Over the past several years, it has become common for companies to control businesses without a majority voting interest while avoiding consolidations, and I have several clients involved with related entities requiring the regular assessment of Variable Interest Entities (VIEs) and its varied implications. This year I had the pleasure of working with San Jose State University students on a project to analyze the provisions of U.S. GAAP as it relates to determination VIEs and primary beneficiaries and the consolidation considerations for such entities. It is certainly not a straightforward topic, and their step-by-step explanation, with the aid of a flowchart, broke down the requirements into layman’s terms that quite succinctly highlighted the salient characteristics of a VIE and when to consolidate.
You may find our analysis from the project helpful as it demonstrates an approach in which we navigate through each possibility and question each criterion, breaking it down into a less intimidating process:
- Determine whether the entity in question is eligible as a VIE, factoring for scope exceptions.
- If VIE guidance applies, assess whether the entity was in fact a VIE. This assessment involves reviewing the equity at risk and voting rights in proportion to the obligation to absorb losses.
- If the entity is in fact a VIE, analyze whether the reporting entity (in most cases this would be our client) has a variable interest in the VIE and is the primary beneficiary, which could trigger a consolidation.
I know it sounds easier on paper than in real life. Here are the four parts of the flow chart to help you make this assessment (Download VIE flowchart source file):
Congratulations the San Jose State University students that developed this. You took on a challenge foreign to you, worked hard at understanding it, and presented a workable solution to explain. I am always amazed by people who do this.
Update: For more info on additional risks that can arise during a related party transaction, please see my latest post, 4 Steps to Reduce Risk Associated with Related Party Transactions.