Ray Pelter, Denton Hutchens, Aaron Lieske

4/4/16
Advanced Accounting
Professor Armstrong
Variable Interest Entities
According to the Financial Accounting Standards Board (FASB), a Variable Interest
Entity is an entity (investee) in which the investor has obtained less than a majority-owned
interest.A variable interest entity (VIE) can take the form of a trust, partnership, joint venture, or
its own corporation. VIEs generally have assets, liabilities, and investors with equity interests
like most business entities. A VIE is subject to consolidation if certain conditions exist. When a
relationship between a firm and a VIE is established, the firm then has to determine if it qualifies
as the VIEs primary beneficiary. If it is determined that a firm is the primary beneficiary of the
VIE, a consolidation of their balance sheets is required by FASB. The primary beneficiary is
defined as the person or company with the majority of variable interests. A few examples of
variable interests are participation rights, asset purchase options, guarantees of debt,
subordinated debt instruments, and lease residual value guarantees.
GAAP and IFRS employ different criteria for determining the consolidation of VIEs.
IFRS has a single consolidation model for all entities, where GAAP has separate models for
assessing control of VIEs and voting interest. In 2011, IFRS issued Consolidated Financial
Statements and Disclosure of Interests in Other Entities. These standards set a new definition
of control that emcompasses all possible ways one entity can exercise power over a VIE.
Disclosure of Interests in Other Entities provides enhanced disclosures about the parent and
VIEs relationship. These two standards help investors understand why a parent company

controls another entity and the claims of non controlling interest. (Hoyle, Schaefer & Doupnik,
2014) They also help investors evaluate the risks assumed by the parent company.
In 2011, FASB issued a proposed change on Consolidations, entitled Principal versus
Agent Analysis. This proposal amended the definition of a VIE by adding a principal versus
agent analysis, as well as affecting the determination of the primary beneficiary. A reporting
entity is required to determine if it has the power to direct the activities of the VIE that
significantly impacts its economic performance. If all other primary beneficiary requirements are
met, the principle consolidates the VIE, not the agent. There are criteria set in place by FASB
that help determine whether a decision maker acts as principal or agent. (Hoyle, Schaefer &
Doupnik, 2014)
The proposed amendments in this Update would affect all reporting entities that
are required to evaluate whether they should consolidate another entity. The proposed
amendments are expected to most significantly affect the financial reporting of entities that are
involved with variable interest entities. The proposed amendments also would change the
evaluation of whether an entity is a variable interest entity. Accordingly, entities that historically
were not evaluated under the Variable Interest Entities Subsections of Subtopic 810-10 may be
required to be evaluated for consolidation under that guidance, while other entities may no
longer be required to be evaluated under that guidance. Finally, the proposed amendments would
change the requirements for determining whether a general partner controls a limited partnership
and, therefore, could affect reporting entities that are involved with partnerships and similar
entities. In addition, the proposed amendments would change the evaluation of participating
rights held by noncontrolling shareholders.

Under this proposed Update, a decision maker with a variable interest in an entity would
be required to perform a separate analysis to evaluate its overall relationship with the entity
being managed and the other parties involved with the entity to assess the capacity in which it
uses its decision-making authority. Accordingly, the Board decided that rather than relying on the
current assessment in the document, which provides a list of requirements a reporting entity must
meet to conclude that it is an agent, the decision makers capacity should be determined
according to a separate qualitative assessment. Under this approach, the reporting entity would
consider the following factors in the context of the purpose and design of the entity when
evaluating the capacity of a decision maker:
1) The rights held by other parties. 2) The compensation to which the decision maker is
entitled in accordance with its compensation agreement(s). 3) The decision makers exposure to
variability of returns from other interests that it holds in the entity.
In June 2011, the FASB issued updated guidance regarding the presentation of
comprehensive income. The updated guidance eliminates the option to present components of
other comprehensive income as part of the statement of changes in stockholders equity. Under
the updated guidance, an entity has the option to present the total of comprehensive income, the
components of net income, and the components of other comprehensive income either in a single
continuous statement of comprehensive income or in two separate but consecutive statements.
The updated guidance does not change the items that are reported in other comprehensive
income or when an item of other comprehensive income must be reclassified to net income. In
December 2011, the FASB issued updated guidance deferring the requirement to separately
present reclassifications from the components of other comprehensive income to the components
of net income on the face of the financial statements. Companies are still required to adopt the

other requirements of the updated guidance. This updated guidance, with the exception of the
requirement to separately present reclassifications from the components of other comprehensive
income to the components of net income, is effective for the first interim or annual reporting
period beginning after December 15, 2011 and should be applied retrospectively. The Company
expects this guidance to impact its financial statement presentation but not to impact the
Companys consolidated financial position or results of operations.
There are many reasons as to why the VIE rules have been put into place. Transactions
involving VIEs have become more and more common and the relevant accounting literature was
fragmented and incomplete. This makes companies with consolidated financial statements
include subsidiaries where they have controlling financial interests. That requirement was
usually applied when the parent company had a majority voting interest. However, many
circumstances did not include the VIEs where it had similar relationships. The voting approach
was not effective in identifying the controlling financial interests in companies that are not
controllable through voting interests or if they do not bear economic risks. The objective of this
was to improve VIEs financial reporting by enterprises involved with the VIEs. If a business
enterprise is involved with a VIE, then the VIEs assets, liabilities, and results of the VIE should
be included in the financial statements with those of the business enterprise. Generally, two
enterprises are included in financial statements because one controls the other, but a company is
not limited to one VIE. However, this interpretation explains how a VIE assess its interests in a
consolidation.
VIEs now are much more cost effective and less time consuming compared to what they
were in the past. Especially to companies whose only VIE relation is to rental activity. This also
helps with the problems of goodwill, as it can be a complex and expensive calculation with no

real benefits. What also makes VIEs a little easier is that private companies are only required to
test goodwill for impairment when an event occurs compared to testing for impairment annually,
while also simplifying the process of impairments to goodwill. The new process allows
companies to perform the impairment test at the entity level and requires a less extensive
analysis to measure impairment with a single step approach.
There are many benefits to the FASB introducing the new VIE rules into the accounting
world. The main benefit FASB intended to achieve is implementing a more consistent
application of consolidation policies, and to improve comparability between VIEs. With
including the assets, liabilities, and results of activities of VIEs in financial statements, they will
provide more complete information about the resources, obligations, risks, and opportunities of
the consolidated enterprise. The disclosures required by FASB regarding the way in which VIEs
are not consolidated but still have significant variable interests helps assess the enterprises risks.

This pronouncement should provide useful information in making business and economic
decisions by including VIEs in consolidated financial statements. This will also help achieve
that objective by providing information that helps assessing the prospective net cash flows of the
consolidated company. FASB also wanted companies to faithfully represent the total assets that
an enterprise controls and liabilities for they are responsible, so this pronouncement achieves just
that. All relevant information regarding VIEs must be included in the company's consolidated
financial statements. The relationship between a VIE and its benefactor results in the control over
the future cash flows of the VIE going to the benefactor. This makes it so that the primary
benefactor may not have the direct ability to make decisions through the use of assets since the
liabilities of the VIE will require sacrificing consolidated assets.

Works Cited
Hoyle, Joe Ben., Thomas F. Schaefer, and Timothy S. Doupnik. Advanced Accounting.
12th ed. New York: McGraw Hill Education, 2014. Print.
Pricewaterhouse Coopers. "Accounting for Variable Interest Entities." Pwc.com. June
2015. Web. 31 Mar. 2016. <https://www.pwc.com/us/en/cfodirect/assets/pdf/accountingguides/pwc-guide-variable-interest-entities-second-edition-2015.pdf>.

"FASB, Financial Accounting Standards Board." Proposed ASU-Consolidation (Topic

810): Principal versus Agent Analysis. 3 Nov. 2011. Web. 31 Mar. 2016.
<http://www.gasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176159223847>.
(2014, November 6). Retrieved 4 2, 2016, from http://www.g3cpa.com/news/the-longawaited-changes-to-u-s-gaap-commonly-referred-to-as-big-gaap-for-private-nonpublicentities-commonly-referred-to-as-little-gaap-is-finally-here-for-vies-and-goodwill/
FASB. (n.d.). Summary of Interpretation No. 46. Retrieved 4 2, 2016, from
http://www.fasb.org/summary/finsum46.shtml