000 63,000,000 1,500,000 300,000 1,800,000 1,000,000 200,000 1,200,000
N/A $ 68,700,000 N/A 1,300,000 70,000,000 N/A N/A 29,500,000 500,000 30,000,000
N/A $27,000,000 N/A 27,000,000
Building Three Building N/A N/A N/A N/A $45,000,000 45,000,000 Total Amounts Financed $ 6,000,000 $ 4,000,000 $63,000,000 $27,000,000 $45,000,000 $145,000,000
In the tables presented throughout the remainder of this Appendix, certain immaterial differences may arise in the summations of totals due to rounding.
F.2
VIE analysis
The illustrative analysis of the LLC described next follows the approach outlined in Appendix D, Step-bystep guide to applying the Variable Interest Model, in determining whether an entity is a VIE. Step 1 Determine whether any of the Variable Interest Models scope exceptions1 are applicable to the LLC. Analysis In this example, none of the Variable Interest Models scope exceptions are applicable. Step 2 Determine which interests are variable interests2 that require the holder to evaluate the LLC as a potential VIE that may require consolidation pursuant to the provisions in the Variable Interest Model. Analysis The following parties hold variable interests in the LLC: 1. The equity investors (Manage Co. and Passive Co.) 2. Lenders A, B and C 3. Guarantors A and B 4. Building Three Lessee The lessees of Big Building and Little Building do not have a variable interest in the LLC because the lease terms are consistent with market terms for such leases at the date of inception of the leases and contain no fixed price purchase options, residual value guarantees or similar features. Accordingly, receivables under these respective operating leases are assets that provide returns to the variable interest holders in the LLC during the lease terms. These leases do not absorb variability in the fair value of Big Building and Little Building because they are a component of that variability. In contrast, the lessee of Building Three has a variable interest due to the residual value guarantee and fixed price purchase option included in the lease. Step 3 Determine whether any silos3 exist in the LLC. Analysis In this example, Building Three represents a silo. The building has been financed in its entirety with debt that has recourse only to Building C and its related cash flows. The lessee has provided a residual value guarantee that will absorb any depreciation in the value of the building and has a fixed price purchase option that allows it to capture any appreciation in the value of the building during the lease term. If the lessee defaults on the lease payments or the residual value guarantee, Lender C will absorb any related losses. Accordingly, essentially all of the expected losses and essentially all of the expected residual
1 2
The Variable Interest Models scope exceptions are discussed in the Interpretative guidance and Questions in Chapter 4. Variable interests are interests that are contractual, ownership or other pecuniary interests in an entity that change with changes (exclusive of the effects of variable interests) in the fair value of the entitys net assets. Identification of variable interests is discussed in the Interpretative guidance and Questions in Chapter 5. The Variable Interest Models silo provisions are discussed in the Interpretative guidance and Questions in Chapter 7. 324
returns relating to Building Three are allocable to either the lessee or Lender C, and none of the expected losses or expected residual returns are borne by, or inure to, Manage Co. or Passive Co. as the LLCs equity holders (or any other variable interest holders in the LLC). Because Building Three is a silo, any expected losses and expected residual returns allocable to the silos variable interest holders (i.e., the Building Three Lessee and Lender C) are not considered in determining whether the LLC is a VIE. Accordingly, Building Three, the associated lease and the related debt will not be considered in evaluating the LLC for the remainder of this example. However, because Building Three is a silo of a host entity that is a VIE (see discussion below on the determination of the host entity as a VIE), the variable interest holders in the silo (i.e., Lender C and the lessee of Building Three) would be required to evaluate the Building Three silo as a separate VIE to determine if either party is the silos primary beneficiary that should consolidate the silo. Step 4 Determine if any of the variable interests identified in Step 2 above (excluding interests in silos) qualify as variable interests in specified assets of the LLC and not variable interests in the entity as a whole.4 Analysis Neither Lender B nor Guarantor B have a variable interest in the LLC because the specified asset in which they have a variable interest (Little Building) does not comprise more than half of the fair value of the LLCs assets (after exclusion of the Building Three silo). Any expected losses that would be absorbed by Lender B or by Guarantor B will be excluded from the expected losses of the LLC for purposes of determining the sufficiency of the LLCs equity investment at risk. Conversely, Guarantor A and Lender A are variable interest holders in the LLC as a whole because each holds a variable interest in a specified asset (Big Building) that comprises more than half of the total fair value of the LLCs assets (after exclusion of the Building Three silo). Step 5 Determine the expected losses of the LLC excluding expected losses related to (1) variable interests in specified assets and (2) interests in silos. In certain instances, it may be possible to qualitatively determine the expected losses of an entity that are attributable to and absorbed by specific variable interest holders. However, the following provides an example calculation of the expected losses of the LLC. To compute the LLCs expected losses and expected residual returns, a distribution of possible outcomes for the LLC, on a discounted basis, first must be projected. Due to the nature of the LLCs assets in this example (i.e., only two assets with distinctly separable values and cash flow streams), the expected losses and expected residual returns are separately computed for Big Building and Little Building. In many cases, the possible outcomes will be projected on an aggregate basis for an entity as whole.
The Variable Interest Models provisions relating to variable interests in specified assets are discussed in the Interpretative guidance and Questions in Chapter 8. 325
The possible outcomes for Big Building are presented in Table B below.
Table B Big Building possible outcomes
Fees paid to Manage Co. for acting as the decision maker. Assumed to be 10% of net possible rental income, before interest expense. Possible values of Big Building upon disposal by the LLC at the end of five years. All outcomes are before amounts paid to Lender A or received from Guarantor A, as each is a variable interest holder in the LLC. Total possible undiscounted outcomes, discounted using the assumed rate of interest on a five-year default-riskfree investment of 5%.
Net of all operating costs, including fees paid to Manage Co. but prior to interest expense.
Possible Rental Income $ 18,000,000 18,750,000 19,500,000 20,500,000 21,250,000 22,500,000 $
Decision Maker Fees 2,000,000 2,083,333 2,166,667 2,277,778 2,361,111 2,500,000 $
Possible Cash Flows From Sale Of Building 55,000,000 58,000,000 64,200,000 70,000,000 71,750,000 76,500,000 $
Total Possible Undiscounted Outcomes 75,000,000 78,833,333 85,866,667 92,777,778 95,361,111 101,500,000 $
Present Value of Possible Outcomes 60,411,846 63,484,004 69,063,445 74,570,003 76,662,753 81,587,135
The possible outcomes for Little Building are presented in Table C below.
Table C Little Building possible outcomes
Net of all operating costs, including fees paid to Manage Co. but prior to interest expense. Fees paid to Manage Co. for acting as the decision maker. Assumed to be 10% of net possible rental income, before interest expense. Possible values of Little Building upon disposal by the LLC at the end of five years. Amounts paid to or received from Lender B and Guarantor B are included in the possible outcomes as these parties do not have a variable interest in the LLC (see Step 4 above). Total possible undiscounted outcomes, discounted using the assumed rate of interest on a fiveyear default-risk-free investment of 5%.
Possible Rental Income $ 7,000,000 8,000,000 8,625,000 9,875,000 10,000,000 10,500,000 $
Decision Maker Fees 777,778 888,889 958,333 1,097,222 1,111,111 1,166,667 $
Possible Cash Flows From Sale Of Building 22,000,000 25,000,000 26,000,000 27,000,000 29,500,000 32,000,000 $
Interest Paid to Lender B (6,750,000) $ (6,750,000) (6,750,000) (6,750,000) (6,750,000) (6,750,000)
Principal Paid to Lender B (27,000,000) $ (27,000,000) (27,000,000) (27,000,000) (27,000,000) (27,000,000)
Fees Paid To Guarantor B (500,000) $ (500,000) (500,000) (500,000) (500,000) (500,000)
Possible Cash Flows From Guarantee 5,000,000 2,000,000 1,000,000 $
Total Possible Undiscounted Outcomes 527,778 1,638,889 2,333,333 3,722,222 6,361,111 9,416,667 $
Present Value of Possible Outcomes 389,948 1,352,054 1,953,370 3,156,003 5,235,081 7,674,950
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In Tables B and C above, we have assumed that the possible rental income in each possible outcome for the buildings is comprised of an equal amount in each of the five years the properties are rented. In an actual situation, net rental income likely would vary in each of the periods, and outcome projections should reflect risks such as vacancy risk, tenant credit risk, rental rate risk, etc. In addition, the number of possible outcomes generally would be significantly more than the six assumed for each building in this illustration (see Question 10.9). Amounts paid to or received from Lender A and Guarantor A are not considered in determining the distribution of possible outcomes of Big Building, because these interests are variable interests in the LLC as a whole. Expected losses and expected residual returns are based on the expected variability in an LLCs net assets, exclusive of the effects of variable interests (which serve to allocate the variability in the fair value of the LLCs net assets). Conversely, because Lender B and Guarantor B do not have a variable interest in the LLC as a whole (see Step 4 above), amounts paid to and received from Lender B and Guarantor B are included in the determination of the distribution of possible outcomes of Little Building, as they represent cash outflows to and inflows from parties that are not variable interest holders in the LLC. Interest and principal payments are based on the assumed terms of the loan. The possible cash inflows from the guarantee are derived by subtracting the assumed value received upon the disposal of Little Building from the guarantee amount. For example, if $22 million is received from the sale of the building, the LLC would be entitled to receive $5 million from Guarantor B, because the guarantee is for $27 million. This example does not include any adjustments for the risk that Guarantor B will not perform on the guarantee. In an actual situation, that risk should be included in the possible outcomes (see Question 10.13). Once the distribution of possible outcomes for each of the buildings has been determined, each possible outcome should be probability weighted based on its estimated likelihood of occurrence and the mean of the distribution of all possible outcomes calculated. The mean of the distribution of all possible outcomes should equal, or closely approximate, the fair value of the variable interests in the assets, including the fair value of any fees paid to a decision maker (computed as the probability-weighted, present value of the amounts that the decision maker may receive). Table D demonstrates that the mean of the distribution of Big Buildings possible outcomes closely approximates (within 1%) the sum of the fair value of the variable interests in the asset.
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Table D Mean of distribution of possible outcomes closely approximates fair value of variable interests in Big Building
From Table B above. Probabilities are judgmentally determined and assigned to each outcome based on estimated likelihood of occurrence. Present value of the possible outcomes, multiplied by the associated probability of occurrence.
Present Value of Possible Outcomes Big Building $ 60,411,846 63,484,004 69,063,445 74,570,003 76,662,753 81,587,135
Estimated Probability Of Outcomes
Proof Of Fair Value
Fair values of variable interests held by Manage Co., Passive Co., Lender A and Guarantor A are from Table A above. Computation of the fair value of the decision maker fees is demonstrated below in Table I.
10% $ 18% 25% 25% 15% 7% 100% $
6,041,185 11,427,121 17,265,861 18,642,501 11,499,413 5,711,099 70,587,180
Variable Interests in Big Building Manage Co. $ Passive Co. Lender A Guarantor A Decision Maker fees $
4,200,000 2,800,000 63,000,000 (1,300,000) 1,918,199 70,618,199
The fair value of Guarantor As interest is included as a negative amount because the LLC paid a premium to obtain the guarantee.
Table E demonstrates that, as for Big Building, the mean of the distribution of Little Buildings possible outcomes closely approximates (also within 1%) the sum of the fair value of the variable interests in the asset.
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Table E Mean of distribution of possible outcomes closely approximates fair value of variable interests in Little Building
Probabilities are judgmentally determined and assigned to each outcome based on estimated likelihood of occurrence.
From Table C above.
Present Value of Possible Outcomes Little Building $ 389,948 1,352,054 1,953,370 3,156,003 5,235,081 7,674,950
Fair values of variable interests held by Manage Co. and Passive Co. are from Table A above. Computation of the fair value of the decision maker fees is demonstrated below in Table I.
Present value of the possible outcomes, multiplied by the associated probability of occurrence.
Proof Of Fair Value
5% $ 10% 25% 30% 20% 10% 100% $
19,497 135,205 488,343 946,801 1,047,016 767,495 3,404,357
Variable Interests in Little Building Manage Co. $ Passive Co. Decision Maker fees $
1,500,000 1,000,000 896,562 3,396,562
Ensuring that the mean of the distribution of the possible outcomes equals, or closely approximates, fair value of the variable interests is one of the reasonableness checks for an expected losses and expected residual returns calculation (see Question 10.8). Satisfying this reasonableness check may prove challenging and may require the use of trial and error relating to the projection of possible outcomes and the probability weights assigned to each possible outcome. Once the distribution of possible outcomes has been determined and probability weighted, and the mean of the distribution equals or closely approximates the fair value of the variable interests under evaluation, expected losses and expected residual returns can be computed, as demonstrated in Table F.
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Table F Calculation of the LLCs expected losses and expected residual returns
See Tables B and C above as to the computation of the present value of the possible outcomes of each building. Fair values for each building represent the mean of the buildings distributions of possible outcomes. The computation of each amount is demonstrated in Tables D and E. Probabilities are the same for each building as demonstrated above in Tables D and E. Once probabilities are assigned to possible outcomes, these should be held constant throughout the computation.
Present Value of Possible Outcomes Big Building $ 60,411,846 63,484,004 69,063,445 74,570,003 76,662,753 81,587,135
Fair Value
Difference
Entity Variability in Outcomes Expected Expected Residual Losses Returns
70,587,180 70,587,180 70,587,180 70,587,180 70,587,180 70,587,180
(10,175,334) (7,103,176) (1,523,734) 3,982,823 6,075,574 10,999,955
10% $ 18% 25% 25% 15% 7% 100%
(1,017,533) $ (1,278,572) (380,934) (2,677,039)
995,706 911,336 769,997 2,677,039
389,948 1,352,054 1,953,370 3,156,003 5,235,081 7,674,950
3,404,357 3,404,357 3,404,357 3,404,357 3,404,357 3,404,357
(3,014,409) (2,052,303) (1,450,987) (248,355) 1,830,724 4,270,592
5% 10% 25% 30% 20% 10% 100% $
(150,720) (205,230) (362,747) (74,506) (793,204) (3,470,243) $
366,145 427,059 793,204 3,470,243
Expected losses and expected residual returns are computed by subtracting the fair value of the variable interests in the buildings from the present value of each possible outcome and multiplying the difference by the probability associated with the possible outcome. To illustrate, the Big Building expected loss of $(1,017,533) for the first possible outcome is computed as the possible outcomes present value of $60,411,846, less the fair value of the variable interests of $70,587,180 (a difference of $10,175,334) multiplied by the associated probability of 10%. The absolute value of expected losses equals expected residual returns.
Expected losses and expected residual returns are computed by subtracting the fair value of the variable interests in each building (i.e., the mean of the distribution of all possible outcomes computed as the sum of the products of (1) each possible outcome, discounted using the interest rate on default risk-free investments, in the distribution of outcomes and (2) the related probability for each such outcome) from the present value of each possible outcome and multiplying the difference by the judgmentally assigned probability weighting associated with the specific outcome. Because the fair values of the variable interests in the buildings are computed as the mean of the distribution of each buildings possible outcomes, the absolute value of total expected losses is equal to the expected residual returns. This is also one of the reasonableness checks that a calculation of expected losses and expected residual returns must satisfy (see Question 10.8).
Step 6 Determine if (1) the LLCs equity investment at risk is sufficient to absorb its expected losses (excluding expected losses attributable to silos and variable interests in specified assets) and (2) as a group, the holders have the characteristics of a controlling financial interest.5 Analysis To assess the sufficiency of the LLCs equity investment at risk, the LLCs equity instruments first must be identified and the fair value of the instruments determined. Once identified, the characteristics of the equity instruments must be assessed to ensure that each is an equity investment at risk. In this example, the LLCs equity investments are comprised of the amounts contributed by Manage Co. and Passive Co. There are no features to the investments that suggest that they would not be reported as equity in the LLCs GAAP balance sheet (e.g., they are not mandatorily redeemable except upon the planned liquidation of the LLC). Because the analysis is being performed at inception of the LLC, the fair value of the interests is equal to the amounts contributed. The equity investments made by Manage Co. and Passive Co. are deemed to be at risk, based on the following analysis. a. The equity investments participate significantly in the profits and losses of the LLC, as they are not protected from the risk of losing their equity investments (the protection provided by the guarantee of the residual value of Big Building only provides protection to Lender A if the value of Big Building declines to an amount that reduces the equity investment at risk in Big Building to zero). Note that for purposes of this analysis, the losses and returns that will be absorbed by or inure to variable interests in silos (i.e., to the lessee and Lender C for Building Three) or to variable interests in specified assets (i.e., to Guarantor B and Lender B for Little Building) are not considered, because these interests are not variable interests in the LLC. b. The equity interests were not issued in exchange for subordinated interests in other VIEs. c. The equity investments were not provided to Manage Co. or Passive Co. directly or indirectly by the LLC or by other parties involved with the LLC.
d. The equity investments were not financed for Manage Co. or Passive Co. by the LLC or by other parties involved with the LLC. Accordingly, the LLC is deemed to have an equity investment at risk equal to the combined investments of Manage Co. and Passive Co., or $10,000,000. The sufficiency of the equity investment at risk may be demonstrated through any one of the following methods:6 a. The LLC has demonstrated the ability to finance its activities without additional subordinated financial support. The LLC has not demonstrated an ability to finance its activities without additional subordinated financial support because Lender A required that a guarantee of the residual value of Big Building be obtained in connection with providing the loan. The guarantee is additional subordinated financial support provided to the entity and indicates that the LLCs equity investment at risk may be insufficient to absorb its expected losses.
5 6
See the Interpretative guidance and Questions in Chapter 9. See the Interpretative guidance and Questions in Chapter 9. 331
b. The LLC has at least as much equity as a similar entity that finances its operations with no additional subordinated financial support. To determine whether another entity is comparable: The type and amount of the entitys assets should be similar, The type and amount of the entitys liabilities, including maturities and interest rates, should be similar, The type and amount of capital used to finance the entity should be similar, and The comparable entity should not have any of the features that would prohibit it from demonstrating the ability to finance its activities without additional subordinated financial support.
Generally, it will be rare that entities are capable of demonstrating the sufficiency of the equity investment at risk through this method. In this example, it is assumed that the sufficiency of the LLCs equity investment at risk cannot be demonstrated via comparison to similar entities. c. The LLCs equity investment at risk can be quantitatively demonstrated to be greater than its expected losses. As demonstrated in Table F, the expected losses of the LLC are $3,470,243 (the sum of the expected losses associated with Big Building and Little Building). The LLCs equity investment at risk ($10,000,000, as determined above) is sufficient, because it exceeds the LLCs expected losses. To assess whether the holders of the LLCs equity investment at risk have the characteristics of a controlling financial interest, they must have the following characteristics: a. As a group, the holders of the equity investments at risk (i.e., Manage Co. and Passive Co.) must have the ability to make significant decisions about the LLCs activities through voting or similar rights.7 Generally, the holders of the equity investments at risk should have the power to direct the activities of an entity that most significantly impact the entitys economic performance in order for the entity not to be a VIE. If parties other than holders of the equity investment at risk have the power to direct the activities of an entity that most significantly impact the entitys economic performance, the entity would be a VIE. In particular, it is important to determine whether the decision maker has a variable interest based upon an evaluation of the criteria on fees paid to decision makers or service providers. This analysis focuses on whether the decision maker or service provider is acting in a fiduciary capacity (as an agent of the equity holders) or as a principal to the transaction. Often in the circumstances in which it is determined that the service provider has a variable interest based upon the analysis of provisions on fees paid to decision makers or service providers, the entity will be a VIE unless an equity holder has the unilateral ability to exercise kick-out or liquidation rights and those rights are otherwise substantive. In this example, under the terms of the debt agreements, Lender A is given significant rights to participate in decisions affecting the LLCs operations that can be unilaterally exercised (i.e., Big Building cannot be sold prior to the end of the five-year term of the LLC without the approval of Lender A, and Lender A must approve all tenants, and related lease terms, of the Big building). These rights are deemed to be of such significance that Manage Co. and Passive Co. do not have substantive decision making ability regarding the LLCs activities. Accordingly, the LLC is a VIE.
See the Interpretative guidance and Questions in Chapter 9. 332
b. As a group, the holders of the equity investments at risk must have the obligation to absorb the LLCs expected losses.8 Manage Co. and Passive Co. have the obligation to absorb expected losses of the LLC to the extent of their at risk equity investments. Although the guarantee obtained from Guarantor A provides protection from a decline in the value of Big Building, this protection only exists for declines in value after the equity investment at risk is eliminated. Note that because Guarantor B does not have a variable interest in the entity (see Step 4), the guarantee of Little Buildings value is not considered in making this assessment. Additionally, the residual value guarantee provided by the lessee of Building Three, and the fact that Building Three has been financed in its entirety by nonrecourse debt, is not considered in this assessment because Building Three is a silo (see Step 3). c. As a group, the holders of the equity investments at risk must have the right to receive the LLCs expected residual returns.9 Manage Co. and Passive Co. have the right to receive the LLCs expected residual returns. No features of their equity instruments indicate that the returns that might inure to them from the LLCs assets are either directly or indirectly capped. Note that the fixed price purchase option held by the lessee of Building Three is not considered in this assessment because Building Three is a silo (see Step 3). Step 7 As determined in Step 6, the LLC is a VIE because the holders of the LLCs equity investment at risk do not have the power to direct the activities of an entity that most significantly impact the entitys economic performance.
8 9
See the Interpretative guidance and Questions in Chapter 9. See the Interpretative guidance and Questions in Chapter 9. 333
Appendix G: Other publications

In addition to our Financial reporting developments publication, Consolidation of variable interest entities, readers may find the following publications regarding the Variable Interest Model to be helpful.
Publication Technical Line, The effects of Statement 167 on PPAs in the power and utilities industry Technical Line, The effects of the revised Variable Interest Model on the life sciences industry Technical Line, The effects of the revised Variable Interest Model on lot option contracts Reference number No. 2009-20 (SCORE No. BB1865) No. 2009-21 (SCORE No. BB1882) No. 2010-2 (SCORE No. BB1918)
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4 Scope .......................................................................................................................... 25 4.1 Interpretative guidance Legal entities ................................................................................ 26

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6.9 6.10 6.11

7 Silos .......................................................................................................................... 104 7.1 Interpretative guidance ...................................................................................................... 104

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12 Reconsideration events ............................................................................................. 210 12.1 Interpretative guidance ...................................................................................................... 210

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19 Presentation ............................................................................................................. 277 19.1 Interpretative guidance ...................................................................................................... 277

Financial reporting developments Consolidation of variable interest entities

20 Disclosures................................................................................................................ 280 20.1 Interpretative guidance ...................................................................................................... 283

Financial reporting developments Consolidation of variable interest entities

Financial reporting developments Consolidation of variable interest entities

Financial reporting developments Consolidation of variable interest entities

Financial reporting developments Consolidation of variable interest entities

Financial reporting developments Consolidation of variable interest entities

ASC 810s overall consolidation model is illustrated by the diagram below.

Scope exception to variable interest model?

Variable interest in an entity?

Primary beneficiary of the VIE?

Follow other GAAP*

Consolidate the VIE

Financial reporting developments Consolidation of variable interest entities

IFRS 10, Consolidated Financial Statements 18

Financial reporting developments Consolidation of variable interest entities

Financial reporting developments Consolidation of variable interest entities

Questions and interpretative responses

Subordinated financial support

Financial reporting developments Consolidation of variable interest entities

Consideration of substantive terms, transactions and arrangements

3 Consideration of substantive terms, transactions and arrangements

Questions and interpretative responses

3 Consideration of substantive terms, transactions and arrangements

Financial reporting developments Consolidation of variable interest entities

Financial reporting developments Consolidation of variable interest entities

Interpretative guidance Legal entities

Financial reporting developments Consolidation of variable interest entities

Questions and interpretative responses

Common arrangements/entities subject to the Variable Interest Models provisions

This list is not all-inclusive. 27

Financial reporting developments Consolidation of variable interest entities

Entities used to facilitate residential and commercial mortgage-backed securities arrangements

There are no exceptions for entities used by specific industries.

Financial reporting developments Consolidation of variable interest entities

Illustration 4-1: Example 1

Collaborative arrangements not conducted through a separate entity

Financial reporting developments Consolidation of variable interest entities

Application of Variable Interest Model to tiered structures

Financial reporting developments Consolidation of variable interest entities

Illustration 4-3: Facts

CompanyA 70% CompanyB

Fiduciary accounts, assets held in trust

Financial reporting developments Consolidation of variable interest entities

Financial reporting developments Consolidation of variable interest entities

Interpretative guidance Scope exceptions general