Ch 6: consolidation of Variable Interest Entities and Other Intracompany Investments

consolidation of a variable interest entity

- when a reporting entity becomes the primary beneficiary of a VIE that is a business - the reporting entity should apply the same ASC 805 Acquisition Method recognition and measure principles as described in CH 2

financial agreements that might meet the definition of a variable interest

- equity securities - debt instruments - guarantees - put and call options - management contracts - franchise agreements - leases - service contracts - derivatives - residual value guarantees - technology licenses - collaborative R&D arrangements

variable interests

contractual, ownership, or other financial interests in a legal entity that change in value as a result of changes in the fair value o the net assets of the legal entity - the idea is that a legal entity's assets and operations increase or decrease in value, these changes in value are received by (i.e., absorbed by) the providers of the entity's equity capital

because the lily asymmetry in the bond discounts/premiums for the afflicted companies, the initial elimination will likely result in a

gain or loss on constructive retirement of the intracompany debt

The evaluation of consolidation based on variable interests is actually done before...

the parent company applies the majority interest criteria when evaluating a consolidation candidate

If the FV of the VIE is greater than the sum of the individual fair values of the identifiable net assets inside the VIE...

the primary beneficiary will recognize goodwill int he consolidated FS (or a bargain purchase again if less)

during consolidation, we eliminate the intercom any indebtedness because...

both the "receivables" and the "payable" are held by the consolidated entity

secularization of Assets (e.g., Receivables)

- sponsoring company (think of this as the parent company in our consolidation examples) forms an SPE as a separate/distinct legal entity - The SPE is structured to make it "bankruptcy remote" (i.e., unlikely to file for bankruptcy). That way, the SPE can borrow on favorable terms - The SPE is only allowed to engage in a highly restricted set of activities, like purchasing receivables from the sponsoring company, borrowing money collateralized by those assets (e.g., receivables), collecting the cash and making debt payments - In this case, the SPE is selling debt securities backed by assets, hence the term "securitization"

consolidation subsequent to acquisition

- the assets, liabilities, and noncontrolling interests of a consolidated VIE are accounted for in the consolidated FS as if the entity were consolidated based on voting interests - All intercom-any transactions between the primary beneficiary and the VIE must be eliminated

parent investment in a subsidiary with preferred stock outstanding

- the existence of PS in the subsidiary does not present any new conceptual issues - If the Parent owns some or all fo the PS, it myst be eliminated against the equity investment account like our elimination of CS - And, the portion of the PS not owned by the parent is included in the NCI equity on the BS - Any div accrued on PS are attributed to NCI in the consolidated IS

Special Purpose Entities (SPE)

- Entities of any form, crated by a company to achieve a specific objective -frequently used as vehicles to achieve financing on more favorable terms than the company can realize by borrowing directly - Securitization of assets (typically receivables) is a common activity of SPEs - The sponsoring entity might have latent rights to the assets held by the SPE, or might be explicitly or implicitly obligated to fund the operations of the SPE if the SPE experiences financial hardship - Thus, technically, the sponsoring company might won a minority of the voting shares of the SPE but might excessively participate in the risks and rewards of the SPE

Evaluation of Control

- If the Legal Entity is not a variable interest entity then Evaluate control based on voting interests - If the legal entity is a variable interest entity then determine if reporting entity is the Primary beneficiary

direct lending to an affiliate

- in a direct purchase of subsidiary notes and/or bonds by a parent company, the journal entries made by the parent mirror those made by the subsidiary - Because of this fact, the required consolidation entry is merely a reversal fo these initial entries by the two companies

FASB ASC 810-10-35-3 requires...

100% of the elimination of "fees or other sources of income or expense between a primary beneficiary and a consolidated VIE" be attributed to the primary beneficiary - in other words, regardless of the direction of payment between the beneficiary and the VIE, these intracompany payments are always treated as downstream intracompany transactions (i.e, none of the intracompany elimination is attributed to he NCI)

to address the complexity that SPEs pose, in 2003 FASB promulgated a..

comprehensive consolidation model that supplements the transitional majority interest model - the new model is often called the Variable Interest Entity (VIE) approach to consolidation - this model integrates the VIE evaluation with the majority interest approach as part of a comprehensive evaluation of an entity for potential consolidation

because the market interest rates likely shift between initial issuance of bonds and subsequent purchase of the bonds by the affiliated bond issuer, the discount/premium accounts of the affiliated bond issuer and affiliated bond holder will...

likely not equal

an entity shall be deemed to have controlling financial interest in a VIE if it has both of the following characteristics

1) the power to direct the activities of a VIE that most significantly impact the VIE's economic performance, and 2) 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

initial measurement if the VIE is a business

FV of the consideration paid for the VIE + FV of any previously held interests + The FV of any non controlling interests in the VIE __________________________________ = Total FV of the VIE - the initial consolidation date FV of the VIE's identifiable net assets _____________________ Goodwill (if positive) or a bargain gain (if negative)