Chapter_06_IMSM - CHAPTER 6 VARIABLE INTEREST ENTITIES,...

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Unformatted text preview: CHAPTER 6 VARIABLE INTEREST ENTITIES, INTERCOMPANY DEBT AND OTHER CONSOLIDATION ISSUES Chapter Outline I. Variable interest entities (VIEs) A. VIEs typically take the form of a trust, partnership, joint venture, or corporation. In most cases a sponsoring firm creates these entities to engage in a limited and well-defined set of business activities. For example, a business may create a VIE to finance the acquisition of a large asset. The VIE purchases the asset using debt and equity financing, and then leases the asset back to the sponsoring firm. If their activities are strictly limited and the asset is pledged as collateral, VIEs are often viewed by lenders as less risky than their sponsoring firms. As a result, such arrangements can allow financing at lower interest rates than would otherwise be available to the sponsor. B. Control of VIEs, by design, often does not rest with its equity holders. Instead, control is exercised through contractual arrangements with the sponsoring firm who becomes the "primary beneficiary" of the entity. These contracts can take the form of leases, participation rights, guarantees, or other residual interests. Through contracting, the primary beneficiary bears a majority of the risks and receives a majority of the rewards of the entity, often without owning any voting shares. C. An entity whose control rests a primary beneficiary is referred to by FASB Interpretation 46R "Consolidation of Variable Interest Entities," ( FIN 46R ) as a variable interest entity. The following characteristics indicate a controlling financial interest in a variable interest entity. 1. The direct or indirect ability to make decisions about the entity's activities 2. The obligation to absorb the expected losses of the entity if they occur, or 3. The right to receive the expected residual returns of the entity if they occur The primary beneficiary bears the risks and receives the rewards of a variable interest entity and is considered to have a controlling financial interest. D. FIN 46R reasons that if a "business enterprise has a controlling financial interest in a variable interest entity, assets, liabilities, and results of the activities of the variable interest entity should be included with those of the business enterprise." Therefore, primary beneficiaries must include their variable interest entities in their consolidated financial statements consistent with the provisions of SFAS 141R . II. Intercompany debt transactions A. No real consolidation problem is created when one member of a business combination loans money to another. The resulting receivable/payable accounts as well as the interest income expense balances are identical and can be directly offset in the consolidation process....
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Chapter_06_IMSM - CHAPTER 6 VARIABLE INTEREST ENTITIES,...

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