Variable Interest 2013

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Guide to Accounting for Variable

Interest Entities
201
This publication has been prepared for general information on matters of interest
only, and does not constitute professional advice on facts and circumstances
specific to any person or entity. You should not act upon the information contained
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be responsible for any loss sustained by any person or entity who relies on this
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The content of this publication is based on information available as of May 15,
2013. Accordingly, certain aspects of this publication may be superseded as new
guidance or interpretations emerge. Financial statement preparers and other users
of this publication are therefore cautioned to stay abreast of and carefully evaluate
subsequent authoritative and interpretive guidance that is issued.
Portions of various FASB documents included in this work, copyright by Financial

Accounting Foundation 401 Merritt 7, Norwalk, CT 06856, are reproduced by
permission.
Dear Clients and Friends:

The requirement to include or consolidate the financial statements of entities over which a
reporting entity has a controlling financial interest is a concept in accounting that has been in
place for many years. The application of this guidance continues to be challenging, particularly
for certain types of structured entities or entities that have limited purposes. To address these
challenges, the standard setters created what is essentially a different accounting model to be
applied when determining if a reporting entity is required to consolidate these types of entities
(known as variable interest entities). This accounting model has been modified a number of
times over the years and preparers, auditors, and regulators continue to develop interpretations
for new fact patterns that arise. In addition, the standard setters are deliberating additional
amendments to the guidance.
PwC is pleased to offer this comprehensive guide on the consolidation model for variable
interest entities. It is intended to assist you in interpreting the existing literature in this complex
area of accounting by bringing together all of the key guidance into one publication. It provides
several examples to help navigate the guidance, and offers our perspective throughout, based
on both analysis of the guidance and our experience in applying it.
This guide is intended to clarify the fundamental requirements involved in the accounting and
disclosure for variable interest entities and to highlight key points that should be considered
before and after transactions are undertaken. It is not a substitute for a thorough analysis of
the facts and circumstances of a particular transaction, nor should it be read in place of the
relevant accounting literature. We hope you will find in these pages the information and insights
needed to work with greater confidence and certainty when applying the consolidation model
for variable interest entities.
PricewaterhouseCoopers LLP
Table of Contents
Executive Summary:....................................................................................................................................... 1
Chapter 1:
Definition of Key Terms
1.1
Voting Interest Entity................................................................................................1-3
1.2
Variable Interest Entity.............................................................................................1-3
1.3
Primary Beneficiary..................................................................................................1-4
1.4
Variable Interest........................................................................................................1-4
1.5
Subordinated Financial Support..............................................................................1-6
1.6
1.6.1
Expected Losses and Expected Residual Returns................................................1-6

Simple Illustration for Calculating Expected Losses and
Expected ResidualReturns.....................................................................................1-8
1.7
1.7.1
1.7.1.1
1.7.1.2
1.7.1.3
1.7.1.4
1.7.2
Related Parties and De Facto Agents...................................................................1-10

Transfer Restrictions..............................................................................................1-12
Rights of First Refusal...............................................................................................1-13
Rights of First Offer...................................................................................................1-14
Approval that Cannot be Unreasonably Withheld....................................................1-14
Lock up Periods........................................................................................................1-14
Close Business Relationship.................................................................................1-14
1.8
Kick-Out Rights, Participating Rights and Protective Rights.............................1-15
1.9
Substantive Terms, Transactions, and Arrangements.........................................1-16
Chapter 2:
Scope and Scope Exceptions
2.1
Definition of an Entity...............................................................................................2-3
2.2
2.2.1
2.2.2
2.2.3
2.2.4
2.2.5
2.2.6
2.2.7
Scope Exceptions.....................................................................................................2-5
The So-Called Business Scope Exception..........................................................2-5
Not-for-Profit Organizations..................................................................................2-13
Employers That Offer Employee Benefit Plans....................................................2-14
Investment Companies..........................................................................................2-14
Separate Accounts of Life Insurance Entities......................................................2-15
Information-Out...................................................................................................2-16
Governmental Organizations.................................................................................2-18
2.3
Deferral of the 2009 Revisions to the VIE Model for Certain

Investment Entities.................................................................................................2-20
2.4
Questions and Interpretive Responses................................................................2-24
Table of Contents / iii
Chapter 3:
Variable Interests
3.1
The Concept of a Variable Interest..........................................................................3-3
3.2
The By Design Approach in Determining an Entitys Variability

and Variable Interests...............................................................................................3-4
Terms of the Interests Issued..................................................................................3-7
Substantive Subordination.......................................................................................3-8
Certain Interest Rate Risk........................................................................................3-9
Certain Derivative Instruments..............................................................................3-10
3.2.1
3.2.2
3.2.3
3.2.4
3.3
3.3.1
3.3.2
3.3.3
3.3.10
3.3.11
Examples of Variable Interests..............................................................................3-11

Equity Investments.................................................................................................3-12
Debt Instruments and Beneficial Interests...........................................................3-12
Guarantees, Put Options, and Similar Obligations: Options
Purchased/Exercisable by the Entity / Written by the
Reporting Entity......................................................................................................3-13
Guarantees, Put Options, and Similar Obligations: Options Written
by the Entity.............................................................................................................3-14
Guarantees, Put Options, and Similar Obligations: Options
Written/Purchased Among Reporting Entities.....................................................3-15
Forward Contracts and Long Term Supply Contracts........................................3-15
Other Derivative Instruments.................................................................................3-17
Assets of the Entity.................................................................................................3-18
Decision Maker or Service Provider Fees............................................................3-18
Condition 1: Fee Commensurate with the Level of Effort Required.........................3-19
Condition 2: Seniority of Service Provider Fees.......................................................3-19
Condition 3: Service Provider and Related Parties Do Not Hold Other
Variable Interests in the VIE......................................................................................3-20
Condition 4: Service Arrangement Includes Customary Terms,
Conditions or Amounts.............................................................................................3-21
Conditions 5 and 6: Total Anticipated Fees and Their Variability are
Insignificant Relative to the VIEs Anticipated Economic Performance
and the VIEs Variability.............................................................................................3-21
Reconsideration of Decision Maker and Service Provider Arrangements................3-22
ASU 2010-10 and Its Potential Impact on Decision Maker and
Service Provider Arrangements................................................................................3-22
License, Royalties, and Other Similar Arrangements..........................................3-23
Leases......................................................................................................................3-23
3.4
Implied Variable Interests...................................................................................3-25
3.5
Variable Interests in Specified Assets..................................................................3-27
3.6
Silos: A VIE within a VIE.........................................................................................3-29
3.7
Chapter 4:
Determining Whether an Entity is a VIE
4.1
4.1.1
4.1.2
First Step: Identifying the Holders of the Equity Investment at Risk...................4-3

Starting Point: GAAP Equity.....................................................................................4-4
Equity Must Participate Significantly in the Entitys Profits and Losses.............4-5
3.3.4
3.3.5
3.3.6
3.3.7
3.3.8
3.3.9
3.3.9.1
3.3.9.2
3.3.9.3
3.3.9.4
3.3.9.5
3.3.9.6
3.3.9.7
iv / Table of Contents
4.1.3
4.1.4
4.1.5
4.1.6
Equity Investments Issued in Exchange for Subordinated

Financial Support in Another VIE............................................................................4-6
Equity Investments Provided to the Equity Investor by Other
Parties Involved with the Entity...............................................................................4-7
Equity Investments Financed for the Equity Investor by the
Entity or Other Parties Involved with the Entity.....................................................4-8
Consideration of Activities Around the Entity........................................................4-8
4.2
4.2.1
4.2.1.1
4.2.1.2
4.2.1.3
Next Steps: Assessing the Five Characteristics of a VIE......................................4-9

Characteristic 1: Insufficient Equity Investment at Risk.......................................4-9
Calculating the Equity Investment at Risk................................................................4-11
Assessing the Sufficiency of the Equity Investment at Risk.....................................4-11
Qualitatively Demonstrating That the Equity Investment at Risk
Is Sufficient...............................................................................................................4-13
4.2.1.4
Quantitatively Demonstrating That the Equity Investment at Risk
IsSufficient...............................................................................................................4-14
4.2.1.5
Development Stage Entities.....................................................................................4-15
4.2.2
Characteristic 2: Equity Lacks Decision Making Rights.....................................4-16
4.2.2.1
Key Consideration of whether Equity Lacks Decision Making Rights......................4-16
4.2.2.2
Which Parties Should Be Evaluated Under this Characteristic?..............................4-17
4.2.2.3
How to Evaluate Whether the Equity Holders as a Group Have Power...................4-17
4.2.2.4
Evaluating Limited Partnerships and the Impact of Kick-Out Rights.......................4-19
4.2.2.4.1
General Partners Interests in a Limited Partnership................................................4-21
4.2.2.5
Decision Making Must Reside within the Equity Instrument....................................4-23
4.2.3
Characteristic 3: Equity with Nonsubstantive Voting Rights..............................4-24
4.2.3.1
Criterion 1: Disproportionate Voting and Economics...............................................4-25
4.2.3.2
Criterion 2: Evaluating the Substantially All Concept............................................4-27
4.2.4
Characteristic 4: Lacking the Obligation to Absorb an Entitys
ExpectedLosses........................................................................................................ 29
4.2.4.1
How to Evaluate this Characteristic in Practice........................................................4-30
4.2.4.2
Impact of Implicit Variable Interests..........................................................................4-30
4.2.4.3
Additional Examples: Evaluating an Entity under Characteristic 4...........................4-31
4.2.5
Characteristic 5: Lacking the Right to Receive an Entitys Expected
Residual Returns.....................................................................................................4-32
4.2.5.1 Examples..................................................................................................................4-33
4.3
4.3.1
4.3.7
4.3.8
4.3.9
Reconsideration Events: VIE Status......................................................................4-34

Reassessment of the Design of an Entity upon a Reconsideration
Event........................................................................................................................4-35
Losses That Reduce the Equity Investment.........................................................4-35
Change in Governing Documents or Contractual Arrangements......................4-36
Return of Investment to Equity Investors.............................................................4-37
Entity Undertakes Additional Activities................................................................4-38
Entity Receives Additional Equity Investment or Decreases Expected
Losses......................................................................................................................4-39
Holders of Equity Investment at Risk Lose Power..............................................4-39
Bankruptcy..............................................................................................................4-39
Decision Maker or Service Provider Arrangements............................................4-40
4.4
4.3.2
4.3.3
4.3.4
4.3.5
4.3.6
Table of Contents / v
Chapter 5:
Identifying the Primary Beneficiary of a VIE
5.1
5.1.1
5.1.2
5.1.3
5.1.4
Identification of the Primary Beneficiary................................................................5-3

What Is a Primary Beneficiary?...............................................................................5-3
Power Criterion.........................................................................................................5-5
Losses/Benefits Criterion......................................................................................5-20
Identifying the Primary Beneficiary within a Related Party
GroupRelated Party Tie Breaker........................................................................5-23
5.2
Questions and Interpretative Responses.............................................................5-26
5.3
Examples.................................................................................................................5-28
Chapter 6:
Initial Consolidation and Subsequent Accounting
6.1
6.1.1
6.1.2
6.1.3
Initial Measurement and Consolidation..................................................................6-3

Initial Measurement upon Consolidation of a VIE..................................................6-3
Asset and Liability Transfers from the Primary Beneficiary to the VIE................6-4
Common Control.......................................................................................................6-4
6.2
6.2.1
6.2.2
6.2.3
Accounting after Initial Measurement.....................................................................6-5

Allocation of Losses to Noncontrolling Interest Holders......................................6-6
Elimination of Intercompany Profits........................................................................6-6
Deconsolidation........................................................................................................6-9
6.3
Chapter 7:
Presentation and Disclosure Requirements
7.1
7.1.1
7.1.2
7.1.3
Disclosure..................................................................................................................7-3
Disclosure Objectives...............................................................................................7-3
The Aggregation Principle.......................................................................................7-4
Specific Required Disclosures About VIEs.............................................................7-5
7.2
Presentation..............................................................................................................7-7
7.3
Information-out Scope Exception........................................................................7-8
7.4
Item 2.01 Form 8-K and Rule 3-05 Reporting Requirements................................7-9
7.5
Chapter 8:
Transition upon Adoption and Effective Date
8.1
8.1.1
8.1.2
8.1.3
8.1.4
8.1.5
8.1.6
Transition upon Adoption of the VIE Model as Amended by ASU 2009-17.........8-3

Initial ApplicationTransition Guidance.................................................................8-3
Fair Value and Unpaid Principal Balance Practicability Exception......................8-7
Deconsolidation........................................................................................................8-7
Fair Value Option.......................................................................................................8-9
Information-out Scope Exception......................................................................8-10
Treatment of Pre-existing Hedge Relationships upon Transition.......................8-10
vi / Table of Contents
8.1.7
8.1.8
Transitional Disclosure Requirements..................................................................8-12

SEC Considerations................................................................................................8-12
8.2
Effective Date..........................................................................................................8-13
8.3
Appendices
FASB Examples of Applying the By Design Model............................................ A-1
Detailed Steps to Navigate through the VIE Model under ASC 810.................... B-1
Technical References and Abbreviations.............................................................. C-1
Summary of Changes.............................................................................................. D-1
Table of Contents / vii
Executive Summary
Executive Summary / 1
Executive Summary
Recognizing that the application of voting control based consolidation accounting
models to certain types of entities and structures did not result in the most
meaningful financial presentation, the FASB created an accounting model to
specifically address variable interest entities or VIEs. Over time, the FASB has
made significant changes to the VIE consolidation model and is in deliberations
following the issuance of an exposure draft to further amend the model.
This fifth edition of our monograph provides the latest additional discussion and
examples on a number of emerging practice issues involving the accounting for
variable interest entities to consider in applying the model. The purpose of this guide
is to clarify a complex area of accounting by bringing together, in one publication, all
of the relevant PwC guidance on accounting for variable interest entities; to provide
an overall framework for the application of the VIE model; to highlight key questions
and answers; and to offer our perspectives, based on our analysis of the guidance
and experience in applying it.
The Consolidation Model for Variable Interest Entities in a Nutshell
Under GAAP, a reporting entity must consolidate any entity in which it has a
controlling financial interest. Under the voting interest model, generally the investor
that has voting control (usually more than 50 percent of an entitys voting interests)
consolidates the entity. Under the VIE model, the party that has the power to direct
the entitys most significant economic activities and the ability to participate in the
entitys economics consolidates the entity. This party could be an equity investor,
some other capital provider, or a party with contractual arrangements.
To determine which accounting model applies, and whichif anyparty must
consolidate a particular entity, a reporting entity must first determine whether the
entity is a voting interest entity or a variable interest entity. An entity is considered a
VIE if it possesses one of the following characteristics:
Characteristic 1The entity is thinly capitalized: Traditionally, it has been
presumed that the equity provided by residual equity holders is sufficient to support
the entitys operations. If the equity is not sufficient, voting power attributed to the
entitys equity holders (i.e., under the voting interest model) is not the only factor that
should be considered in a determination of who should consolidate the entity.
Characteristic 2Residual equity holders do not control the entity: The voting
interest model should not be applied if the residual equity holders cannot control the
entitys destiny. This runs counter to conventional economic thinking, which suggests
that the holder of an entitys residual equity should be in a position to control its
destiny.
Characteristics 3 & 4Equity holders are shielded from economic losses or do
not participate fully in an entitys residual economics: Conventional economic
thinking suggests that residual equity holders should not only enjoy the rewards
of owning an entity, but also be exposed to the risks of ownership. Such thinking
does not extend to contractual arrangements that shield equity holders from
losses associated with the entitys predominant risks or that either cap the return
on equity or allow the returns to be shared with other parties. In the case of such
arrangements, a reporting entity should not use the voting interest model to decide
which party consolidates the entity.
2 / Executive Summary
Characteristic 5The entity was established with non-substantive voting

interests: The guidance includes an anti-abuse clause that prevents the sponsor of
an entity from structuring or organizing it in a way that allows the sponsor to avoid
consolidation under the voting interest model. The anti-abuse clause requires a
two-part test. First, a reporting entity must determine if the distribution of economic
benefits generated by an entity is proportionate to equity ownership and voting
rights. If they are not proportionate, the reporting entity must determine whether
substantially all of the entitys activities either involve or are conducted on behalf
of a party that has voting rights disproportionately low relative to its economic
interest. When both conditions exist (i.e., the distribution of economic benefits is
disproportionate to equity ownership/voting rights and substantially all of the entitys
activities either involve or are conducted on behalf of a party with disproportionately
low voting rights), the entity is deemed a VIE and is subject to the risk and rewards
model.
Determining the Primary Beneficiary
The reporting entity that consolidates a VIE is the primary beneficiary of that entity.
A party consolidates a VIE when that party has a variable interest (or combination of
variable interests) that provides the party with a controlling financial interest. A party
is deemed to have a controlling financial interest if it meets both of the following
criteria:
Power criterionPower to direct activities of the VIE that most significantly impact
the VIEs economic performance.
Losses/benefits criterionObligation to absorb losses from or right to receive
benefits of the VIE that could potentially be significant to the VIE.
Variable Interest Entity Consolidation Analyses Are Not Static Events
The characterization of an entity as either a voting interest entity or a VIE can change
during the entitys life. This may result from changes in the entitys capital structure
and/or in its activities or assets. These changes are known as reconsideration
events. The reconsideration of a VIEs primary beneficiary, however, is not limited
to certain reconsideration events. Instead, a VIEs primary beneficiary is an ongoing
assessment.
Establishing Sound Policies and Procedures
Reporting entities must gain access to the terms of each entitys key contractual
arrangements, as well as be sure to understand the implications of those
arrangements. Such contractual arrangements include those that establish
governance practices and those that absorb economic gains and losses. Under
the voting interest model, some of these contractsincluding derivative contracts,
leases, royalty contracts, and licenseswere generally ignored in the consolidation
analysis. Since under the VIE model a reporting entity might have to consolidate
entities over which it does not have complete control over all activities, the reporting
entity must ensure that such contracts are considered during the informationgathering process.
The guidance in the VIE model will affect financial statements, as well as many other
things, including companies financial ratios, debt covenants, and credit ratings.
On the HorizonThe FASB / IASB Joint Consolidation Project

In November 2011, the FASB issued an exposure draft proposing changes to the
consolidation guidance for VIEs and partnerships that are not VIEs.
The proposal provided that a reporting entity that has a variable interest in a VIE and
decision-making authority would need to assess whether it uses its decision-making
authority to act in a principal or an agent capacity. A decision maker determined to
be an agent would not consolidate the entity. The principal versus agent analysis
would also be instrumental in determining if the entity is a VIE.
With respect to partnerships, the presumption that a general partner controls a
partnership that is a voting interest entity could be overcome by applying the same
principal versus agent assessment and determining that the general partner is using
its power in an agent capacity.
The proposal would rescind ASU 2010-10, Consolidation (Topic 810), Amendments
for Certain Investment Funds, which deferred application of the most recently
developed VIE model in ASC 810 for certain types of investment entities. The most
recently developed VIE model focuses on power and potentially significant economic
interests. Those entities subject to the deferral are currently continuing to apply
the prior VIE model which was based on absorbing a majority of risks and rewards.
The proposal could also impact the consolidation conclusion for other entities and
partnerships that were not subject to the deferral. The effective date has not been
determined.
The comment letter period ended in February 2012. The FASB is in the process of
re-deliberating many of the key aspects of the proposal. Consequently, significant
changes may be made before the standard is finalized, which is currently targeted for
the second half of 2013.
The IASB issued IFRS 10, Consolidated Financial Statements, in May 2011,
introducing new guidance on when investors will have to consolidate investees. The
key principle in IFRS 10 is that control exists, and consolidation is required, only if the
investor possesses power over the investee, has exposure to variable returns from its
involvement with the investee, and has the ability to use its power over the investee
to affect its returns. Although this definition of control is broadly consistent with the
control definition for VIEs that was introduced by the FASBs VIE model in ASC 810,
it applies to all entities, including entities that would be considered voting interest
entities under U.S. GAAP. In evaluating control, IFRS 10 also includes the principal
versus agent analysis that is similar to the one proposed by the FASB in November
2011. Consequently, if the FASB changes are adopted as proposed, IFRS and U.S.
GAAP consolidation guidance would be broadly aligned for VIEs although some
differences may exist.
Shortlist of Potential VIEs:

Transactions, Relationships and Structures
Leasing/Real Estate
Sale-leasebacks of real estate or equipment.
Built-to-suit real estate or equipment subject to an operating lease (e.g., office
buildings, manufacturing plants, airplanes).
Synthetic leases (lease structures that are treated as operating leases for
accounting purposes, even though for tax purposes the lessee is considered
the owner).
Certain partnerships in real estate investments.
Financial Assets
Transactions involving the sale/transfer of financial assets such as receivables
(e.g., factoring arrangements or securitizations) to SPEs.
Transactions involving a commercial paper conduit, such as sponsoring a
conduit to purchase and securitize assets from third parties.
Securitization transactions involving commercial debt obligations,
collateralized-bond obligations, and commercial-loan obligations.
Vehicles used to hedge off-balance sheet positions.
Start-ups, Research and Development
Funding arrangements for research and development.
Newly formed entities that are designed to manage or fund the start-up of a
new product or business.
Entities sponsored by venture capital reporting entities.
Reporting entities in the developmental stage.
Vendor Financing
Structures designed to help customers finance the purchase of products and
services (i.e., vendor financing), often in collaboration with a financial institution.
Insurance
Insurance associations (reciprocals).
Reinsurance securitizations.
(continued)

Transactions Involving Management, Officers and Employees
The transfer or sale of assets to an entity owned by a single employee or by
members of an entitys management.
Management of an unconsolidated asset or business by a reporting entity or its
officers.
Funding of an entitys independent equity by another reporting entitys
managing members.
Obligations Associated with Other Entities
Certain captive arrangements operated on behalf of an investor.
A reporting entitys guarantee of (i) an unconsolidated entitys performance or
debt or (ii) the value of an asset held by the unconsolidated entity (including
explicit and implicit guarantees).
A reporting entitys contingent liability should an unconsolidated entity default.
A transaction with an embedded put option that enables the entity or an
outside party to sell the assets and/or operations back to a reporting entity.
A transaction with an embedded call option that allows a reporting entity to
repurchase the assets and/or operations that were previously sold to another
entity.
A reporting entitys enhancement of another entitys credit (e.g., via escrow
funds, collateral agreements, discounts on transferred assets, take-or-pay
arrangements).
An agreement requiring a reporting entity to make a payment if its credit rating
is downgraded.
Rights to Assets
Rights to use an under construction asset not recorded in the reporting
entitys balance sheet (the debt used to fund the construction being recourse
only to that specific asset).
Leasing assets from an entity that financed these assets with debt that is
recourse to the individual asset rather than to all of the lessor entitys assets.
The transfer of financial assets to an entity subject to debt that is recourse only
to those financial assets rather than to all of the entitys assets.
Variable lease payments, variable license-fee payments, or other variable
payments for the right to use an asset (e.g., the payments change with
fluctuations in market interest rates).
Ownership of an asset that a reporting entity holds for tax purposes but does
not record on its balance sheet.
(continued)

Other
Sale of assets or operations where the seller retains some governance rights
and/or an economic interest.
The purchase of businesses or assets by a third party or a newly formed entity
on behalf of another company (i.e., an off-balance-sheet acquisition vehicle).
Investments made through intermediaries in entities that generate losses from a
financial-reporting perspective.
Tolling arrangements with project finance companies.
Transactions in which a reporting entitys primary counterparties are financial
institutions (e.g., banks, private equity funds, insurance companies).
Arrangements with an entity whose capital structure (often the equity) is partially
owned by (or provided by) a charitable trust.
An unconsolidated entity whose name is included in the reporting entitys name.
When a reporting entity provides administrative or other services on behalf of an
unconsolidated entity or services its assets.
When an unconsolidated entity provides financing or other services exclusively
to a reporting entity, its vendors or customers.
Chapter 1:
Definition of Key Terms
Definition of Key Terms / 1 - 1
Executive Takeaway
There are several terms and concepts that are important to understand before
attempting to apply Variable Interest Entities Subsections of FASB Accounting
Standards Codification 810, Consolidation (the VIE model). Many of these
concepts necessitate a different way of thinking and make the guidance a
challenge to understand and apply.
Expected losses and expected residual returns are not GAAP losses and returns.
The primary beneficiary is the party required to consolidate a variable interest
entity.
Shared power is when power to direct activities that are most significant to the
entitys economic success is shared among non-related variable interest holders
and decisions with regard to these activities require the consent of each of the
parties sharing power.
The identification of related parties and de facto agents is critical in evaluating
entities under the VIE model.
1 - 2 / Definition of Key Terms
Chapter 1: Definition of Key Terms

1.1 Voting Interest Entity

Although the term voting interest entity is not defined in the VIE model, it has
emerged in the accounting practice as a term meaning an entity that is not a variable
interest entity (VIE). In a voting interest entity, the equity investment is deemed
sufficient to absorb the expected losses of the entity, and the equity investment has
all of the characteristics of a controlling financial interest. As a result, voting rights
are the key driver for determining which party, if any, should consolidate the entity. All
entities that are not VIEs (and therefore meet the definition of voting interest entities)
are subject to consolidation guidance in the other (not variable interest entity)
subsections of ASC 810, Consolidation (ASC 810).
1.2 Variable Interest Entity

A VIE is an entity subject to the VIE model discussed in ASC 810. This model
identifies the party, if one exists, that possesses a controlling financial interest in a
VIE and is required to consolidate it. A VIE is defined as follows:
Excerpt from ASC 810-10-20:
Variable interest entity refers to a legal entity subject to consolidation
according to the provisions of the Variable Interest Subsections of
Subtopic 810-10.
A VIE is an entity that by design possesses the following characteristics:
The equity investment at risk is not sufficient for the entity to finance its activities
without additional subordinated financial support; or
As a group, the holders of equity investment at risk do not possess:
1. The power, through voting rights or similar rights, to direct the activities that
most significantly impact the entitys economic performance; or
2. The obligation to absorb expected losses or the right to receive the expected
residual returns of the entity; or
3. Symmetry between voting rights and economic interests and where
substantially all of the entitys activities either involve or are conducted
on behalf of an investor with disproportionately fewer voting rights (e.g.,
structures with nonsubstantive voting rights).
A VIE is different from a voting interest entity because it is designed in a manner
where voting rights held by equity holders are ineffective in determining which
party has a controlling financial interest in the entity. The VIE model is based on
the fundamental concept that the voting interest model may not identify the party
with the controlling financial interest in a VIE, because control of an entity may be
achieved through arrangements that do not involve voting equity.
1.3 Primary Beneficiary

A primary beneficiary is defined as follows:
Primary beneficiary refers to an entity that consolidates a variable
interest entity.
The primary beneficiary of a VIE is the variable interest holder (e.g., a contractual
counterparty or capital provider) deemed to have the controlling financial interest(s) in
the VIE and therefore must consolidate it. The primary beneficiary is not necessarily
the party with the majority or even any of the voting interests in an entity. Rather, the
primary beneficiary is the reporting entity (or member of a related party groupsee
VE 5.1 for more details) that has both of the following characteristics:
a. the power to direct the activities that most significantly impact the VIEs
economic performance; and
b. the obligation to absorb losses or the right to receive benefits that could
potentially be significant to the VIE.
Note that a primary beneficiary need not be a legal entity. For example, an individual
that holds a variable interest in an entity may be its primary beneficiary.
The most recent amendments to the VIE model introduced a new termshared
power in the evaluation of the primary beneficiary.
Excerpt from ASC 810-10-25-38D:
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 power is shared with other unrelated parties such that no one party has the power
to direct activities that most significantly impact the VIEs economic performance,
then the reporting entity is not deemed to be the primary beneficiary.
VE 5 discusses in detail the analysis involving the identification of the primary
beneficiary of a VIE.
1.4 Variable Interest

A variable interest is an accounting term used in the VIE model to describe any
contractual or sometimes implied relationship that a reporting entity has with a VIE
that shares in the VIEs risks and rewards. A variable interest could be in many forms,
but is commonly an investment in, financing provided to, or monetary arrangement
with a VIE. However, there are more unconventional relationships with a VIE that may
be variable interests (e.g., certain service contracts). A variable interest is defined as
follows:

Variable interests are 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. 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 entitys 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 explains in general how they may affect the
determination of the primary beneficiary of a VIE.
The identification of a variable interest represents one of the more challenging
aspects of the VIE model. This is highlighted in ASC 810, as follows:
Excerpt from ASC 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 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 entitys variabilitythat
distinguishes a variable interest. That role, in turn, often depends on the
design of the legal entity.
It is the changes in the cash flows generated by certain interests that drive the
success or failure of the entity, thus creating the variability in the entity. Most forms
of financing or capital (including guarantees and some derivative instruments) absorb
variability of an entity. The return to the creditor or capital provider is dependent
upon the success or failure of the interests described above (those that create the
variability), thus these interests absorb the variability of the entity. Only those
interests that absorb the variability of the entitys cash flows are considered variable
interests.
A simple example of a contractual relationship that absorbs an entitys variability
is an equity investment in the entity. The equity investment absorbs some or all
of the changes in the fair value of the entitys assets (its variability). If the entity
generates poor operating cash flows (below expectations), the holder of that equity
investment will receive a lower return on its investmentthus absorbing some of the
negative variability in the entity. Although this example is relatively straightforward,
distinguishing between economic interests that create or absorb variability can
be challenging. This is especially true when evaluating entities with complex
capital structures, various service or management agreements, and/or derivative
instruments.
Refer to VE 3 for a detailed discussion of variable interests.
1.5 Subordinated Financial Support

Subordinated financial support is defined as follows:
Subordinated financial support refers to variable interests that will
absorb some or all of a variable interest entitys (VIEs) expected losses.
An equity investment in a VIE would be considered a form of subordinated financial
support because it often provides the VIE with subordinate financing, thus absorbing
at least some amount of the entitys expected losses (or negative variability).
Other forms of subordinated financial support would include loans to the entity;
commitments to fund an entitys operations; certain guarantees on an entitys assets;
as well as certain derivative instruments. Depending on the facts and circumstances,
other economic interests in an entity may meet the definition of subordinated
financial support (such as certain service/management contracts).
1.6 Expected Losses and Expected Residual Returns

While the earlier VIE model (prior to the amendments in Accounting Standards
Update No. 2009-17, Consolidations (Topic 810)Improvements to Financial
Reporting by Enterprises Involved with Variable Interest Entities (ASU 2009-17))
used a risks and rewards model to determine the primary beneficiary of a VIE, the
VIE model as amended by ASU 2009-17 focuses on the power and losses/benefits
criteria to determine the primary beneficiary of a VIE. Therefore, the expected losses
and expected residual returns concept is not as significant under the VIE model as
amended by ASU 2009-17. However, there are still some provisions in the VIE model
as amended by ASU 2009-17 that refer to the expected losses and expected residual
returns concept. Therefore, it is helpful to understand these concepts and how they
are interpreted.
Expected losses and expected residual returns as well as expected variability are
defined as follows:
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 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.
The definition of expected losses and expected residual returns is further defined as
follows:
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 losses are not the GAAP losses that are expected to be incurred by the
entity; and expected residual returns are not the GAAP income that is expected to
be earned by the entity. Rather, they are statistical measures of the variability (or risk)
inherent in the fair value of a particular entity.
Many reporting entities have mistakenly assumed that entities that generate only
net income (i.e., entities that do not expect to incur GAAP losses) would not have
expected losses. That logic is flawed since expected losses do not reflect the
anticipated amount of variability of net income or loss, but rather the negative
variability in the fair value of an entitys net assets. This point is clarified in the
definition of expected losses as included in the excerpt above.
Generally speaking, the riskier the activities (or the assets) of the entity, the greater
the expected losses and expected residual returns. All entities have expected losses
and expected residual returns since there is at least some level of risk associated
with their activities.
ASC 810-10-55-42 through 55-49 demonstrates the calculation of an entitys
expected losses and expected residual returns (included below), using the presentvalue methodology, as described in CON 7. The cash flow modeling approach used
in CON 7 requires a determination of expected cash flows by considering multiple
cash flow scenarios and the inherent uncertainty as to the timing and amount of
those cash flows. Possible cash flow scenarios are to be identified, along with the
relative probability of each scenario occurring. The probability-weighted cash flow
estimates are then discounted using an appropriate discount rate to arrive at their
present values. Using this approach, the present value of the total expected cash
flows associated with those assets should equal their fair value.
The determination of the appropriate discount rate requires judgment. Under the
CON 7 model, the FASB indicated that the individual cash flows should be explicitly
adjusted for the risk of uncertainty and discounted back using the risk-free rate.
However many traditional valuation techniques do not involve adjustments to each
cash flow scenario to account for the risk of uncertainty. Instead, many valuation
experts utilize a weighted-average cost of capital because this discount rate
considers the uncertainty in the entitys cash flows. We believe that clients should
consider consulting with designated PwC valuation specialists when faced with
such decisions. These two methods are further described in ASC 820, Fair Value
Measurements and Disclosures (ASC 820).

1.6.1 Simple Illustration for Calculating Expected Losses and Expected

ResidualReturns
The example includes the following assumptions:
a. A single party holds all of the beneficial interests in the VIE, and
the VIE has no liabilities
b. There is no decision maker because the VIEs activities are
completely predetermined
c. All cash flows are expected to occur in one year or not to occur at
all
d. The appropriate discount rate (the interest rate on risk-free
investments) is 5 percent
e. No other factors affect the fair value of the assets. Thus, the
present value of the expected cash flows from the pool of
financial assets is assumed to be equal to the fair value of the
assets.
A set of six possible (or estimated) cash flow scenarios are illustrated. Each of these
scenarios is probability weighted, the sum of which represents the entitys expected
cash flows. From the illustration below, the entitys expected cash flows are
$795,000 (the present value of those expected cash flows is $757,143).
(Amounts in Thousands)
Estimated Cash
Flows
$650,000
700,000
750,000
800,000
850,000
900,000
Probability
5.0%
10.0
25.0
25.0
20.0
15.0
Expected Cash
Flows
$ 32,500
70,000
187,500
200,000
170,000
135,000
Fair Value
$ 30,952
66,667
178,571
190,477
161,905
128,571
100.0%
$795,000
$757,143
For each scenario where the estimated cash flow is less than the expected cash flow
of the entity, there is an expected loss. For example, from the illustration below, in the
first scenario the estimated cash flows are $650,000 and the expected cash flows of
the entity are $795,000, resulting in negative deviation in that scenario of $145,000.
When probability-weighted and present-valued, the expected loss generated by the
first scenario is $6,905. The sum of all of the scenarios in which the estimated cash
flows are less than the expected cash flows equals the total expected losses of the
entity ($26,667).
Estimated
Cash Flows
$650,000
700,000
750,000
800,000
850,000
900,000
Expected
Cash Flows
$795,000
795,000
795,000
795,000
795,000
795,000
Difference
Estimated
(Losses)
Residual
Returns
$(145,000)
(95,000)
(45,000)
5,000
55,000
105,000
Probability
5.0%
10.0
25.0
25.0
20.0
15.0
100.0%
Expected
Losses
Basedon
Expected
Expected Losses Based
Cash Flows on Fair Value
$ (7,250)
$ (6,905)
(9,500)
(9,048)
(11,250)
(10,714)
$(28,000)
$(26,667)
The same calculation is performed for the expected residual returns, only using the
scenarios where the estimated cash flows are greater than the expected cash flows.
For example, from the illustration below, the entitys expected residual returns are
calculated as $26,667. It is no coincidence that these two amounts are equivalent,
since an entitys expected losses will always equal its expected residual returns as a
result of this calculation.
Estimated
Cash Flows
$650,000
700,000
750,000
800,000
850,000
900,000
Expected
Cash Flows
$795,000
795,000
795,000
795,000
795,000
795,000
Difference
Estimated
(Losses)
Residual
Returns
$(145,000)
(95,000)
(45,000)
5,000
55,000
105,000
Probability
5.0%
10.0
25.0
25.0
20.0
15.0
100.0%
Expected
Residual
Return
Basedon
Expected
Cash Flows
Expected
Residual
Return
Basedon
FairValue
$ 1,250
11,000
15,750
$ 28,000
$ 1,191
10,476
15,000
$ 26,667
While the CON 7 methodology is outlined as the model for calculating an entitys
expected losses and expected residual returns, it is not the only acceptable method.
Since expected losses and expected residual returns are calculated based on how
widely potential future outcomes differ from the expected outcome, expected losses
can be calculated using the value of a put option written on the value of an asset
(or group of assets). The volatility related to the expected outcome can usually be
calculated by reference to readily available capital-market information relating to
asset values and may be preferable to subjectively determined distributions of future
value under the CON 7 methodology.
There is little guidance on how a reporting entity would derive the cash flow
estimates necessary to perform these calculations. It is clear that the first step for a
reporting entity is to identify the variable interests in the entity. Variable interests in
an entity are those assets, liabilities, or equity that absorb an entitys variability. For
purposes of the expected loss calculation, net assets of the entity are those assets
and liabilities that create variability in the entity and thus are not variable interests.
It is the riskiness of the cash flows inherent in the fair value of these net assets that
drive the calculation of an entitys expected losses and expected residual returns.
The estimated cash flows of the entity should not include payments that are made
to variable interest holders (i.e., absorbers of the entitys variability). For example,
Partnership X borrows money from Bank Y. Assume the debt is a variable interest.
Partnership Xs estimated cash flows should not include interest or principal
payments to Bank Y for purposes of calculating the entitys expected losses and
expected residual returns.
Another nuance to these calculations is excluding variable interests in specified
assets. Any variable interests in specified assets of an entity that are not variable
interests in the entire entity should also be identified. Expected losses absorbed
and expected residual returns received by variable interests in specified assets are
generally excluded from the entitys calculation of expected losses and expected
residual returns. This concept is discussed in VE 3.

1.7 Related Parties and De Facto Agents

Excerpt from ASC 810-10-25-42 through 25-43:
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.
For purposes of the Variable Interest Entities Subsection, 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. 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
b. A party that received its interests as a contribution or a loan from
the reporting entity
c. An officer, employee, or member of the governing board of the
reporting entity
d. 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.
e. A party that has a close business relationship like the relationship
between a professional service provider and one of its significant
clients.
Related-party and de facto agency relationships can play a critical role in the VIE
model in two ways: (i) the determination of whether the entity is a VIE, and (ii) the
determination of a VIEs primary beneficiary, if one exists. As noted above, for the
purposes of the VIE model, the related-party definition includes de facto agency
relationships.
Related parties are defined as follows:
Excerpt from the ASC Master Glossary:
Related parties include:
a. Affiliates of the entity
b. Entities for which investments in their equity securities would
be required, absent the election of the fair value option under
the Fair Value Option Subsection of Section 825-10-15, to be
accounted for by the equity method by the investing entity
c. Trusts for the benefit of employees, such as pension and profitsharing trusts that are managed by or under the trusteeship of
management
d. Principal owners of the entity and members of their immediate
families
e. Management of the entity and members of their immediate
families
f. 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
g. 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.
A reporting entity, along with its affiliates, employees, agents and other related
parties, may collaborate to create and manage a VIE. In expanding the definition of
related parties in the VIE model to include de facto agency relationships, the intent
was to prevent a variable interest holder from avoiding consolidation of a VIE by
protecting its interest(s) or indirectly expanding its holdings through related parties
or de facto agents. It is important to understand this rationale when evaluating the
related-party guidance in the VIE model, as the application of this guidance will often
necessitate judgment on the part of preparers and auditors.
While the definition of a related party is well established, the concept of de facto
agents is unique and merits further discussion. Some of the de facto relationships
in the VIE model are relatively straightforward. Parties are deemed de facto agents
of a reporting entity if they (a) are financially dependent on the enterprise; (b) receive
the investment or the funds to make the investment from the enterprise; or (c) are an
officer, employee or on the governing board of the enterprise.
Under the VIE model, a de facto agency relationship is created when a party cannot
sell, transfer, or encumber their interests without the approval of the reporting entity
(often referred to as transfer restrictions). However, mutual transfer restrictions do
not cause a de facto agency relationship if they are based on mutually agreed terms
by willing, independent parties. A de facto agency relationship is also created when
a party provides significant amounts of professional services or other similar services
to a reporting entity (significant service provider). De facto relationships due to
transfer restrictions and significant service provider relationships are more difficult to
apply and necessitate judgment on the part of both preparers and auditors.

1.7.1 Transfer Restrictions

A reporting entity could avoid consolidation of a VIE by parking its interests with
a third party and control that partys actions by restricting its ability to sell, transfer
or encumber its interest. We believe that the FASBs rationale was to identify these
situations and other situations where the restricted party (the party that must obtain
approval) is acting as an agent or de facto agent on behalf of another enterprise or in
the case of cross transfer restrictions may act in concert. The FASB acknowledged
that the identification of these types of situations would be heavily dependent on
particular facts and circumstances and that judgment is required in assessing the
substance behind the approval rights contained in a particular agreement.
Whether or not transfer restrictions create a de facto agency relationship under the
VIE model is dependent mainly on two factors: (a) whether or not the restricted
party has the ability to realize (or manage) its economic interest in the entity and (b)
the reasons and economic rationale behind the restrictions placed on that party. The
FASB believes that a party possesses the ability to manage its economic interest if
the party has the right to sell, transfer or encumber its interest in that entity without
prior approval. If a party has any of these rights, a de facto agency relationship would
not exist. For example, if a party has the right to sell its interest without prior approval
but must obtain such approval to transfer or encumber that interest and, it is feasible
that such party has the ability to realize its economics through a sale, no de facto
agency relationship would exist. As mentioned previously, mutual transfer restrictions
do not cause a de facto agency relationship if they are based on mutually agreed
terms by willing, independent parties. This exception to the de facto agency concept
for transfer restrictions may prove helpful for many joint venture arrangements that
are determined to be VIEs. Many joint ventures include mutual transfer restrictions.
Without providing relief in situations whereby there are mutual transfer restrictions,
even if the joint venture partners were determined to have shared power, one of the
parties would have been required to consolidate the entity. This result seemed to be
inconsistent with the notion that no party should consolidate if there is shared power.
As a result, the FASB provided an exception from the definition of de-facto agency
relationships for mutual transfer restrictions.
Regarding the economic rationale behind the transfer restrictions, if the approval
rights over the sale of the interest are merely to prevent the party from selling its
interest to a competitor or to a less creditworthy (or otherwise less qualified) holder
and there are a sufficient number of non-competitive or creditworthy buyers, the
restriction would not necessarily create a de facto agency relationship. For example,
a franchise agreement between the franchisee and the franchisor gives the franchisor
the right to approve the sale of the franchise. If the transfer restriction is designed to
prevent the sale of the franchise to a less-than-creditworthy buyer, it would normally
not create a de facto agency relationship, provided there are sufficient creditworthy,
potential buyers of the franchise. In practice, the economic rationale of the approval
rights or transfer restrictions may not always be evident, and considerable judgment
will be involved.
Care should be used when evaluating whether a restricted party truly has the means
to realize the economics associated with its interest in the entity. If a restricted
party has the right to encumber its interest in the entity without prior approval, but
due to market factors, can only borrow against a small percentage of the interests
fair value (say, below 80 percent of its value), it would be difficult to conclude that
the restricted party has the ability to realize the economics of its interest. We believe
an appropriate comparison is the one described in ASC 860, Transfers and Servicing
(ASC 860), which reads as follows:
Many transferor-imposed or other conditions on a transferees right
to pledge or exchange both constrain a transferee from pledging or
exchanging and, through that constraint, provide more than a trivial
benefit to the transferor. Judgment is required to assess whether a
particular condition results in a constraint. Judgment also is required to
assess whether a constraint provides a more-than-trivial benefit to the
transferor. If the transferee is an entity whose sole purpose is to engage
in securitization or asset-backed financing activities, that entity may be
constrained from pledging or exchanging the transferred financial assets
to protect the rights of beneficial interest holders in the financial assets
of the entity. Paragraph 860-10-40-5(b) requires that the transferor look
through the constrained entity to determine whether each third-party
holder of its beneficial interests has the right to pledge or exchange the
beneficial interests that it holds. The considerations in paragraphs 86010-40-16 through 40-18 apply to the transferee or the third-party holders
of its beneficial interests in an entity that is constrained from pledging or
exchanging the assets it receives and whose sole purpose is to engage
in securitization or asset-backed financing activities.
If the restricted party has the ability to obtain all or most of the cash flows associated
with its interest in the entity without prior approval, there is no substantive transfer
restriction for purposes of this analysis.
Preparers and auditors should consider involving internal and external legal counsel,
as well as the appropriate level of company management when assessing the
design of these rights/restrictions.
Many questions have been raised in practice with regard to how the phrase without
the prior approval of the enterprise should be applied in practice. For example,
should transfer restrictions be applied generically to any circumstance whereby
an approval right exists (regardless of its effect), or should one look at the level of
approval required? There is no single answer and the determination depends upon
the specific facts and circumstances.

1.7.1.1 Rights of First Refusal

A right of first refusal exists in many arrangements and requires a variable interest
holder to provide notice to another variable interest holder setting forth the price and
payment terms for which a transferred interest is proposed to be sold. The nontransferring variable interest holder would have the right and option to purchase the
transferring variable interest holders interest at the same price. We believe that a right
of first refusal does not create a de facto agency relationship because the variable
interest holder is not constrained from managing its economic interest in the entity.

1.7.1.2 Rights of First Offer

In many circumstances, a right of first offer may exist that would require a variable
interest holder to first offer to transfer its interest to another variable interest holder
prior to selling it to a third party. Under these circumstances, the holder of the right of
first offer would have the ability to bid to purchase the sellers interest at a price. The
seller can decide to accept or reject such bid; however, it cannot sell its interest to
another party at a price lower than the price bid by the holder of the right of first offer.
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 constrained from managing its economic interest in the entity.
1.7.1.3 Approval that Cannot be Unreasonably Withheld

A party may have an agreement that it cannot sell, transfer, or convey its interest
in the entity without the prior approval of the enterprise, and such approval cannot
be unreasonably withheld. At issue is whether such a clause requiring approval that
cannot be unreasonably withheld would result in a de facto agency relationship.
As with any other transfer restriction, we believe there is a rebuttable presumption
that such provisions create a de facto agency relationship. A reporting entity can
overcome that presumption if (1) legal counsel can conclude that the approval right
would not prevent the restricted party from selling its interest to a qualified or other
third party (specifically considering the specific reasons for which approval can be
withheld) and (2) there are a sufficient number of such qualified buyers to provide a
non-restricted market.
1.7.1.4 Lock up Periods

In certain agreements, the variable interest holders in an entity may be precluded
from selling, transferring, or pledging its interest for a particular time period. For
example, consider a fact pattern where Party A and Party B each own 50 percent
of the equity in Entity X. Party A and Party B have entered into an arrangement
whereby during the first 5 years, Party B is precluded from selling, transferring, or
encumbering its interest in the entity. In this fact pattern, we believe that Party B is
a de-facto agent of Party A because while there may not be explicit prior approval
required, we believe there are implicit approval rights since in the fact pattern, Party
B would need to renegotiate with Party A in order to have the right to dispose of its
interest. Once the lock-up period expires, the variable interest holders are no longer
considered de-facto agents which might result in a change in the primary beneficiary
conclusion. Note that in instances where there are several investors who may be
precluded from selling, transferring, or pledging their interest in an entity but are
represented on the board, no single party controls the board and decision-making
at the board is by majority vote, the lock-up provision would not generally cause the
investors to be considered as de facto agents.
1.7.2 Close Business Relationship

Determining whether a service provider is acting as a de facto agent of a reporting
entity can also be difficult and will depend on the facts and circumstances present
in each situation. This provision is necessary to prevent enterprises from avoiding
consolidation by parking interests with a service provider, such as a lawyer or

investment bank.
In the past, enterprises often worked with financial intermediaries (e.g., investment
banks) to create financing vehicles that were accounted for as off balance sheet
structures. The intermediary (or an affiliate thereof) might have decision-making
abilities related to that entity through its service contract. We believe that the Boards
inclusion of close business relationships as de facto agency relationships was
intended to address these types of relationships by preventing situations in which
a portion of a reporting entitys variable interest could contractually be transferred
from a reporting entity to a financial advisor, a law firm, or other service provider, in
an attempt to avoid consolidation of the entity. Reporting entities evaluating these
relationships should consider the following factors (which are not meant to be allinclusive):
Was the service provider involved with the formation of the entity?
Is the service provider merely acting as an intermediary between the reporting
entity and the entity?
Is there a round-trip transaction through the service provider?
In addition, in a speech to the 2008 AICPA National Conference on Current SEC and
PCAOB Developments, Robert Malhotra of the SEC Staff stated the following, which
further elaborates key principles of the close business relationship concept:
the staff believes that close business associates may only be
considered related parties if one party can control or can significantly
influence the other party to an extent that one of the parties might be
prevented from fully pursuing their own separate interest should that
party choose to do so. That being the case, the mere past practice
or future intent of close business associates to collaborate would be
insufficient to conclude the parties are related.

1.8 Kick-Out Rights, Participating Rights and Protective Rights

The VIE model introduced new definitions for kick-out rights and participating
rights that are different than the definitions of such rights that are applicable to
consolidation evaluations under the voting interest entity model.
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.
It is important to note that both kick out rights and participating rights are defined
differently under the VIE model than they are in applying the voting interest entity
model. For example, approval of an operating budget is a participating right under
the voting model but may not be considered a participating right under the VIE
model if such right is not considered a right that most significantly impacts the
entitys economic performance. Further, we believe that protective rights under the
VIE model are the opposite of participating rights and include any rights to block the
actions of an enterprise that are not considered participating rights. Said another
way, we believe protective rights are the ability to block the actions through which
an enterprise exercises the power to direct the activities of a variable interest entity
that do not most significantly impact the entitys economic performance. The VIE
model clarifies that protective rights should not be considered in assessing whether
an enterprise has the power to direct activities that most significantly impact a VIEs
economic performance. Determining whether rights are protective or participating
may involve significant judgment. For example, depending upon the facts, rights that
are protective in the case of one entity may not be protective in the case of another
entity. See VE 5.1 for more details.
Under the VIE model, only substantive kick-out and participating rights that can
be unilaterally exercised by a single party (including related parties and de facto
agents) should be considered in determining which enterprise, if any, is the primary
beneficiary of a VIE and whether an enterprise has the power to direct activities that
most significantly impact a VIEs economic performance.

1.9 Substantive Terms, Transactions, and Arrangements

The VIE model introduced the notion that only substantive terms, transactions and
arrangement should be considered for purposes of applying this model as follows.
Excerpt from ASC 810-10-15-13(A):
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. A legal entitys status as a VIE
b. A reporting entitys power over a VIE
c. A reporting entitys obligation to absorb losses or its right to
receive benefits of the legal entity
Excerpt from ASC 810-10-15-13(B):
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.
Chapter 2:
Scope and Scope Exceptions
Scope and Scope Exceptions / 2 - 1
Executive Takeaway
The variable interest entity consolidation model typically only applies when the
reporting entity has a variable interest in a legal entity.
There is no blanket scope exception for entities that meet the definition of a
business. The business scope exception contains a number of requirements which
are often difficult to meet.
The VIE model eliminated the scope exception for reporting entities with interests
in qualifying special purpose entities.
Other scope exceptions exist for certain not-for-profits, certain employee
benefit plans, certain governmental organizations, as well as certain investment
companies.
The FASB deferred the VIE model as amended by ASU 2009-17 for certain
investment entities that have the attributes of entities subject to ASC 946 (the
investment company guide). The deferral also applies to registered money
market funds as well as all other (unregistered) funds that operate in a similar
manner as registered money market funds. For these entities subject to the
deferral, the pre-amended VIE model consolidation analysis (formerly FIN 46(R))
should be applied.
The FASB is currently in the process of re-deliberating a proposal that would
remove the deferral of the VIE model as amended by ASU 2009-17 (FAS 167) for
investment companies. A final standard is expected in the second half of 2013.
2 - 2 / Scope and Scope Exceptions
Chapter 2: Scope and Scope Exceptions

This chapter provides an overview of the types of entities that are within the scope
of the Variable Interest Entities Subsections of ASC 810-10, ConsolidationOverall
(the VIE model). Critical to this assessment is (1) whether or not the variable interest
held is in a legal entity and (2) whether or not that legal entity has been specifically
scoped out of the VIE model. There are very few exceptions, and, unless specifically
scoped out, all entities must be evaluated under its provisions. It is important to note
that with the issuance of ASU 2009-17 the FASB eliminated the scope exception
for qualifying special purpose entities (QSPEs) that was previously available. As a
result, QSPEs and their affiliates are no longer scoped out of the VIE model. The
FASB deferred the VIE model as amended by 2009-17 for certain investment entities
that have the attributes of entities subject to ASC 946. This deferral also applies to
registered money market funds as well as all other (unregistered) funds that operate
in a similar manner as registered money market funds. See VE 2.3 for more details.

2.1 Definition of an Entity

In general, the VIE model applies to all legal entities, regardless of whether the
entity is a special purpose entity (SPE). The definition of a legal entity and certain
clarifications as applicable to the VIE model are as follows:
Excerpt from ASC Master Glossary:
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.
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
subsections and may be VIEs.
The definition of legal entity includes all legal structures established to manage or
administer activities of any kind or to hold assets or liabilities. Many people fail to
realize the broad applicability of this concept. For example, the following types of
entities would all qualify as entities under the VIE model:
Corporations
Partnerships
Other unincorporated entities
Limited liability companies
Grantor trusts
Other trusts
The VIE model applies to legal entities that are used to conduct activities or to hold
assets. It does not apply to arrangements between individuals. Concluding that an
arrangement involves a legal entity necessitates evaluating the relevant facts of the
transaction. Following are examples that illustrate the importance of evaluating all of
the facts prior to concluding that the guidance in the VIE model does not apply:
A franchise agreement may be entered into between the franchisor and an
individual. This arrangement does not fall within the scope of the VIE model. On
the other hand, if the franchise agreement is between the franchisor and a legal
entity (e.g., a corporation, partnership, LLC, or unincorporated entity), that entity
falls within the scope of the VIE model.
In the insurance industry, it is common practice to use syndicates to accept
insurance business on behalf of the members of the syndicate. Depending on the
legal form of the structure, some syndicates may fall within the scope of the VIE
model, since the activities take place in a legal entity (e.g., a partnership), while
other syndicates may be scoped out of these subsections because there is no
legal form in which they conduct their underwriting activities.
Following are factors that may be considered when evaluating whether a structure is
a legal entity:
Does the structure meet the definition of a legal entity in the resident country?
If not, does the structure have characteristics similar to those of a legal entity
in the U.S. For example, does the unincorporated foreign joint venture have
characteristics similar to those of a U.S. partnership or LLC?
Is the structure/entity permitted to enter into contracts under its own name (i.e.,
not in the name of the partners or parent company)?
Can the structure sue or be sued in its own name?
Is the liability of the partners limited or do the liabilities of the structure flow
through to the partners?
Is the structure recognized for tax purposes? Is a tax return filed in the structures
name?
Is the structure able to open a bank account in its own name?
Prior to assessing these factors, it may be necessary to seek the legal advice of an
attorney to fully understand the characteristics of the structure (i.e., to understand
what the structure can and cannot do). Additionally, it is possible that one indicator
may not be conclusive in evaluating that the entity is in fact, a legal entity. Therefore,
all of the factors should be considered.
Virtual SPEs (divisions, departments, branches, or pools of assets subject to
liabilities that are otherwise nonrecourse to the reporting entity) are excluded from the
scope of the VIE model because they are not separate legal structures from the entity
that holds title to the assets. However, there are certain rules that may require virtual
SPEs or silos to be consolidated. Silos are discussed in more detail in VE 3.6.
Majority-Owned or Wholly-Owned Subsidiaries
Even a wholly- or majority-owned subsidiary (that is, a legal entity separate from the
parents legal entity) is subject to the VIE model and may be a variable interest entity
(VIE). If the subsidiary is a VIE, it is possible that a reporting entity, other than the
subsidiarys legal parent, may be required to consolidate it. In this case, the owner of
a majority (or all) of the voting rights may be required to deconsolidate its subsidiary.
Consider the following example:
Reporting Entity A holds a majority of the voting rights of Entity XYZ and had
appropriately consolidated Entity XYZ pursuant to the voting interest guidance in
ASC 810-10.
Entity XYZ entered into certain contractual arrangements with Reporting Entity B
that transfer to Reporting Entity B certain risks and rewards relative to all of the
activities of Entity XYZ.
Reporting Entity B has not made any equity investments in Entity XYZ.
Since consolidated subsidiaries are not exempt from the VIE model, the parent and
other parties that hold interests in Entity XYZ must determine whether it is a VIE. It
does not matter whether or not Reporting Entity B has any equity investment in Entity
XYZ. Therefore, Reporting Entity A and Reporting Entity B must re-evaluate whether
either reporting entity should consolidate Entity XYZ. This situation represents an
example of how the analysis of consolidation accounting regarding any entity must
begin with the VIE model. The other subsections in ASC 810 would apply only after
concluding that Entity XYZ is not a VIE subject to the scope of the VIE model.

2.2 Scope Exceptions

The VIE model provides for certain scope exceptions. Although these scope
exceptions appear straightforward, we believe that their application necessitates
thoughtful judgment and consideration. The reporting entity must continually assess
whether or not it still qualifies for the scope exceptions.
2.2.1 The So-Called Business Scope Exception

One of the more confusing aspects is determining whether the VIE model applies
to an entity that meets the definition of a business. The VIE model provides the
following scope exception (the business scope exception) for reporting entities with
variable interests in an entity:
Excerpt from ASC 810-10-15-17(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.
(continued)
2. 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.
3. 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.
4. The activities of the legal entity are primarily related to
securitizations or other forms of asset-backed financings or
single-lessee leasing arrangements.
The objective of the VIE model is to provide guidance to address situations where
the voting interest approach is not effective in identifying a party that has a
controlling financial interest in an entity. The Board was specifically opposed to
a scope exception for all businesses, citing that such a distinction was contrary
to the principle underlying the VIE model. Therefore, an assumption that these
subsections provide a scope exception to all businesses is not correct and
many entities that are businesses may be VIEs.
We believe that the objective of the business scope exception is to allow reporting
entities to avoid applying the VIE model to entities when it is unlikely that the
reporting entity would be required to consolidate the entity (as the primary
beneficiary) even if the entity is a VIE. The Board considered the most useful way to
provide this aid to implementation would be in the form of a scope exception, that
is, in a list of conditions that, if met, would obviate the need for further analysis and
application of this guidance.
The criteria in the business scope exception focus on the relationships between
the reporting entity and the entity, rather than on whether the entity has the
characteristics of a VIE, as specified in ASC 810-10-15-14. Each reporting entity
with an interest in the entity will separately need to evaluate its own relationships
with the entity. The fact that one reporting entity concludes that it is eligible for the
business scope exception does not provide a basis for any other entity to conclude
that the entity is not a VIE. In fact, one reporting entity may conclude that it meets
the business scope exception, while another entity may not be eligible for the scope
exception and may conclude that the entity is a VIE.
Although the evaluation under the business scope exception may seem
straightforward, it is not. It involves evaluating several factors in addition to the
specific facts and circumstances of the transaction. The first step is to determine
whether or not the entity is a business. The second step is to determine whether
or not any of the four conditions in the business scope exception are met. If any
are met, the reporting entity is precluded from utilizing the scope exception. If a
reporting entity concludes that the business scope exception is met, it implies that
the reporting entity should evaluate whether or not the business scope exception is
met at each subsequent reporting period. The guidance below includes some of the
significant matters for consideration when assessing the business scope exception.
What is a Business?
In order to apply the business scope exception, the reporting entity must determine
whether or not the entity is a business. The guidance for accounting for business
combinations is located in ASC 805, Business Combinations (ASC 805). ASC 80510-55-4 through 55-9 state that the definition of a business for use in the VIE model
is as follows:
Excerpts from ASC 805-10:
20: A business is 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.
55-4: A business consists of inputs and processes applied to those
inputs that have the ability to create outputs. Although businesses
usually have outputs, outputs are not required for an integrated set to
qualify as a business. The three elements of a business are defined as
follows:
a. Input. Any economic resource that creates, or has the ability to
create, outputs when one or more processes are applied to it.
Examples include long-lived assets (including intangible assets or
rights to use long-lived assets), intellectual property, the ability to
obtain access to necessary materials or rights, and employees.
b. Process. Any system, standard, protocol, convention, or rule that,
when applied to an input or inputs, creates or has the ability
to create outputs. Examples include strategic management
processes, operational processes, and resource management
processes. These processes typically are documented, but an
organized workforce having the necessary skills and experience
following rules and conventions may provide the necessary
processes that are capable of being applied to inputs to create
outputs. Accounting, billing, payroll, and other administrative
systems typically are not processes used to create outputs.
c. Output: The result of inputs and processes applied to those inputs
that provide or have the ability to provide a return in the form
of dividends, lower costs, or other economic benefits directly to
investors or other owners, members, or participants.
ASC 805-10-55-5: To be capable of being conducted and managed
for the purposes defined, an integrated set of activities and assets
requires two essential elementsinputs and processes applied to those
inputs, which together are or will be used to create outputs. However, a
business need not include all of the inputs or processes that the seller
used in operating that business if market participants are capable of
acquiring the business and continuing to produce outputs, for example,
by integrating the business with their own inputs and processes.
(continued)
ASC 805-10-55-6: The nature of the elements of a business varies

by industry and by the structure of an entitys operations (activities),
including the entitys stage of development. Established businesses
often have many different types of inputs, processes, and outputs,
whereas new businesses often have few inputs and processes and
sometimes only a single output (product). Nearly all businesses also have
liabilities, but a business need not have liabilities.
ASC 805-10-55-7: An integrated set of activities and assets in the
development stage might not have outputs. If not, the acquirer should
consider other factors to determine whether the set is a business. Those
factors include, but are not limited to, whether the set:
a. Has begun planned principal activities
b. Has employees, intellectual property, and other inputs and
processes that could be applied to those inputs
c. Is pursuing a plan to produce outputs
d. Will be able to obtain access to customers that will purchase the
outputs.
Not all of those factors need to be present for a particular integrated
set of activities and assets in the development stage to qualify as a
business.
ASC 805-10-55-8: Determining whether a particular set of assets and
activities is a business should be based on whether the integrated set
is capable of being conducted and managed as a business by a market
participant. Thus, in evaluating whether a particular set is a business,
it is not relevant whether a seller operated the set as a business or
whether the acquirer intends to operate the set as a business.
ASC 805-10-55-9: In the absence of evidence to the contrary, a
particular set of assets and activities in which goodwill is present shall
be presumed to be a business. However, a business need not have
goodwill.
An entity that meets the definition of a business does not need to be evaluated by
the reporting entity unless one or more of the following conditions are met:
Condition 1: Design of the Entity
Excerpt from ASC 810-10-15-17-(d)(1):
The reporting entity, its related parties (all parties identified in paragraph
810-10-25-43, except for de facto agents under paragraph 810-10-2543(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.
This condition (the design of the entity condition) requires an understanding of the
dynamics involved in the design (or redesign) of the entity being evaluated. Indicators
that the reporting entity was involved in the design (or redesign) of the entity include
input to activities involving
capital structure;
governance structure; or
operating activities.
If the capital structure, governance structure and/or operating activities are
significantly revised as a result of the reporting entitys involvement with the
entity being evaluated or shortly thereafter then the entity has been substantively
redesigned. Moreover, the reporting entity must identify whether its related parties
participated in these activities. If so, this scope exception may not be available. For
purposes of evaluating the design of the entity condition, related parties include de
facto agents identified in ASC 810-10-25-43, except for de facto agents under ASC
810-10-25-43(d) as a result of transfer restrictions (refer to VE 1.7 for a discussion of
related parties and de facto agents).
In addition, when an entity undergoes a redesign or restructuring, the reporting entity
must re-evaluate this condition (refer to VE 4.3 for discussion of reconsideration
events of the VIEs status).
There are two exceptions to the design of the entity condition:
Operating joint ventures under joint control of the reporting entity and one or more
related parties
To qualify for this exception, the entity must meet the definition of a joint venture
as defined in the ASC Master Glossary, An entity 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, (the 1979 AcSEC Issues Paper,
Joint Venture Accounting also provides guidance for determining which entities are
operating joint ventures). Joint control over decision making is the most significant
attribute of a joint venture. Under the design of the entity condition, it is critical
that the reporting entity and at least one other unrelated party jointly control the
entity. This means that neither party may have unilateral control. For example, if
one joint venture partner (or another party) controls an entity through an operating
or management agreement, the reporting entity would be required to apply the VIE
model. A distinguishing feature of a corporate joint venture is joint control. Joint
control requires that all venturers consent to the major decisions of the entity. For
example, an entity with three or more shareholders where decisions are made
by majority is not a joint venture. While not specifically addressed as part of the
exception to the design of the entity condition for joint ventures, given the principles
in the guidance, preparers should consider whether evaluating the power to direct
activities of the entity that have a significant impact on the entitys performance (i.e.,
consistent with the primary beneficiary analysis) is jointly controlled.
Although joint control is a key defining feature of a corporate joint venture, the
existence of joint control is not the only determinant when identifying whether an
entity is a joint venture. Other factors must also be present to distinguish a corporate
joint venture from other entities (such as those discussed in the ASC Master
Glossary). Lastly, operating joint ventures must still be evaluated under the remaining
conditions of the business scope exception prior to utilizing this scope exception.
Franchise Agreements, as defined in the Master Glossary contained in the FASB

codification:
While all franchisee entities would meet the design condition of the entity, the Board
does not believe that entities holding franchise agreements are, by definition, VIEs.
Therefore, to alleviate the burden of applying the VIE model to franchises, the Board
decided that the design of the entity condition should not apply to an entity that is a
franchise. Franchisee entities must still be evaluated under the remaining conditions
of the business scope exception prior to utilizing the business scope exception.
Condition 2: The Substantially All Test
Excerpt from ASC 810-10-15-17-(d)(2):
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.
This condition (the substantially all condition) attempts to address those entities
that have a narrow business purpose because they were designed to complement
the reporting entitys operating or financing activities. Most questions regarding this
condition concern how the phrase substantially all of its activities either involve or
are conducted on behalf should be interpreted. This is the same phrase that is
used in connection with entities established with non-substantive voting rights, and
thus we believe that this condition should be interpreted in a consistent manner.
The phrase substantially all of the entitys activities either involve or are conducted
on behalf is often misinterpreted as to whether or not substantially all of the
activities are conducted on behalf of the reporting entity and its related parties,
which overlooks whether the activities involve the reporting entity or its related
parties.
As a general rule, we believe that this assessment is primarily qualitative. Some have
suggested that the phrase substantially all should be interpreted to mean that 90
percent or more of the economics of the entity relate or accrue to the benefit of a
particular party. We do not share this view. Rather, we believe that such a quantitative
measure is only one of many factors that should be considered in evaluating this
criterion. However, we recognize there may be circumstances where the economics
of the arrangement are so skewed in the direction of one reporting entity that a
quantitative analysis may in and of itself override other considerations.
We often use the following list of indicators in our evaluation:

Strong Indicators*
Other Indicators*
The reporting entity sold assets to the entity

in an effort to remove underperforming
assets from the reporting entitys balance
sheet.
The reporting entity sold assets to the

entity.
The entitys major activities include selling

substantially all of its products to the
reporting entity under long-term contracts.

a majority of its products to the reporting
entity, and such relationship is expected
to continue either because of long-term
contracts or for other reasons.
The entitys major activities include

purchasing substantially all of its
purchased products from the reporting
entity.

purchasing a majority of its purchased
products from the reporting entity.
The reporting entity holds a non-reciprocal,

fixed-price or in the money call option
on the other investors equity investments,
and/or the other investors have a fixedprice or in the money put option whereby
they can put their investments to the
reporting entity.
The reporting entity holds a non-reciprocal

(or fair-value) call option on the other
investors equity investments, and/or the
other investors have a similarly priced,
non-reciprocal put option.
The reporting entity is obligated to provide

substantially all of any additional capital
contributions that may be necessary to
cover operating shortfalls.

a majority of any additional capital
The entity performs research and

development activities, and the reporting
entity has an economic interest (e.g.,
through a purchase option) in the results of
the research that constitutes substantially
all of the entitys activities.

entity is in a business that could capitalize
on the results of the research that
constitutes a majority of the entitys
activities.
The reporting entity has outsourced

operations to the entity, constituting
substantially all of the entitys activities.
The reporting entity has outsourced to the

entity operations that constitute a majority
of the entitys activities.
Substantially all of the entitys assets are

leased to the reporting entity.
A majority of the entitys assets are leased

to the reporting entity.
The principal activity of the entity is to

provide financing (e.g., loans or leases) to
the reporting entitys customers.
A majority of the entitys activities involve

providing financing (e.g., loans or leases) to
The principal purpose of the entity is

to conduct a business that is uniquely
complementary to a significant business
operation of the reporting entity and is not
similar to activities of other participants in
the entity.
The principal purpose of the entity is to

conduct a business that is more closely
related to a significant business operation
of the reporting entity and only broadly
similar to activities of one or more of the
other participants in the entity.
The economics (e.g., capital at risk,

participation in profits, etc.) are heavily
skewed (e.g., close to 90 percent or
greater) toward the reporting entity.

participation in profits, etc.) are weighted
(e.g., greater than 60 percent) toward the
reporting entity.
* With respect to evaluating these indicators, the term reporting entity covers the reporting entitys
related parties (as defined in ASC 810-10-25-43, other than those de facto agents resulting from ASC
810-10-25-43(d)).
There are no broad rules of thumb that can be used to shortcut the evaluation
required for the substantially all condition. Instead, reporting entities will need to
evaluate the relevant facts and circumstances surrounding each individual situation.
Absent mitigating factors (e.g., indicators that point to a different conclusion), we
believe that the presence of a single item from the Strong Indicators column may,
at times, be sufficient to support a conclusion that substantially all of the activities
of the entity either involve or are conducted on behalf of the reporting entity. At
other times, multiple strong indicators may need to be present to reach the same
conclusion. There are no bright lines and this assessment requires judgment. If
the reporting entity meets several of the Other Indicators, it may need to seriously
consider whether or not the requirements of the substantially all condition have been
met, and consultation with an accounting professional familiar with these provisions
may be appropriate.
Franchise agreements entered into by a franchisor with a franchisee often possess
unique attributes in order to protect the franchise brand. As a result, the criterion in
the substantially all condition must be carefully analyzed. The table on the previous
page should prove useful when evaluating whether a franchise is designed so
that substantially all of its activities either involve or are conducted on behalf of
the franchisor. However, there may be other factors to consider in the franchise
relationship, including the ability to select and set pricing of the menu (or products
sold by the franchise) and other factors, some of which are described in more detail
in ASC 952, Franchisors (ASC 952), specifically in ASC 952-810-55-2.
Condition 3: Subordinated Financial Support
Excerpt from ASC 810-10-15-17(d)(3):
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.
Subordinated financial support is defined under the VIE model as variable interests
that will absorb some or all of a variable interest entitys (VIEs) expected losses.
Therefore, virtually any variable interest in the entity is considered subordinated
financial support. Consequently, reporting entities making this evaluation must
consider all variable interests they and other parties have with the entity, including
variable interests in the form of guarantees, management contracts, derivatives,
purchase options, and supply contracts, as well as loans and equity investments.
This will not be easy since fair-value information is often not available. Therefore,
we believe that this assessment may be difficult to perform, particularly in situations
where the various forms of financial support provided to the entity by the reporting
entity are substantial. Therefore, from a practical perspective, this scope exception
would generally be available when it is obvious that the reporting entity would not
absorb the majority of the economics of the entity on a fair value basis. For many
arrangements, such as for example, 50:50 ventures, it will be difficult to make
this assertion. In a 50:50 venture, while the economics are intended to be shared
on a 50:50 basis, it may not be the case in practice. There are often commercial
arrangements between the venturers and the venture that may be variable interests
and it becomes very hard to establish without a complex analysis that the economics
with respect to all the variable interests held by the venturers are split exactly on a
50:50 basis. Therefore, the entity will more often than not need to be evaluated under
the VIE model.
Condition 4: Common Financing Structures
Excerpt from ASC 810-10-15-17(d)(4):
The activities of the legal entity are primarily related to securitizations
or other forms of asset-backed financings or single-lessee leasing
arrangements.
This condition (the common financing structure condition) is the most
straightforward. The primary logic for including this criterion is to ensure that entities
that were previously considered typical SPE structures are always assessed under
the VIE model. In applying this condition, we believe the phrase single-lessee
leasing arrangements should be interpreted broadly. Therefore, it includes entities
that have entered into long-term supply arrangements that contain an embedded
lease under ASC 840-10-15-6. In fact patterns where an entity is deemed to be a
single-lessee leasing arrangement, the reporting entity would not be eligible for this
scope exception.

2.2.2 Not-for-Profit Organizations

Excerpt from ASC 810-10-15-17(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 25-44. 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 guidance
in the Variable Interest Entities Subsections, that entity shall be subject
to the guidance in the Variable Interest Entities Subsections.
This scope exception applies to all not-for-profit entities/reporting entities (NFPs)
that are subject to the consolidation requirements in ASC 958, Not-for-Profit
EntitiesConsolidation (ASC 958). The exception also applies to NFP health care
organizations subject to the AICPAs Audit and Accounting Guide, Heath Care
Organizations. Under this scope exception:
NFPs do not have to analyze their relationships with potential VIEs, since NFPs are
not subject to the VIE model; and
A for-profit reporting entity does not have to apply the VIE model to a NFP unless
the NFP was established to avoid consolidation under the VIE model. In the latter
case, a for-profit reporting entity with a relationship with a NFP entity would need
to apply the VIE model in assessing whether or not the NFP is a VIE, and if it is a
VIE, identify the primary beneficiary.
Despite this exception, a NFP reporting entity must be considered a related party
to a reporting entity (i.e., a for-profit reporting entity) when that reporting entity is
assessing whether or not it is the primary beneficiary of a VIE. Refer to VE 1.7 for a
further description of related parties.
A for-profit reporting entity could use certain leasing structures involving NFPs to
circumvent the provisions of the VIE model. In these cases, the scope exception
would not apply. In most cases, we would not expect a NFP charitable foundation
that was established by a reporting entity to be subject to the VIE model.
Although EITF 90-15, Impact of Nonsubstantive Lessors, Residual Value Guarantees,
and Other Provisions in Leasing Transactions (EITF 90-15), was nullified by the
guidance in the Variable Interest Entities subsections of ASC 810-10 for entities
within the scope of that guidance, we believe that NFP entities previously evaluated
by way of analogy to EITF 90-15 should continue to be evaluated in that manner.

2.2.3 Employers That Offer Employee Benefit Plans

An employer shall not consolidate an employee benefit plan subject to
Topic 712 or 715.
Although an employer that sponsors an employee benefit plan is not required to
consolidate that plan, the exception does not specifically provide a scope exception
to employee benefit plans (i.e., the VIE model may apply to interest/investments in
entities held by the plan). However, defined-benefit plans that fall within the scope
of ASC 960, Plan AccountingDefined Benefit Pension Plans (ASC 960), should
continue to follow the guidance of ASC 960 and are not subject to the VIE model.
Additionally, the scope exception would not be available to a service provider (who
is not the sponsoring employer). We do not believe that it was the FASBs intent to
require employee benefit plans to consolidate entities in which they invest.
2.2.4 Investment Companies

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.
This scope exception only applies to investments that are owned by a reporting
entity that qualifies as an Investment Company under the guidance of ASC 946. It
does not apply to non-investment companies that hold interests in such an
Investment Company.
The AICPA issued 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 (SOP 071), in an attempt to clarify whether an entity is within the scope of the AICPA Audit
and Accounting Guide, Investment Companies (the Audit Guide), and, for those
entities that are within the scope of the Audit Guide, address whether the specialized
accounting in the Audit Guide should be retained by a noninvestment company
parent or equity method investor of an Investment Company. The original effective
date, fiscal years beginning on or after December 15, 2007, with earlier adoption
encouraged, was indefinitely deferred by FSP SOP 07-1-1, Effective Date of AICPA
Statement of Position 07-1.
An entity that early adopted SOP 07-1 is allowed to continue to follow this guidance
in which case, at each reporting period end, the parent (i) will first need to evaluate
whether or not the subsidiary or equity method investee continues to qualify as an
Investment Company per SOP 07-1, and (ii) determine if the parent is able to retain
the specialized accounting in consolidation. If the parent company is unable to retain
the specialized accounting in consolidation, the parent company will then need to
evaluate each investee of the consolidated entity under the applicable guidance.
For those entities that did not early adopt SOP 07-1 but invest in entities that follow
the specialized accounting in the Audit Guide, the investee entity is not required
to consider whether any of the investee entitys investments are VIEs potentially
requiring consolidation under the VIE model. The parent of such a consolidated
entity retains the specialized accounting in consolidation under EITF Issue No. 85-12,
Retention of Specialized Accounting for Investments in Consolidation, and EITF Topic
D-74, Issues Concerning the Scope of the AICPA Guide on Investment Companies.
The FASB and IASB are currently working on a joint project to provide
comprehensive guidance for assessing whether an entity is an investment company
and to provide measurement requirements for an investment companys investments.
The FASB and IASB are redeliberating certain aspects of their proposal and
preparers should continue to monitor developments of this project.
Reporting entities such as investors, managers and other parties that hold an
interest in an entity that follows the specialized accounting in the Audit Guide need
to consider whether the entity itself is a VIE potentially requiring consolidation under
the VIE model. If the reporting entity determines that it is required to consolidate the
entity under the VIE model, it then needs to apply the discussion in the paragraphs
above to determine whether or not the reporting entity is required to apply the VIE
model to each investee of the consolidated entity.

2.2.5 Separate Accounts of Life Insurance Entities

Excerpt from ASC 810-10-15-17(b):
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.
This scope exception indicates that separate accounts of life insurance companies
are not subject to consolidation by another reporting entity. The Board chose not
to change current GAAP for separate accounts of life insurance companies without
a broader reconsideration of accounting by insurance entities, which is beyond the
scope of the VIE model. Separate accounts that are governed by SEC Regulation
S-X, Rule 6-03(c)(1) are eligible for the same scope exception as other registered
investment companies. Non-registered separate accounts that are subject to the
Audit Guide should consider the discussion in VE 2.2.4 above.
Note that the scope exception for the separate accounts as discussed above is not
applicable to the general account of the insurers. Therefore, insurers should include
variable interests associated with the general account when determining the primary
beneficiary of an investment fund under the VIE model.
2.2.6 Information-Out
Excerpt from ASC 810-10-15-17(c):
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 (1) determine whether the legal entity is
a VIE, (2) determine whether the reporting entity is the VIEs primary
beneficiary, or (3) perform the accounting required to consolidate the VIE
for which it is determined to be the primary beneficiary. 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 appliesonly
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.
The FASB recognized that there may be instances where reporting entities have
entered into arrangements prior to December 31, 2003 and are unable to obtain the
information necessary to apply the VIE model. Oftentimes, the reporting entity may
not have the contractual or legal right to the information necessary to apply the VIE
model, and the entity is unwilling to supply the information to the reporting entity.
The FASB has indicated that it expects such instances to be infrequent, especially if
the reporting entity was involved in the design of the entity or if the reporting entity is
exposed to substantial risks of the entity. The FASB declined to provide examples or
further explain the term exhaustive as it is used in this context. The reporting entity
must also continue to make exhaustive efforts to obtain the necessary information
in subsequent periods. ASC 810-10-65 provides transition guidance for subsequent
adoption when the reporting entity obtains the necessary information to apply
the provisions of the VIE model (refer to VE 8.1 for a discussion of the transition
guidance).
As reporting entities enter into arrangements with new entities or change
arrangements with existing entities, they should ensure that they obtain the right to
access the information that is necessary for applying the provisions of the VIE model.
Additionally, if a reporting entity avails itself of this exception, it is required to make

the following additional disclosures required by the VIE model as amended by (refer
to VE 7):
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 810-1015-17(c) shall
disclose the following information:
a. The number of legal entities to which 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
b. The nature, purpose, size (if available), and activities of the legal
entities and the nature of the reporting entitys involvement with
the legal entities
c. The reporting entitys maximum exposure to loss because of its
involvement with the legal entities
d. 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.
At the 2003 AICPA National Conference on Current SEC Developments, Eric
Schuppenhauer of the SEC staff stated:
The scope exception only applies to an enterprise with an interest in a variable
interest entity or potential variable interest entity created before December31,
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 re-configured 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 reactivated after December 31st to carry out new activities and issue new variable
interests, the staff would consider the use of the information scope exception
abusivethe 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.
At the 2004 AICPA National Conference on Current SEC Developments, Jane Poulin
of the SEC stated:
I would also like to address the information scope out in FIN 46R. 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.
Given the Staffs comments and the FASBs current views on the informationout exception, we anticipate that the use of this scope exception will be rare and
reporting entities using this exception will come under scrutiny.
If the information-out scope exception has been previously applied and the
information subsequently becomes available the VIE model must be applied (i.e., the
scope exception is no longer available). If the reporting entity has determined that
the entity being considered for consolidation is a VIE and the reporting entity is the
primary beneficiary, then the reporting entity may consolidate the entity through a
cumulative effect of an accounting change or a restatement of prior periods, which is
described in ASC 810 (see VE 8.1 for more details).

2.2.7 Governmental Organizations

Excerpt from ASC 810-10-15-12(e):
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 (1) is not a governmental
organization and (2) is used by the business entity in a manner similar
to a VIE in an effort to circumvent the provisions of the Variable Interest
Entity subsections.
In most cases, a reporting entity subject to the VIE model shall not consolidate
a governmental organization or a financing entity established by a governmental
organization. The term governmental organization is described in the AICPA Audit
and Accounting Guide, Audits of State and Local Governments, 1.01 and 1.02, which
states the following:
Excerpt from AICPA Audit and Accounting Guide, Audits of State and
Local Governments, 1.01 and 1.02
Public corporations4 and bodies corporate and politic are governmental
entities. Other entities are governmental if they have 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 a government with the net
assets reverting to a government; or
The power to enact and enforce a tax levy.
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 if their determination is supported by
compelling, relevant evidence.
Entities are governmental or nongovernmental for accountingbased
solely on the application of the above criteria; other factors are not
determinative. For example, the fact that an entity is incorporated as
a not-for-profit organization and exempt from federal income taxation
under the provisions of Section 501 of the Internal Revenue Code is
not a criterion in determining whether an entity is governmental or
nongovernmental for accountingpurposes.
4
Blacks Law Dictionary defines a public corporation as: An artificial person (e.g. [a]
municipality or a governmental corporation) created for the administration of public affairs.
Unlike a private corporation it has no protection against legislative acts altering or even
repealing its charter. Instrumentalities created by [the] state, formed and owned by it in
[the] public interest, supported in whole or part by public funds, and governed by managers
deriving their authority from [the] state. Sharon Realty Co. v. Westlake, Ohio Com. Pl.,
188 N.E.2d 318, 323, 25, O.O.2d 322. A public corporation is an instrumentality of the state,
founded and owned in the public interest, supported by public funds and governed by
those deriving their authority from the state. York County Fair Assn v. South Carolina Tax
Commission, 249 S.C. 337, 154 S.E.2d 361, 362.
This definition should be carefully considered when applying this scope exception.
This scope exception requires that a reporting entity should apply the VIE model to a
financing entity that is created by a governmental organization if
the financing entity was established in order for the reporting entity to circumvent
the provisions of the model; and,
the financing entity is not itself a governmental organization.
Since the Governmental Accounting Standards Board (GASB) establishes the
accounting rules for state and local governmental organizations, the VIE model does
not apply to a governmental organization when assessing whether or not that

governmental organization should consolidate another entity.
Examples of situations covered by this exception include, but are not limited to,
(i) the issuance of tax-exempt debt by a governmental organization (or a financing
entity established by a governmental organization) to finance the construction
of an asset leased to the reporting entity and (ii) a tax-increment financing entity
established by a municipality to finance certain infrastructure assets on land that
is owned by the reporting entity (commonly referred to as industrial development
bonds).
In practice the governmental scope exception is difficult to apply particularly when
dealing with an entity that is a financing entity that has been established by a
governmental organization.

2.3 Deferral of the 2009 Revisions to the VIE Model for Certain
InvestmentEntities
On February 25, 2010, the Financial Accounting Standards Board (FASB) issued
Accounting Standards Update 2010-10 (ASU 2010-10) to defer the VIE model as
amended by ASU 2009-17 for certain investment entities that have the attributes of
entities subject to ASC 946 (the investment company guide). The deferral amends
the guidance in the VIE model as amended by ASU 2009-17 to defer its effective
date for entities that meet the following conditions:
1. The entity either:
Has all of the attributes specified in ASC 946-10-15-2(a) through (d) (i.e., the
attributes of an entity that would be considered subject to investment company
accounting) or,
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 industry practice to apply guidance consistent
with the measurement principles in ASC 946 (including recognizing changes
in fair value currently in the statement of operations) for financial reporting
purposes.
2. The reporting enterprise 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 enterprises
interest, the purpose and design of the entity, and any guarantees provided by the
reporting enterprises related parties.
3. The entity is not a securitization entity, an asset-backed financing entity, or an
entity formerly considered a qualifying special-purpose entity.
The deferral is not optional. In order for an entity to be subject to the deferral, all
three conditions must be met on the date the reporting entity adopts the VIE model
as amended by ASU 2009-17. If the conditions are no longer met after the reporting
entity has adopted the VIE model as amended by ASU 2009-17, the reporting entity
must apply the provisions of the VIE model as amended by ASU 2009-17 to the
entity, and the entity cannot re-qualify for the deferral in the future.
Even though an entity may initially be subject to the deferral, a subsequent change
in facts and circumstances may result in it ceasing to qualify. Accordingly, reporting
entities will need to establish a process to monitor ongoing qualification for the
deferral.
Obligation to fund losses

The deferral does not apply to situations in which the reporting entity could be
required to fund losses of the entity, including through either an implicit or explicit
guarantee that could potentially be significant to the entity, other than money market
funds as noted below. Determining whether a reporting entity has the obligation to
absorb losses that could potentially be significant to an entity requires judgment and
should consider all facts and circumstances related to the terms and characteristics
of a reporting entitys interest or interests in the entity along with the design and
characteristics of the entity.
The determination of whether a limited partnership meets the conditions for
the deferral will require careful analysis. The FASB has indicated that a general
partners unlimited legal liability would not necessarily by itself disqualify the limited
partnership for the deferral, but that additional analysis would be required. Under
partnership law in the United States, the general partner has joint and several liability
for all obligations of the limited partnership, unless otherwise agreed to by a claimant
(e.g., a creditor) or provided by law.
In many situations (e.g., where the limited partnership has outstanding debt), the
general partner interest is held by a blocker entity (e.g., an LLC) designed in a
manner to limit the general partners unlimited legal liability. That is, the blocker entity
(1) sits between the investment manager and the limited partnership and (2) has no
other substantive assets that provide it with the wherewithal to make good on the
obligations of the limited partnership if called upon. ASU 2010-10 states that if a
reporting enterprises exposure to the obligations of a partnership is limited based on
the legal structure, the limited partnership may meet the conditions for the deferral.
As a result, we generally believe that the existence of such a blocker entity would
allow the general partner to conclude that its legal liability is limited, and therefore, it
does not have an obligation to fund losses of the entity (i.e., the limited partnership)
that could potentially be significant.
If a blocker entity does not exist, additional analysis may be warranted. ASU 2010-10
states that both the purpose and design of the entity and any guarantees provided
by the general partner and its related parties, as well as the legal structure of the
limited partnership should be considered in the analysis. For example, debt issued
by a limited partnership should be assessed to determine if the general partner
is in effect (through its legal liability) guaranteeing the debt or if the debt has sole
recourse to assets of the entity (and therefore no recourse to the general partner).
If the general partner is in effect guaranteeing the debt, the potential significance of
the guarantee should be evaluated regardless to its probability of being funded. The
limited partnership would not meet the conditions for the deferral if the guarantee is
determined to be potentially significant, unless a blocker entity is in place.
Given the overall design of most investment partnerships, we would not expect a
general partners unlimited legal liability to cover general administrative liabilities
(e.g., legal or audit fees) and potential liabilities from general lawsuits to represent
risks that the entity was designed to pass along to its interest holders. Accordingly,
we would generally expect that these types of implicit guarantees will not prevent an
entity from meeting the conditions for the deferral.
Many investment funds include claw back arrangements whereby previous
performance distributions from the limited partnership to the general partner
(investment manager) may need to be returned, because the performance fee is
no longer being earned. As mentioned above, the FASB decided that the expected
performance of the entity over its life along with its nature and design should be
considered in making the determination as to whether the reporting enterprise (i.e.,
the general partner) has an obligation to fund losses of the entity that could be
potentially significant. Accordingly, claw back arrangements, where an investment
manager may be required to refund prior fees to the entity, may not violate the
conditions for the deferral.
Similarly, any future capital commitments required to be made by the reporting
enterprise to the entity should be analyzed to determine whether they represent
the funding of future investments or the funding of prior losses. This determination
should be based on the facts and circumstances. If a capital commitment is
determined to be a funding of investments as the investment manager finds suitable
investments, it would not violate the conditions for the deferral. If, on the other hand,
a capital commitment is determined to be a funding of prior losses, it would violate
the deferral conditions even if all investors were funding the losses on a pro-rata
basis.
Determining whether capital commitments are the funding of future investments or
the funding of prior losses may be challenging. For example, a reporting enterprise
may choose to fund losses by having the entity issue a subordinate class of equity
such that the holder of that class will in essence fund the initial or continuing losses
of the entity. In such a case, if the reporting enterprise acquires the subordinate
class of equity, this may violate the deferral conditions. Reporting entities may want
to consider the guidance in ASC 323-10-35-29 (formerly EITF 02-18) to determine
whether a capital commitment represents the funding of future investments or prior
losses.
Entities generally expected to meet the requirements for deferral
The FASB expects the deferral to generally apply to a limited number of types of
entities, including, but not limited to, mutual funds, hedge funds, private equity funds,
venture capital funds, and certain mortgage REITs. The FASB recognizes that there
are investments funds that are (1) not subject to U.S. GAAP or (2) are not included in
the scope of ASC 946 but have the same characteristics as entities within the scope
of ASC 946. For example, certain real estate investment trusts (REITs) may meet the
conditions for the deferral even though they are not subject to ASC 946.
The deferral applies to an entity regardless of the magnitude of the reporting entitys
investment in the entity provided that all the conditions for the deferral are met.
Application of the VIE model as amended by ASU 2009-17 is also deferred for
reporting entities with interests in money market funds that 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 as discussed below.
Entities not expected to meet the requirements for deferral
The deferral does not apply to securitization entities, asset-backed financing entities
or entities formerly classified as qualifying special-purpose entities, even if practice
considers those entities to have the characteristics similar to that of an investment
company as defined in ASC 946 or for which it is industry practice to apply the
guidance in ASC 946. Some examples of entities that do not meet the conditions for
deferral include structured investment vehicles, commercial paper conduits, credit
card securitization structures, residential or commercial mortgage-backed entities,
and government sponsored mortgage entities.
Entities with multiple levels of subordinated investors for which the primary purpose
is to provide credit enhancement to the senior interest holders do not qualify for the
deferral. These may include certain collateralized debt obligations and collateralized
loan obligations as these types of entities are typically considered to be assetbacked financing entities and not investment companies that meet the conditions for
the deferral.
ASU 2010-10 states that entities with characteristics like those examples included in
ASC 810-10-55-93 will not meet the conditions for the deferral.
Money market mutual funds
In addition to the deferral requirements discussed above, ASU 2010-10 also includes
a separate deferral for a reporting enterprises interest in a fund that is required to
comply with or operates 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. Judgment will be required to determine whether unregistered money
market funds qualify for the deferral.
Money market funds generally invest in short-term government securities, certificates
of deposit, and commercial paper and pay dividends that generally reflect short-term
interest rates. Although credit losses in a money market fund could occur, these
funds are typically required to be managed in a manner to minimize credit losses.
Money market funds recognize their investments at amortized cost and maintain a
constant net asset value (NAV) (typically $1.00) per share by adjusting the returns to
their investors as general interest rates fluctuate.
Some believe that a money market managers fees represent a variable interest in the
money market fund as a result of implicit or explicit guarantees to fund credit losses
when the NAV decreases to a value less than $1.00 (often referred to as breaking
the buck). In other words, some believe that historical funding provided by an asset
manager implies that investors would be protected, at least in part, by the asset
manager, even in situations in which the asset manager has no contractual obligation
to provide future funding. Such an interpretation could result in the money market
manager concluding that consolidation of the fund is required under ASU 2009-17.
However, the FASB decided not to conclude on whether it agreed or disagreed with
these views until the broader joint consolidation project with the IASB is completed.
Based on the restrictive requirements under which money market funds operate, and
the required credit quality of the assets they are permitted to hold, the FASB believes
that the VIE model as amended by ASU 2009-17 should not result in reporting
entities having to consolidate money market funds. Therefore, ASU 2010-10 provides
for a deferral of the implementation of the VIE model as amended by ASU 2009-17
for money market funds until the FASBs joint project with the IASB is completed.
The FASB made the deferral explicit, because some may have concluded that money
market funds are not subject to the broader deferral described above given the
view that many money market managers generally provide either implicit or explicit
guarantees to money market funds.
Application of the VIE model as amended by ASU 2009-17 to a money market fund
is unconditionally deferred, even if its investment managers or others provide support
arrangements or guarantees. Any such support arrangement or guarantee (implicit
or explicit) would be subject to the pre-amended VIE model consolidation analysis
(formerly FIN 46(R)) as such funds would continue to be subject to the consolidation
guidance prior to the VIE model as amended by ASU 2009-17.
Disclosures
The amendments in ASU 2010-10 do not defer the disclosure requirements of the VIE
model as amended by ASU 2009-17. Accordingly, public and nonpublic companies
will be required to provide the disclosures required by ASC 810-10-50-1 through
50-19 for all variable interests in variable interest entities, including variable interest
entities that qualify for the deferral and were variable interest entities prior to the VIE
model as amended by ASU 2009-17. A reporting entity is not required to provide
these disclosures if an entity qualifies for the deferral under ASU 2010-10 and was
not a variable interest entity prior to the VIE model as amended by ASU 2009-17.
Effective date and transition
The effective date for the deferral is the same as the effective date of the VIE model
as amended by ASU 2009-17 which is as of the beginning of the reporting entitys
first annual reporting period that begins after November 15, 2009, and for interim
periods within that first annual reporting period. If an entity meets the conditions
for the deferral, the reporting entity should continue to apply the pre-amended VIE
model in ASC 810-10 (i.e., FIN 46(R) prior to its amendment) or other applicable
consolidation guidance, such as ASC 810-20 (formerly EITF 04-5), when evaluating
the entity for consolidation. Refer to the 2007 edition of PwCs Guide to Accounting
for Variable Interest Entities which includes the guidance under FIN 46(R) prior to its
amendment.

2.4 Questions and Interpretive Responses

Not-for-Profit Organizations
Question 2-1: Assume a for-profit entity (FP X) was involved with the design of a NFP
entity (NFP A) that was established to do business with another NFP entity (NFP B)
(i.e., state or local government) because NFP B was prohibited from doing business
with FP X. Concurrently, all of NFP As activities are outsourced to FP X. May FP X
apply the NFP scope exception to NFP A?
PwC Interpretive Response: Yes, we believe that the FP X could apply the NFP
scope exception since NFP A was established as a NFP for a legitimate reason
(legal prohibitions) and not to circumvent the VIE model. We understand that the
SEC would share this view and has applied the NFP scope exception literally.
Employers That Offer Employee Benefit Plans
Question 2-2: Are non-leveraged ESOPs included in the scope of the VIE model,
potentially requiring consolidation by the sponsor entity?
PwC Interpretive Response: No, non-leveraged ESOP plans are defined
contribution plans and similar in important respects to pension arrangements
covered by ASC 715, CompensationRetirement Benefits (ASC 715). As a result,
for employers, we believe non-leveraged ESOPs are excluded from the scope of
the VIE model by the employee benefit plan scope exception described in VE 2.2.3.
QSPEs
Question 2-3: Do investors in a QSPE need to apply the guidance in the VIE model
or are they scoped out?
PwC Interpretive Response: Yes, investors in a QSPE need to consider the
VIE model since the scope exception previously available has been eliminated
under the VIE model. The QSPE concept was introduced by the FASB to permit
derecognition of transferred financial assets in securitization, provided that the
securitization vehicle was considered a passive entity that met certain conditions.
Those conditions included the requirement that the entity only hold passive
financial assets and that its activities be significantly limited and entirely specified
in the legal documents establishing the entity or creating beneficial interests.
However in practice these conditions proved difficult to achieve because few
assets were truly passive such that little or no-decision making is required.
Consequently, the FASB decided to eliminate the QSPE concept from the
accounting guidance.
Separate Accounts of Life Insurance Entities
Question 2-4: Does the separate account scope exception described in VE 2.2.5
include the general account of a life insurance entity (as described in the AICPAs
Audit and Accounting Guide, Life and Health Insurance Entities)?
PwC Interpretive Response: No, an insurance company must consider the
guidance in the VIE model to determine whether the investments made by the
general account are variable interests in a VIE that would necessitate consolidation
or disclosure pursuant to the VIE model.
Governmental Organizations
Question 2-5: An entity (the Entity) was formed through a competitive bid process
to issue revenue bonds in order to finance the construction of a power plant (the
facility). Although the Entity will legally own the facility, the facility was constructed
for the sole benefit of a governmental entity (i.e., an entity that meets the definition
per AICPA Audit and Accounting Guide, Audits of State and Local Governments). The
owners of the Entity selected to issue revenue bonds are in the business of managing
power plants. The facility was constructed on government owned land, and that land
was leased to the Entity for the estimated life of the facility. At the end of the land
lease term the title to the facility will automatically transfer to the governmental entity.
At the inception of the land lease, the governmental entity simultaneously entered
into an arrangement with the Entity that required the governmental organization
to purchase 100 percent of the output of the facility, i.e., electricity, on a long term
basis. The governmental entity also had a fair value purchase option that allowed it
to purchase the facility at any time during the lease term. As part of a competitive
bidding process, Company X, a party that is not related to the Entity or to the
governmental entity, entered into an arrangement with the Entity to guarantee the
revenue bonds.
Company X is evaluating whether or not the Entity is in the scope of the VIE model
because of the application of ASC 810-10-15-12(e). If the Entity is in the scope of the
VIE model, then Company X would need to (1) determine if it holds a variable interest
in the Entity (through its guarantee), (2) whether the Entity is a VIE, and if the Entity is
a VIE (3) whether Company X should consolidate the Entity.
ASC 810-10-15-12(e) states that 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 (1) is not a governmental
organization and (2) is used by the reporting entity in a manner similar to a variable
interest entity in an effort to circumvent the provisions of the VIE model.
What factors should be considered when assessing the governmental organization
scope exception?
PwC Interpretive Response: The first step in determining whether the Entity
is eligible for the governmental organization scope exception is to determine
whether the Entity meets the definition of a governmental organization. Guidance
for making that determination is found in Federal Accounting Standards Advisory
Board (FASAB), the Governmental Accounting Standards Board (GASB) standards
and in paragraphs 1.01 and 1.02 of the AICPA Audit and Accounting Guide, Audits
of State and Local Governments, and not in accounting standards issued by the
FASB. If the Entity is a governmental organization, then it is excluded from the
scope of the VIE model.
In this fact pattern, it is assumed that the Entity does not meet the definition of a
governmental organization. Therefore, Company X must also consider whether
the Entity is in substance a financing entity established by a governmental
organization. This analysis is subjective and requires an understanding of all the
facts and circumstances. While the Entity was formed to finance the construction
of a power plant to be used by a governmental organization, it may not be clear
whether the Entity was formed by a governmental organization. Listed below are
some factors that should be considered when making this determination:
What was the nature of the governments involvement in establishing the
Entity?
What was the level of the governments involvement with the selection of the
board members of the Entity?
Does the government have the right to unilaterally dissolve the Entity?
What percent of the activities of the Entity are on behalf of the government?
What are the terms of the contract between the government and the Entity?
Do the assets revert back to the government at the end of the contract term?
Did the government provide any guarantees?
(Note: This list is not all inclusive.)
In addition, Company X is required to determine if the Entity was set up to
circumvent the VIE model. When making this assessment, Company X should
consider the intent and purpose of the Entity and whether Company X was
involved in the design of the Entity for the purpose of obtaining off-balance sheet
treatment for its relationship with the Entity.
(continued)
In this fact pattern, the Entity is determined to be a financing entity established

by a governmental organization and therefore not included in the scope of the VIE
model (i.e., Company X does not have to determine if the Entity is a VIE). The basis
for this conclusion is predicated on the following: the Entity was established to
finance and construct a power plant for the governmental entity, the governmental
entity was integral in the design of the Entity, the experience of the owners of the
Entity, and the creation of lease agreements, power purchase agreements, and
the purchase option. Therefore, even though the Entity does not meet the GASB
or FASAB definition of a governmental organization, the facts and circumstances
support that the Entity was a financing entity established by the governmental
entity for the purpose of constructing a plant that the governmental entity would
take 100 percent of the output and ultimately the governmental entity would own
the Entitys assets (either through the exercise of the purchase option or because
the assets would revert back to the governmental entity at the end of the lease
term).
Additionally, Company Xs involvement with the Entity was not to circumvent the
VIE model because the Entity was established with the intention of financing the
facility for the governmental entity and Company Xs guarantee contract was
obtained through a competitive bid process.
Chapter 3:
Variable Interests
Variable Interests / 3 - 1
Executive Takeaway
The VIE model introduced a new accounting term: variable interest. A holder of
a variable interest in an entity is required to determine whether the entity is a VIE
and, if so, whether it must consolidate the entity.
Variable interests must be identified and evaluated under the VIE model, as they
can impact whether an entity is a VIE and which party, if any, is the entitys primary
beneficiary.
Variable interests can take many forms, including equity and debt investments,
guarantees, derivatives, management contracts, service contracts, and leases.
Variable interests can exist in implicit relationships, especially if related party
relationships are involved.
3 - 2 / Variable Interests
Chapter 3: Variable Interests

3.1 The Concept of a Variable Interest

A variable interest results from an economic arrangement that gives a reporting entity
the right to the economic risks and/or rewards of the entity, or its variability. A
variable interest is a contractual arrangement or other agreement that does not give
rise to or create variability in the fair value of the entitys net assets and operations.
Rather, it absorbs or has rights to some or all of the variability that the entity was
designed to create. ASC 810-10-20 defines the term variable interest as follows:
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 81010-15-14. 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 legal 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.
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 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 entitys variabilitythat
distinguishes a variable interest. That role, in turn, often depends on the
design of the legal entity.
The following example demonstrates the theoretical concept of a variable interest:
Example 3-1: An entity is formed, and its primary activities involve the
manufacture and sale of furniture. The entity purchases supplies and/or
services from vendors, employees, and other parties in order to run its
activities and create value in the business. The entitys equity investors
capitalize the entity to ensure that it has a level of financing sufficient to
achieve its business purpose. The entitys assets and other contractual
arrangements reflect the results of the entitys activities (i.e., the value of the
business). The equity investors share in the value of the business positively
(i.e., when the activities generate a value that is greater than expected)
or negatively (i.e., when the activities generate a value that is less than
expected). In this simple example, there are no parties, other than the equity
investors, that share in the variability of the fair value of the entitys net assets.
Now lets consider what would happen if the entity were to finance the
acquisition of a new manufacturing facility through a subordinated loan from
a third-party bank. The existence of the loan does not create variability in the
value of the business, rather the new manufacturing facility does. The bank
is exposed to the risks and uncertainties of the entitys activities through its
loan. The bank and the equity investors stand to lose or gain from changes
in the value of the business, and thus they each have a variable interest in
the entity. The equity investors are not the only parties with a variable interest
because the bank also has a variable interest that stands to lose or gain
depending upon the changes in the value of the business.
Most assets of an entity create variability in an entity. They create changing cash
flows that drive the success or failure of the entity, and therefore drive the economic
performance (variability) in the entity. Most forms of financing or capital (including
guarantees of debt and the value of assets and some derivative instruments) absorb
variability in an entity (or an asset). The return to the lender or capital provider
depends on the success or failure of the assets or liabilities that create the variability.
Only those arrangements that absorb the variability of the entity are considered
variable interests under the VIE model.

3.2 The By Design Approach in Determining an Entitys Variability and

Variable Interests
Diversity in practice developed in determining whether certain contracts were
creators of variability or absorbers of variability (i.e., variable interests). Much of
this diversity resulted from different interpretations as to whether certain derivatives
(interest rate swaps and foreign currency derivatives) were variable interests
(absorbers of variability) or creators of variability. In determining whether these
contracts were variable interests, some believed that only those that absorbed the
variability resulting from changes in the entitys cash flows (cash flow variability)
should be considered variable interests, while others believed that those that
absorbed changes in the entitys fair value (fair value variability) should be considered
variable interests. For example, assume that a VIEs sole asset is a fixed rate U.S.
treasury bond. Some would believe that this asset creates no variability because the
U.S. Treasury is risk free from a credit perspective and interest rate payments are
fixed (i.e., no cash flow variability). Others argued that the asset creates variability
because the fair value of the bond fluctuates with changes in interest rates (i.e., fair
value variability). These different viewpoints fostered diversity in practice with respect
to the identification of the risks associated with an entity (i.e., the entitys variability)
and the party that absorbs those risks, which could potentially impact which party
consolidates the VIE.
In April 2006, the FASB Staff responded to this diversity in practice by issuing
guidance which indicates that an analysis of an entitys design must be conducted
to determine the variability that the entity was designed to create and distribute to
its interest holders. It is important to note that the determination of the variability to
be considered in applying the VIE model affects not only the determination of which
interests are variable interests in the entity, but also whether the entity is considered
a VIE, and which party, if any, is the primary beneficiary of the VIE.
The VIE model requires the use of significant judgment in determining what variability
the entity was designed to create and distribute to its interest holders. The by design
model is intended to provide a principle that allows for more consistent application.
ASC 810-10-55-55 through 55-86 also include eight examples that illustrate how to
apply these principles. We have included these examples in Appendix A.
The by design model in ASC 810-10-25-22 through 25-36 presents a two-step

process for determining which variability should be considered in the assessment of
an entitys variability. The two-step process is as follows:
The variability to be considered in applying the Variable Interest
Subsections shall be based on an analysis of the design of the legal
entity as outlined in the following steps:
a. Step 1: Analyze the nature of the risks in the legal entity (see
paragraphs 810-10-25-24 through 25-25)
b. 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 36).
For the 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.
The interest holders who absorb the risks that an entity was designed to pass along
are the entitys variable interest holders.
Step 1 of the by design model is fairly straightforward and its objective is to identify
all of the risks of the entity. Examples of possible risks to which an entity may be
subject to provided in the guidance are as follows:
The risks to be considered in Step 1 that cause variability include, but
are not limited to, the following:
a. Credit risk
b. Interest rate risk (including prepayment risk)
c. Foreign currency exchange risk
d. Commodity price risk
e. Equity price risk
f. Operations risk.
The purpose of Step 2 is to identify which of the risks identified in Step 1 create
variability and are relevant to the assessment of an entitys variability. Under the by
design model, the relevant risks are those that the entity was designed to pass
along to variable interest holders. Step 2 is further elaborated in the by design
model as follows:
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. The activities of the legal entity
b. The terms of the contracts the legal entity has entered into
c. The nature of the legal entitys interests issued
d. How the legal entitys interests were negotiated with or marketed
to potential investors
e. Which parties participated significantly in the design or redesign
of the legal entity.
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.
In performing Step 2 of the by design model, a careful analysis of an entitys
governing documents, formation documents, marketing materials, and terms of
all other contractual arrangements should be closely examined to determine the
variability that the entity was designed to create (i.e., which risks in Step 1 the entity
was designed to create).
To further assist financial statement preparers in making this determination, the
guidance highlights a number of strong indicators that suggest whether or not an
interest is a variable interest (i.e., absorber of variability).
These indicators relate to the following:
the terms of the interest;
subordination of the interest;
certain interest rate risk; and,
certain derivative instruments.
Each of these indicators are discussed further below.

3.2.1 Terms of the Interests Issued

Terms of Interests Issued
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.
If the interest transfers risk and/or return of the entitys assets or operations to the
holder of the interest, this is a strong indicator that the interest is a variable interest
(i.e., absorber of variability). The guidance provides an example of the application
of this concept. In this example, an entity is established with funding in the form of
a 5-year fixed rate note and equity so that it can acquire property. The property is
leased under a 5-year lease to a lessee that has provided a residual value guarantee
for the expected future value of the property at the end of 5 years. Because the
residual value guarantee effectively transfers substantially all of the risks of the
underlying property, there is a strong indication that the residual value guarantee
absorbs the variability that the entity is designed to create.
The determination of whether an interest is a variable interest should not be based
solely on the legal or accounting designation. Rather, the assessment should be
based on whether the interest was designed to transfer risk to the interest holder,
regardless of accounting or legal treatment. This is illustrated in the following
examples.
Example 3-2: Assume that a reporting entity transferred loan receivables in a
true sale at law to a legal entity in return for cash, a beneficial interest in the
legal entity, as well as a noncontingent fixed price call option on the financial
assets transferred. Notwithstanding the true sale at law, the existence of
the fixed price call resulted in the transfer failing sale accounting under
ASC 860, Transfers and Servicing (ASC 860), and as a result, the transfer
must be accounted for as a secured borrowing by both the transferor and
the transferee (i.e., the transferor borrowed from the transferee). Given that,
for accounting purposes, the receivables remain assets on the financial
statements of the reporting entity, many previously believed that the retained
risk (in the form of the beneficial interest in the legal entity) associated with
the receivables would not constitute a variable interest in the legal entity. The
FASBs clarification that economic risks and rewards, not the accounting
designation, should be considered when identifying variable interests could
potentially change this determination. The accounting treatment is not
relevant when assessing the risks that the entity was designed to pass along
to the variable interest holders.
Example 3-3: A reporting entity leases one asset from a legal entity that holds
only two assets. The reporting entity has a fixed price purchase option to
acquire the asset. The fair value of the leased asset is more than 50 percent
of the fair value of the legal entitys total assets. The lease was previously
accounted for as a capital lease. The fixed price purchase option would be
viewed as a variable interest in the entity. If the entity was considered a VIE
(which would be very likely in this fact pattern), the reporting entity could be
required to consolidate the VIE under the power and losses/benefits criteria
(see VE 5.1). The results achieved by consolidating the entire entity (i.e., both
assets and the liabilities of the VIE) could be substantially different from those
achieved by applying prior capital lease accounting to only the leased asset.

3.2.2 Substantive Subordination

The absorption of risks by substantive subordinated interests issued by the entity is a
strong indicator of the variability that the entity is designed to create.
Subordination
For legal entitys 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-atrisk, 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 81010-15-14(a) and 810-10-25-45.
When considering whether a subordinated interest is substantive, we believe that the
following factors should be considered (this is not meant to be an all inclusive list):
The overall waterfall (tranching) of the entity.
Yields (interest rates) of the various interests issued.
Amount and size of the subordinated interests to all other interests issued (e.g., to
total capitalization of the entity).
The nature of any credit ratings of the interests issued.
The nature of the investors and how the instrument was marketed.
3.2.3 Certain Interest Rate Risk

Significant questions have arisen in the past as to whether counterparties to
market-based interest rate swaps and other absorbers of interest rate risk have
variable interests or should consider the interest rate risk variability of the entity.
Consideration of interest rate risk is clarified as follows:
Certain Interest Rate Risk
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 variability that the legal entity was designed to
create and pass along to its interest holders.
Interest rate risk should be excluded from variability if the entity was not designed
to pass along interest rate risk to its interest holders. However, if an entity holds
fixed-rate investments and expects to actively manage the portfolio by selling prior
to maturity, the entity may be designed to pass along interest rate risk to its interest
holders. The cash received upon redemption will vary based on fluctuations in the
interest rate.
The following examples may be helpful in applying this guidance:
Example 3-4: Consider a fact pattern in which an entitys only asset is a
fixed-rate bond that is funded with variable-rate liabilities. The entity enters
into a receive-float, pay-fixed interest rate swap, which allows the entity
to pay a fixed interest rate in return for receiving a variable interest rate. This
swap arrangement synthetically creates a variable-rate asset, which will
absorb the interest rate exposure from the fixed-rate bond (unless the bond is
expected to be held to maturity). We believe that in certain instances, interim
fair-value variability can be ignored if it has no net cash-flow effect on the
variable interest holders.
Example 3-5: Consider an entity which is established to invest in a fixedrate bond that is expected to be held to its maturity, which is funded with
matching maturity fixed-rate debt. In this case, since there is no planned
sale of the fixed-rate bond, the entitys variability would not include variability
caused by changes in interest rates.
Four additional examples that are helpful for determining how to consider interest
rate risk variability have been included in the guidance (these are included as Case A,
Case B, Case C and Case D in Appendix A).
3.2.4 Certain Derivative Instruments

Guidance for making the assessment of whether certain derivative contracts create
or absorb variability is as follows:
Certain Derivative Instruments
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).
b. The derivative counterparty is senior in priority relative to other
interest holders in the legal entity.
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.
It is important to note that this guidance does not constitute a scope exception
for derivatives, but rather simplifies the analysis for many common derivatives
(e.g., certain market-based interest rate swaps and foreign currency contracts). A
determination should be made as to whether the contract meets the characteristics
of a derivative under ASC 815, Derivatives and Hedging (ASC 815). We believe
that only contracts that meet the characteristics of a derivative are eligible for
consideration under the by design guidance, regardless of whether or not the
contract is afforded one or more of the scope exceptions in ASC 815-10.
Next, an evaluation of the contracts underlying must be made to determine whether it
is based on 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). ASC 815-10-15-88 through 91 provides additional guidance on
what constitutes an underlying of a derivative. Generally speaking, normal market
contracts such as Treasury and LIBOR based interest rate swaps, foreign currency
contracts, and commodity futures, would have market observable variables.
Finally, whether the derivative contract is senior in priority (i.e., senior in the waterfall)
relative to other interest holders in the entity should be carefully considered. We
believe that if the derivative is at least pari passu with the most senior interest issued
by the entity, this condition would be met. Although, in practice, this condition
is typically met for many market-based derivatives, this condition should still be
carefully considered.
However, the by design guidance specifies that even if the two conditions
discussed above are met, a derivative may still be a variable interest if the changes
in the value of the instrument are expected to offset all, or essentially all, of the risk
or return related to the majority of the assets or operations of the entity. In these
cases, the design of the entity must be further evaluated. If the entity was designed
to create and pass along specific risks to the derivative counterparty, the derivative
would likely be considered a variable interest.
Refer to VE 3.3.7 for a further discussion of derivatives and embedded derivatives.

3.3 Examples of Variable Interests

Variable interests are not limited solely to equity investments. The excerpt below
clarifies this point:
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.
The following interests (the list is not all-inclusive) may be considered variable
interests:
Examples of Potential Variable Interests

Equity Securities
Beneficial Interests
Debt Instruments
Guarantees
Put Options
Call Options
Management Contracts
Franchise Arrangements
Co-Manufacturing Arrangements
Leases
Co-Marketing Arrangements
Cost-Plus Arrangements
Forward Contracts
Service Contracts
Derivatives
Residual Value Guarantees
Purchase Options
Technology License
Collaborative R&D Arrangements
ASC 810-10-55-16 through 55-41 provide examples of some common contractual

and ownership arrangements, and guidance on determining when these
arrangements are variable interests. Examples of some of the variable interests
included in the list above are discussed in further detail below. Keep in mind that
the guidance provided below discusses the overall concepts of a variable interest
and does not address how the economic risks and rewards are allocated to variable
interest holders. This concept is discussed in VE 5.1.
3.3.1 Equity Investments

The most obvious variable interests are equity investments. The equity investors
provide capital to the entity and receive an ownership interest that exposes the
investors to potential losses and potential returns of the entity. Therefore, they
absorb the entitys economic risks and rewards.
Equity investments in a VIE are variable interests to the extent they
are at risk. (Equity investments at risk are described in 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.
The guidance in ASC 810-10-55-22 differentiates between an equity investment that
is at risk and an equity investment that is not at risk. VE 4.1 provides guidance on
determining when equity investment is at risk. Generally, the principles are based
on whether or not the equity investor is exposed to losses, however there are some
exceptions. The guidance for identifying an equity investment at risk is found in ASC
810-10-15-14a.(1)-(4).
ASC 810-10-55-22 clarifies an important point: just because an equity investment is
not at risk does not necessarily mean that the investment is not a variable interest.
An equity investment that is not at risk may nevertheless absorb expected losses and
3.3.2 Debt Instruments and Beneficial Interests

Reporting entities that provide financing to the entity are entitled to receive fixed or
variable returns from the entity. Because the actual activities and the resulting fair
value of an entity may affect the collectability of these returns, debt instruments
absorb variability. As a result, virtually all debt instruments are variable interests.
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.
As the level of priority with respect to returns of investments increases, the variability
associated with those returns diminishes. Senior debt (e.g., investment grade
debt) and senior beneficial interests with fixed interest rates or other fixed returns,
are nevertheless interests that qualify as variable interests. The level of variability
absorbed by senior interests may be reduced by the nature of subordinated interests
and the relative credit quality of the entity.
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.

3.3.3 Guarantees, Put Options, and Similar Obligations: Options Purchased/

Exercisable by the Entity / Written by the Reporting Entity (see VE 3.3.5 for
arrangements among variable interest holders)
In many circumstances, entities offset the potential risks associated with changes in
the fair value of one or more of their assets or liabilities by entering into arrangements
that transfer some or all of that risk to other parties. In addition, guarantees of the
value of assets or liabilities, written put options on the assets of an entity, and other
similar arrangements are examples of interests that absorb the potential variability
related to the entitys operations and assets. In most cases, the writer of the contract
with respect to these arrangements will absorb at least some portion of the expected
losses of the entity.
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.
In assessing guarantees to determine if they are variable interests, management
should consider whether the guarantee is on specific assets or liabilities of the entity.
The analysis can be different for a guarantee is on the entitys assets compared to a
guarantee on the entitys liabilities.
If a guarantor has guaranteed the value of an asset of the entity, that guarantee is a
variable interest in the entity only if the fair value of the guaranteed assets constitutes
a majority (greater than 50 percent) of the fair value of the entitys total assets. A
guarantee of the value of an entitys assets must first be evaluated to determine
when it is a variable interest in the entire entity (as opposed to a variable interest in
specified assets). This concept, known as variable interests in specified assets, is
described in further detail in VE 3.5.
Similar to a guarantee, a put option written by a reporting entity and purchased
by the entity is a variable interest in the asset underlying the put. The entity (that
purchased the put) receives the right, but not the obligation, to put a specified item
to the reporting entity at a fixed price (i.e., the strike price) during a specified period
or on a specified date. When an entity purchases a put option, it receives the right
to transfer the potential risk of loss on certain assets to the writer of the put (i.e., the
option writer absorbs the risk of loss on the assets value).
Typically, in these arrangements, the purchaser of a put option pays a premium to the
writer for its rights under the contract (i.e., the price of protection on the underlying
asset). That amount is influenced by factors such as the duration of the option, the
difference between the exercise price and the fair value of the underlying assets,
price volatility, and other characteristics of the underlying assets. In return for the
premium, a writer of a put option is exposed to the risk of loss if the fair value of the
underlying assets declines, but profits only to the extent of the premium received,
and if the underlying assets increase in value (because the holder of the option will
not exercise it).
If a reporting entity has guaranteed (e.g., written a put option) a liability of the entity,
that guarantee is a variable interest in the entity. This is because the guarantee is
protecting holders of other variable interests from suffering losses. For example,
a financial guarantor of beneficial interests issued by a securitization entity has a
variable interest in that entity. When assessing such financial guarantee of liabilities
of the entity, it is important to note that they are always variable interests, regardless
of the design of the entity.
If the entity has the option to buy an asset (i.e., a call option) from the writer of the
option at a specified price, this contract is not a variable interest in the entity, as the
option is creating variability for the entity.

3.3.4 Guarantees, Put Options, and Similar Obligations: Options Written by the
Entity (see VE 3.3.5 for arrangements among variable interest holders)
If a 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).
If the entity is a writer of a put option, the contract transfers risk of loss to the
entity and therefore creates variability for the entity. As a result, such contracts
are not generally viewed as variable interests. The variability resulting from these
arrangements must be considered in determining the entitys economic risks and

rewards. This is also consistent with the example in the by design guidance, where
the FASB indicated that the credit default swap written by the entity is not a variable
interest (see Case E in Appendix A).
If the entity writes a call option on its assets, the purchaser of this option has the
right to buy an asset owned by the entity at a specified price. This contract is a
variable interest in the asset because it absorbs the positive variability in the asset
and may be a variable interest in the entity if the underlying asset is greater than 50
percent of the entitys total assets.

3.3.5 Guarantees, Put Options, and Similar Obligations: Options Written/

Purchased Among Reporting Entities
In many circumstances, reporting entities write options that are purchased by
another reporting entity or purchase options that are written by another reporting
entity with respect to an entitys assets/liabilities/equity. These options are not direct
variable interests in the entity since they are not related to a specific contract with
the entity but instead are contracts among reporting entities that have a variable
interest in the entity. Even though the entity is not the counterparty to such options,
however, such options do alter the cash flows with respect to the variable interests
held by the reporting entities in the entity. For example, two Reporting Entities A and
B hold variable interests in Entity X via their ownership of Entity Xs common stock.
Reporting Entity A writes a put option on Reporting Entity Bs variable interest in
Entity X (i.e., a put on Entity Xs common stock held by Reporting Entity A) whose
strike price is fixed. Reporting Entity B holds this put option written by Reporting
Entity A. While this put option may not be a separate variable interest in Entity X and
does not change the variability of Entity X, it is part of the variable interest held by
Reporting Entity A and Reporting Entity B because it alters the cash flows associated
with the variable interest (i.e., Entity Xs common stock) held by Reporting Entity A
and Reporting Entity B. Therefore, it is a variable interest and the option should be
considered when analyzing who the primary beneficiary is, both from the point of
view of the power criterion and losses/benefits criterion (see VE 5.1).
3.3.6 Forward Contracts and Long Term Supply Contracts

The determination of whether forward contracts or long-term supply agreements are
variable interests is complex and involves a careful consideration of the design of the
entity. The FASB has provided little guidance on this determination.
Excerpt from ASC 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.
(continued)
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.
Forward contracts include contracts that meet the characteristics of a derivative
under ASC 815-10 as well as long-term contracts such as purchase or supply
contracts relating to plant output, raw materials, or other goods.
The contract should be evaluated to determine whether it contains an operating lease
(considering applicable lease accounting guidance in ASC 840, Leases (ASC 840)).
If the contract contains a lease, then refer to VE 3.3.11 for a further discussion of
evaluating leases to determine if they are variable interests. The non-lease elements
should also be analyzed to determine if they are variable interests.
If the contract does not contain an operating lease, the contract should be evaluated
to determine whether it constitutes a derivative. If the forward contract meets the
characteristics of a derivative under ASC 815-10, the contract should be evaluated
under the derivative strong indicator in the by design model (see VE 3.2.4).
For those forward contracts and supply arrangements which are not determined
to be creators of variability, a careful analysis of the terms of the contract and the
design of the entity should be considered. The pricing of a contract (e.g., fixed
price or fixed formula, cost plus, etc.) might affect the determination of whether the
contract is a variable interest.
ASC 810-10-55-81 through 55-86 (see Appendix A) illustrates an example of how a
forward purchase contract (i.e., a contract to purchase assets in the future at a fixed
price) may be evaluated when considering whether the contract creates or absorbs
variability. However, we believe that forward contracts are and will continue to be
some of the most difficult interests to evaluate under the VIE model. Whether or not
fixed price forward contracts absorb or create variability in an entity will often depend
on whether there are significant other risks in the entity, other than the volatility in the
pricing of the assets in a forward contract.
Generally, a forward or supply contract to sell assets owned by an entity at a fixed
price (or fixed formula) will absorb the variability in the fair value of those assets.
Similarly, a contract that has certain types of a variable pricing mechanism (e.g., cost
plus) may also be variable interests. However, this does not automatically lead to a
conclusion that such forward contacts are variable interests in the entity. A careful
consideration of the risks associated with the underlying entity and its design must
be considered in making this determination.
A question sometimes arises as to when an asset purchase contract is a variable
interest. In certain cases, it may be viewed similarly to a traditional fixed price
forward contract and, therefore, be considered a variable interest.
Note that if a forward contract relates to specified assets that comprise less than
50 percent of the fair value of the entitys total assets, the contract would not be a
variable interest in the entity (see VE 3.5).

3.3.7 Other Derivative Instruments

29: Derivative instruments held or written by a VIE should be analyzed
in terms of their option-like, forward-like, 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.
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 a VIE without actually transferring the
assets. Derivative instruments with this characteristic should be
evaluated carefully.
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.
The determination of whether a derivative contract is a variable interest can be

difficult and the following factors should be considered:
Entitys activities and design.
Role of the derivative (hedging/speculative purposes).
As mentioned previously, derivatives should be carefully evaluated (see VE 3.2.4 for
further discussion).
In general, an embedded derivative that is not clearly and closely related to its asset
or liability host should be evaluated to determine if it is a variable interest.
When examining debt instruments, the following embedded derivatives would not
typically be evaluated separately as variable interests:
Call options.
Put options.
Caps or floors on interest rates.
Other interest rate indexes.
Credit-sensitive payments or indexes to the issuers creditworthiness.
In these cases, the economic characteristics of the embedded derivatives are clearly
and closely related to the debt instrument. However, in cases where the instruments
have significant leverage or are based on factors that are not economically related to
the debt instrument, each feature should be examined to determine whether it is a

variable interest. This would occur in situations where the debt includes a derivative
that is indexed to one of the following:
Another partys credit (other than the issuers).
Movements in commodities.
Equity prices (e.g., the S&P 500 index).

3.3.8 Assets of the Entity

Assets held by a VIE almost always create variability and, thus, are not
variable interests. However, as discussed separately in this Subsection,
assets of the VIE that take the form of derivatives, guarantees, or other
similar contracts may be variable interests.
Examples of assets that may be variable interests are derivatives, purchased
guarantees, and similar contracts. In addition, an asset may have an embedded
derivative feature that might be considered a variable interest (refer to VE 3.3.7).
3.3.9 Decision Maker or Service Provider Fees

If all of the following characteristics are present, the service provider/decision maker
fee is not a variable interest.
Fees paid to an entitys decision maker(s) or service provider(s) are not
variable interests if all of the conditions below are met:
a. The fees are compensation for services provided and are
commensurate with the level of effort required to provide those
services.
b. 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.
c. 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 a insignificant amount of the VIEs
d. The service arrangement includes only terms, conditions, or
amounts that are customarily present in arrangements for similar
services negotiated at arms length.
(continued)
e. The total amount of anticipated fees are insignificant relative to

the total amount of the VIEs anticipated economic performance.
f. The anticipated fees are expected to absorb an insignificant
amount of the variability associated with the VIEs anticipated
Excerpt from ASC 810-10-55-37A:
For purposes of evaluating the conditions in the preceding paragraph,
the quantitative approach described in the definitions of the 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 810-10-55-37, 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.
b. 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.
Although the conditions appear straightforward, the analysis is complex. We will
address each of these six conditions in more detail below.

3.3.9.1 Condition 1: Fee Commensurate with the Level of Effort Required

We believe that the purpose of this condition is to identify arrangements that
clearly provide a service provider with a significant off market fee element or that is
designed in a manner such that the fee determined or earned is inconsistent with
the service providers role. Ultimately, the facts and circumstances will drive the
conclusion regarding whether the service provider contract meets this condition.
3.3.9.2 Condition 2: Seniority of Service Provider Fees

If substantially all of the service-providers fee is not at or above the same level of
seniority as the entitys other operating liabilities that arise in the normal course of
business, the service contract is a variable interest.
The guidance lacks clarity as to whether or not the evaluation of seniority of the fee
should be based on priority in liquidation (e.g., bankruptcy) or based on how the fee
is determined (i.e., how calculated and whether it is based on earnings of the entity
after consideration of other operating liabilities). It is important to note that the FASB
included such a requirement in order to identify those service provider arrangements
whose fees may not accrue in a manner that is similar to other service providers.
For example, consider a situation where a performance fee is earned based on the
net income of the entity. While a service provider who has earned such a fee may
have a senior claim in bankruptcy, it would seem that such a fee may not be typical
of other service providers of the entity, as it is only owed if there is a residual profit
to calculate it against. However, we believe that preparers could interpret that level
of seniority as only referring to rights in liquidation, or view it more broadly based on
how the fee is determined, provided that either interpretation is consistently applied.
Note that if an accounting policy decision is made to interpret seniority based upon
the contracts standing in liquidation, a careful evaluation of how the service contract
is paid in liquidation should be made. Preparers may require the assistance of legal
counsel in making this evaluation.
Additionally, the new VIE model does not provide guidance to help assess
substantially all. While the guidance allows some element of the fee to not be
considered as senior, it neither discusses a bright line, nor how to measure such a
threshold. Some of the factors that could be considered in interpreting substantially
all are as follows:
Substantially all is intended to be a very high threshold. While we do not believe
that there are any bright lines in interpreting such threshold, substantially all has
been interpreted in other areas of GAAP to mean greater than 90%.
The design of the fee arrangement and the role of the service provider may provide
insights into why there is a fee element which could be earned that is not at least
pari passu to other operating liabilities.
A critical assessment of the underlying fee economics. For example a qualitative
understanding of both of the following may aid in performing this assessment:
Expectations regarding the anticipated portion of both the senior fee element
and the non-senior fee element.
The potential variability of the senior fee element and the non-senior fee
element.

3.3.9.3 Condition 3: Service Provider and Related Parties Do Not Hold Other
Variable Interests in the VIE
A service provider fee is considered a variable interest if the service provider or its
related parties have another variable interest in the VIE that absorbs more than an
insignificant amount of the entitys variability. We understand from our discussions
with the FASB that it believes that probability should be one of the factors considered
in assessing the requirements of Condition 3.
With respect to this condition, the term related parties denotes all related parties
and de facto agents as defined in the VIE model except that employees and
employee benefits plans of the service provider are excluded unless the employees
and employee benefit plans are used in an effort to circumvent the provisions of the
standard.
Companies should identify and consider all contractual arrangements with an entity in
the aggregate (including, for example, equity investments, debt investments, lines of
credit, liquidity arrangements, letters of credit, derivatives, financial guarantees, etc.).
Judgment will be required to assess whether another interest or interests absorb
more than an insignificant amount of the entitys expected losses or receive more
than an insignificant amount of the entitys expected residual returns. While the
FASB has included the concept of expected losses and expected residual returns,
they did not intend for this requirement to be demonstrated by performing a detailed
expected loss analysis. Rather, the FASB expects preparers to exercise judgment
in performing a qualitative assessment of the economics provided by the service
providers other interests.
Additionally, more than an insignificant amount has not been defined and is
intended to mean the same as significant. However, in assessing more than an
insignificant amount, it is clear that the FASB does not expect it to be a bright
line analysis. In assessing this threshold, the FASBs objective of identifying
arrangements that are fiduciary in nature should be considered. We believe that the
interpretation of the more than an insignificant amount is a fairly low threshold and
if the reporting entity determines it absorbs more than an insignificant amount with
respect to a variable interest, then it will likely also meet the losses/benefits criterion
(see VE 5.1.3). We also believe that a qualitative assessment of the additional variable
interest(s) held by the service provider (and its related parties) utilizing the following
factors may assist in that determination:
The size of the variable interest to the overall capitalization of the entity.
The commercial reasons as to why such variable interest is held by the service
provider. For example, consider situations in which investments by the service
provider were made to support marketing of investments into the entity. In this
case, it may indicate that the service provider made such investment to signal
to others that the service provider is willing to put its own interests at risk. This
may indicate that the service provider is not acting as a fiduciary as it made the
investment to demonstrate to the other investors that it has skin in the game.
The relative risks and rewards of the variable interests held by the reporting entity
to the overall economics of the structure.
The seniority of the other variable interests. We believe that as the variable
interests seniority becomes lower (i.e., more subordinate to other interests) the
threshold at which the interest is more than insignificant becomes lower.
The FASB decided to exclude interests held by employees from this evaluation
in recognition of the fact that employees of investment managers often invest in
their employers funds. The FASB did not believe this should prevent the fees from
qualifying for the exception under condition 3. Further, the FASB also decided
to exclude interests held by employee benefit plans because it believed that the
substantive regulatory and fiduciary requirements governing employee benefit plans
are sufficient to permit this exclusion.

3.3.9.4 Condition 4: Service Arrangement Includes Customary Terms, Conditions

or Amounts
Unique and uncustomary provisions indicate that the service provider/decision maker
may be functioning in a manner that is inconsistent with the behavior of a provider of
customary fiduciary-type services to the entity. Corroborating whether the provisions
are customary may require a reporting entity to evaluate similar contracts in similar
industries.
3.3.9.5 Conditions 5 and 6: Total Anticipated Fees and Their Variability are
Insignificant Relative to the VIEs Anticipated Economic Performance and
the VIEs Variability
The FASB included these two conditionsone based on anticipated performance
and the other based on the variability in performanceto assist in the identification
of whether the fees of a service contract may indicate that the service provider is
acting as a principal rather than an agent. The FASB believes that if the fee is more
than insignificant to the entity (i.e., the fee is significant), then it would indicate that
the service provider has sufficient economic benefit to conclude that it is not solely
acting as a fiduciary. This is despite contractual limitations that may be provided
in the contract to act as a fiduciary (e.g., contractual terms that require the service
provider to act as a fiduciary or to provide professional due care in carrying out its
role as a service provider).
The FASB does not believe that more than insignificant is a bright line analysis,
but rather should be assessed on a qualitative basis. Additionally, when assessing
service contracts under these two conditions, it is not expected that preparers
would perform an analysis that is consistent with the expected losses and expected
residual return analyses that may have been typically performed under the prior
VIE model. In performing the evaluation of these two conditions, the following
considerations may be useful:
The anticipated economic performance of the entity and the service contract over
the anticipated life of the entity should be considered based on its design.
In considering the variability of the economic performance of the entity and the
service contract, a careful consideration should be made with respect to the key
drivers of variability of the entity (based upon the analysis described in VE 3.2).
The performance elements of the fee may have certain hurdle rates whereby
the fee will only be earned if such a rate is met. An evaluation of the likelihood
of meeting that rate could be useful in the analysis as well as the size of the fee
relative to the performance of the entity (if the hurdle is met).
We understand from our discussions with the FASB that it believes that probability
should be considered in considering the anticipated economic performance of the
entity and its variability.

3.3.9.6 Reconsideration of Decision Maker and Service Provider Arrangements

VE 4.3 describes reconsideration events to re-evaluate whether or not an entity is,
in fact, a VIE under the VIE model. VE 5.1 discusses that the VIE model requires an
ongoing reconsideration of whether a reporting entity is the primary beneficiary of
a VIE due to changes in facts and circumstances. The VIE model does not specify
reconsideration of whether or not a decision maker or service provider arrangement
is a variable interest should be based on reconsideration events or should be carried
out on a continuous basis. We believe that reconsideration of whether or not a
decision maker or service provider arrangement is a variable interest is a policy
choice by the reporting entity (see Question 3.2 in this Chapter).
3.3.9.7 ASU 2010-10 and Its Potential Impact on Decision Maker and Service
Provider Arrangements
On February 25, 2010, the FASB issued Accounting Standards Update 2010-10
(ASU 2010-10) to defer the VIE model as amended by ASU 2009-17 for certain
investment entities that have the attributes of entities subject to ASC 946. Included
in ASU 2010-10 were two clarifications to the variable interest evaluation of service
provider and decision maker arrangements. The ASU clarifies that related parties
should be considered when evaluating each of the criteria (i.e., each of the conditions
described above) for determining if a decision maker(s) or service provider(s) fee
represents a variable interest, with an exclusion for an employee of the service
provider or an employee benefit plan as long as the exception is not used in an effort
to circumvent the provisions of the VIE model. Based upon the language used in the
guidance, some users had inferred that related parties had to only be considered
when evaluating Condition 3.
In addition, ASU 2010-10 clarifies the FASBs view that when evaluating whether
a decision maker or service provider holds other interests in the variable interest
entity that would absorb more than an insignificant amount of the expected losses
or receive more than an insignificant amount of the expected residual returns (i.e.,
Condition 3), a formal quantitative assessment (e.g., expected loss calculation) is
not required and should not be the sole determinant as to whether such rights and
obligations exist.

3.3.10 License, Royalties, and Other Similar Arrangements

Generally, these contracts are linked to an entitys performance indicators (e.g.,
revenue, EBITDA, etc). As a result, such contracts typically absorb variability in the
entity in that they have variable payments that entitle the counterparty to changes in
the fair value of the entitys net assets. For example, if a reporting entity earns royalty
from a technology license that it licensed to the entity based on the entitys sales,
then such an arrangement is a variable interest that absorbs variability in the entity.
However, if the entity earns royalty from a technology license that it licensed to the
reporting entity based on the reporting entitys sales, then such an arrangement is
typically a variable interest to the entity that absorbs variability in the reporting entity.
3.3.11 Leases
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.
Entity Is Lessor (Entity Leases Assets to Others)
Lease receivables of the entity are not variable interests. Rather, receivables under
operating leases create variability in the entitys operations and fair value.
The following embedded features included in operating leases may be variable

interests:
Lessee purchase options.
Lessee residual value guarantees.
Lessee renewal options.
Lessee Purchase Options
A fixed-price or formula-based purchase option is a variable interest in the asset
because it provides the holder of that option with the potential to purchase the asset
at a price that is less than fair market value. Effectively, if the purchase option were
exercised, the equity investors would not receive all of the assets expected residual
returns. If the purchase option were on assets that comprise less than 50 percent of
the fair value of the entitys total assets, the purchase option would not be a variable
interest in the entity as a whole. Rather, it would be a variable interest in specified
assets (refer to discussion in VE 3.5 regarding variable interests in specified assets).
Lessee Residual Value Guarantees
In many leasing arrangements, the lessee provides a residual value guarantee on
the leased asset. A residual value guarantee is a variable interest because it protects
the equity investors from negative variability in the fair value of the leased asset (i.e.,
the equity investors do not have the obligation to absorb all of the entitys economic
risks). If the residual value guarantee covers only specified assets that comprise
less than 50 percent of the fair value of the entitys total assets, the residual value
guarantee would not be a variable interest in the entity; rather it would be a variable
interest in specified assets (refer to discussion in VE 3.5 regarding variable interests
in specified assets).
Lessee Renewal Options
We also believe that renewal options in leases with strike prices at an amount other
than fair value may be variable interests. If a lease includes one or more renewal
options, and those renewal options are not included in the lease term, as defined
in ASC 840-10-20, the renewal option is a variable interest because it provides
the lessee with the right to use the assets for a period beyond the original lease
term. Thus, the renewal option captures a portion of the residual value of the asset.
However, if the renewal option was solely for specified assets that represent less than
50 percent of the fair value of the entitys total assets, the renewal option would not
be a variable interest in the entity. Rather, it would be a variable interest in specified
assets (refer to VE 3.5 for a discussion of variable interests in specified assets).
See VE 5 for primary beneficiary analysis, particularly with respect to certain single
asset owning special purpose entities (lessor entities).
Entity Is the Lessee
When the entity is the lessee (in both operating and capital leases), it should be
treated much like a debt instrument is treated since these are, in essence, financing
arrangements.
3.4 Implied Variable Interests

In applying the VIE model, in addition to assessing the economic arrangements in
the form of an explicit contractual arrangement with an entity, implied relationships
should also be considered. Implicit guarantees of an entitys assets are variable
interests if they protect holders of other interests from suffering losses. Such implicit
guarantees are implied variable interests that should be considered in determining
whether an entity is a variable interest entity and in identifying which party, if any, is
the entitys primary beneficiary. In essence, an implicit variable interest should be
treated no differently than an explicit variable interest. Implicit variable interests often
manifest themselves in fact patterns where two related parties may be involved in an
entity, but only one has an explicit variable interest.
The VIE model provides guidance for determining when activities around the entity
would cause a reporting entity to have a variable interest. An implicit variable
interest is described as an interest that absorbs or receives the variability of an entity
indirectly, rather than through contractual interests in the entity.
Excerpts from ASC 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 an
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 VIE from absorbing
losses incurred by the legal entity. See Example 4 (paragraph
810-10-55-87) for an illustration of this guidance.
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.
The guidance does not, however, provide a bright line for determining when an
implicit variable interest exists. Instead, it indicates that such determinations are a
matter of judgment and will depend on the relevant facts and circumstances.
The guidance on implicit variable interests is important for a number of reasons. In
particular, it helps to ensure that the objective in the VIE model is met regarding the
consolidation of variable interest entities by a company that (a) has the power to make
decisions that significantly affect the economic performance of the entity and (b)
absorbs losses or has the right to receive benefits from the VIE that could potentially
be significant to the VIE. It also prevents reporting entities from circumventing the
provisions of the VIE model by absorbing variability indirectly, such as through an
arrangement with another interest holder, rather than directly from the entity.
Implicit variable interests may arise from transactions with related parties, as well
as unrelated parties. The VIE model provides one clear example: Reporting Entity
A leases a facility from Entity B, which is owned by one of Reporting Entity As
two owners and has the facility as its only asset. The lease, which qualifies as an
operating lease, contains no explicit guarantees or purchase options, and is therefore
not considered a variable interest. Reporting Entity A should consider whether it
holds an implicit variable interest in Entity B as a result of its leasing arrangement
and its relationship with the owner of Entity B. All relevant facts and circumstances
should be considered to determine whether Reporting Entity A may effectively
protect all or a portion of the owners investment or would be expected to make
funds available (this would indicate that an implicit variable interest exists). Those
facts and circumstances may include both impediments to protect and incentives to
protect. The following table illustrates this concept:
Impediments to Protect
Incentives to Protect
Whether Reporting Entity A has the

capacity to provide protection of Entity B
Whether Reporting Entity A is a related

party, has other fiduciary responsibilities to
Entity B, or is under common ownership
Whether Reporting Entity A has any debt

covenants or other restrictions that would
prevent it from protecting Entity B
The importance of the facility and the

economic reality for Reporting Entity A to
relocate
Whether there are regulatory or other

constraints that could consider such
actions as conflict of interest or illegal
Whether there may be any consequences

to Reporting Entity A with Entity B
defaulting on its debt
Another indicator is whether Reporting Entity A has, in the past, provided any
guarantees or indemnified losses of Entity B.
It is important to note that implicit interests can also result from contractual
arrangements with unrelated variable interest holders. A reporting entity may enter
into contractual agreements with variable interest holders that effectively protect
those holders from absorbing a significant amount of an entitys variability. In these
circumstances, the contractual agreements with the variable interest holders may be
considered implicit interests in the variable interest entity, although there may be no
direct contractual interest in the variable interest entity.
At a minimum, reporting entities should consider the following questions (which by
no means constitute an all-inclusive list) when assessing whether an implied variable
interest is held in an entity:
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 entity?
We believe that all activities between variable interest holders, the entity, and entities
involved with the entity must be considered in the application of the VIE model. A
reporting entity should also consider the substance of the arrangement, including
all economic and related-party relationships between the reporting entity and the
entity in assessing whether the reporting entity might be exposed to the majority
of the risks associated with the VIE. The need to determine the substance of such
arrangements underscores the importance of understanding and assessing the terms
for all significant contracts and arrangements.

3.5 Variable Interests in Specified Assets

Some reporting entities may have a variable interest in certain assets of an entity, as
opposed to a variable interest in the entity as a whole.
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.
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.
If a reporting entity has a variable interest in an asset, both of the following conditions
must exist for a reporting entity to conclude that its variable interest is not in the
entity as a whole:
The variable interest relates to specified assets that comprise less than a majority
of the total value of the entitys assets (on a fair-value basis).
That holder of the variable interest does not have another variable interest in
the entity as a whole (except interests that are insignificant or have little or no
variability).
We believe that this guidance applies only to variable interests in specified assets. A
guarantee on the repayment of debt which is dependent on the general credit of the
entity, regardless of how much debt the guarantee relates to, is a variable interest in
the entity.
The following example illustrates the application of variable interest in specified
assets of a VIE:
Example 3-6: Background: Assume that an entity owns two assets: a building
worth $5.2 million and equipment worth $4.8 million. The building is leased to
Reporting Entity A under a long-term lease, and Reporting Entity A provides
a residual value guarantee that the building will be worth $4.2 million at the
end of the leases term. The equipment is leased to Reporting Entity B under
a long-term lease, and Reporting Entity B provides a residual value guarantee
that the equipment will be worth at least $3.0 million at the end of the leases
term.
Evaluation of Residual Value Guarantee Provided by Reporting Entity A: The
residual value guarantee provided by Reporting Entity A is a variable interest
in the entity, since the guarantee is on an asset that represents more than 50
percent of the total fair value of the entitys assets (the fair value of the asset
is 52 percent of the total fair value of assets).
Evaluation of Residual Value Guarantee Provided by Reporting Entity B: The
residual value guarantee provided by Reporting Entity B is not a variable
interest in the entity since it is on an asset that represents less than 50
percent of the total fair value of the entitys assets (the fair value of the asset is
only 48 percent of the total assets). Expected losses covered by this residual
value guarantee would not be considered as part of the expected losses of
the overall entity.
It is important to note that the determination of whether the variable interest relates
to the entity or a specified asset in the entity is based solely on the fair value of
the asset compared to the fair value of the entitys total assets, and not the level
of protection provided to the asset or rights to upside on the asset. The reporting
entitys actual obligation related to the specified assets does not influence the
evaluation. For example, a guarantee related to the value of assets that comprise 90
percent of the entitys assets may be limited to 10 percent of the total loss in value
of those assets. Although limited, that guarantee would constitute a variable interest
in the entire entity and would likely result in the entitys being considered a VIE
because that guarantee protects the equity investors from first-dollar losses on their
investments.
How Variable Interests in Specified Assets Affect the Determination of the Expected
Losses of the Entity
If a variable interest is determined to be a variable interest in specified assets and
not a variable interest in the entity as a whole, the expected losses and expected
residual returns related to those specified assets that are absorbed by such
interests should be excluded from the calculation of the entitys expected losses
and expected residual returns. Effectively, this means that the entitys expected
losses and expected residual returns are calculated net of the effects of any variable
interests in specified assets that are not variable interests in the entity as a whole. If
an interest is determined to be a variable interest in specified assets and not in the
entity as a whole, it is viewed in essence as a creator of variability, not an absorber.
If an interest in specified assets of an entity is a variable interest in the entity as a

whole, the losses related to those specified assets absorbed by the variable interest
are included in the entitys expected losses for the purposes of determining whether
the entity is a VIE (refer to VE 4.2.1 for information on assessing the sufficiency of the
equity investment). In this case, the entitys expected losses and expected residual
returns are grossed up to the amounts that they would be absent the effects of the
variable interest.
For example, if the guarantee in Example 3-6 above only provided protection up to
the first $100,000 of losses on the equipment, expected losses of the entity would
exclude the first $100,000 of losses in the value of the equipment, but include the
amount in excess of $100,000 (i.e., losses not absorbed by the guarantee).

3.6 Silos: A VIE within a VIE

While only legal structures can be VIEs, the FASB was concerned that VIEs could
be structured to separate the rights and obligations of different parties involved and
therefore to avoid consolidation.
As a result, the FASB included the notion of a silo in the VIE model. A silo can be
thought of as a VIE within a VIE, in which a party holds a variable interest in selected
assets and liabilities of a VIE (i.e., a reporting entity consolidates a discrete portion of
a VIE as if it were a separate legal entity).
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.
To help with the identification of silos, the VIE model guidance states the following:
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.
Given this guidance, we believe that silos will exist in very limited circumstances and
only be given recognition when the following conditions are met:
Specified assets, specified liabilities, and specified equity are separate from the
overall entity.
Specified assets, specified liabilities, and specified equity are clearly identifiable.
Essentially none of (1) the returns from the separate assets are shared/used by
holders of interests in the larger VIE and (2) the specified liabilities are not paid
using assets of the larger VIE.
There is a primary beneficiary of the silo.
The entity as a whole is a VIE.
How Silos Affect VIE Analysis
A silo can only exist within a VIE. If the silo is deconsolidated from the larger VIE,
expected losses and expected residual returns of the silo would not be considered
in the calculation of expected losses and expected residual returns of the larger legal
entity. Therefore, in determining the expected losses and expected residual returns o
the remaining VIE the following steps should be performed:
Identify potential silos.
Determine whether a primary beneficiary exists for the potential silo.
If so, exclude the expected losses and expected residual returns of the potential
silo from the overall entity.
Performing these steps complicates the expected-loss considerations of the larger
legal entity. However, silos only exist in a few limited cases (i.e., the conditions of
being a silo are extremely restrictive and very difficult to meet). Therefore, most
reporting entities will not need to perform this step.


Decision Maker or Service Provider Fees
Question 3-1: Should significant unanticipated market changes and their impact on
the performance of the entity require a reassessment of whether or not a decision
maker or service provider arrangement is a variable interest under Conditions 3 (other
interests that absorb more than an insignificant amount of the entitys variability),
5 (anticipated fees are insignificant to the total entitys anticipated economic
performance) and 6 (anticipated fees are expected to absorb an insignificant amount
of the variability associated with the entitys anticipated economic performance)?
PwC Interpretive Response: The new guidance does not specify whether the
reassessment of whether or not a decision maker or service provider contract is
variable interest should be re-performed when the entity has a significant change
in its anticipated performance. We believe that reporting entities can reassess
on an ongoing basis whether or not a decision maker or service provider fee is
a variable interest for such situations. If a reporting entity were to establish an
accounting policy requiring such assessment, we would generally expect that
only significant economic changes in the performance of the entity could change
previous conclusions reached. For example, if a reporting entity has concluded
that the service contract is no longer a variable interest because other interests
held no longer absorb more than an insignificant amount of the entitys variability
(Condition 3), then the reporting entity must be comfortable that the likelihood of
the interest attracting significant variability in the future is highly unexpected or
anticipated. Additionally, it would be important to assess whether the substance
of the entitys role as a service provider has evolved as that of a fiduciary (or vice
versa).
Additionally, we believe there can be specific events that occur that would require
a re-evaluation, for example, a sale of another interest held by the reporting entity
which would result in the service provider no longer holding another interest in the
entity therefore allowing it to now meet Condition 3 (other interest that absorb a
more than insignificant amount of the entitys expected losses).
Question 3-2: Do servicing arrangements that include servicing advances and
clean up calls meet the service arrangement includes customary terms, conditions
or amounts condition (i.e., Condition 4) to not be considered as a variable interest?
PwC Interpretive Response: Yes, we believe that servicing contracts that include
the right to provide servicing advances and the right to exercise clean up calls
are customary in many asset-backed securitization arrangements and would
generally meet Condition 4 (i.e., the service arrangement includes customary
terms, conditions or amounts condition to not be considered as a variable
interest).
Implied Variable Interests
Question 3-3: The chief executive officer (CEO) owns 100 percent of Lessor and
holds 61 percent of the voting rights of Lessee. Lessor is a real estate company that
principally leases office buildings to Lessee. Lessee is a publicly traded financial
institution. Lessee is governed by an independent board of directors and is regulated
by governmental banking agencies. Both the board of directors and the banking
regulators govern related party transactions. All of the lease arrangements between
the two companies are classified as operating leases under ASC 840. In addition,
the lease terms are considered at market rates and terms. The leases do not have
residual value guarantees or purchase options, and therefore are not explicit variable
interests that Lessee has in Lessor. From Lessees perspective, are the lease
agreements considered implied variable interests in Lessor?
PwC Interpretive Response: No, the facts do not support this conclusion.
The independent board of directors that governs Lessee and the governmental
banking regulatory oversight preclude the CEO from making any decisions
regarding Lessees involvement with Lessor that would not be in the best interest
of Lessees public shareholders.
The identification of an implicit or explicit variable interest may affect (1) the
determination of whether the entity should be considered a VIE, (2) the calculation
of expected losses and expected residual returns, and (3) the determination of
the VIEs primary beneficiary (or, alternatively, the determination that the VIE has
no primary beneficiary). The determination of whether the Lessee is effectively or
implicitly guaranteeing all or a portion of the CEOs investment in the Lessor or the
property subject to lease should take into consideration all of the relevant facts
and circumstances, including the following:
Does the lessee have an economic incentive to act as guarantor or to make
funds available to the lessor, even though the lessee is not contractually
required to do so?
Has economic protection been historically provided?
In performing a consolidation analysis, clients and engagement teams should
consider both the impediments and incentives. In this particular fact pattern, the
impediments far outweigh the incentives.
An implicit guarantee may exist if there were incentives for Lessee to protect
Lessor and there were no substantive barriers impeding the following:
CEOs decision making ability vis--vis Lessor in the setting of lease rates
between Lessor and Lessee.
CEOs ability to require Lessee to make payments to Lessor, above and
beyond those contractually stipulated under the lease arrangements as
reimbursement for losses that Lessor incurred by virtue of holding the leased
assets.
In this fact pattern, however, the CEOs decision making ability is thwarted by
various impediments, including the independent audit committee, the board of
directors, and the need to comply with governmental banking regulations. These
barriers preclude Lessee from (1) entering into leases with above-market rents
to protect the CEOs interest in Lessor; (2) making payments other than rental
payments required by the lease; (3) entering into lease agreements for space that
is not needed; and (4) providing Lessor with additional cash to protect the CEOs
equity in the event that losses are incurred. Historically, Lessee has not leased
property from Lessor at above-market terms or that it did not need.
Call Options
Question 3-4: A venture is created, whereby Company A and Company B each
contributes $50 million in cash in exchange for a 50% equity ownership. The
ventures board of directors consists of 4 directors. Company A and Company B
each has equal representation on the board and decisions require a unanimous vote.
Company A has an option to purchase Company Bs equity interest for $60 million
two years from the ventures inception date. Is the option to purchase Company Bs
equity interest a variable interest at inception under ASC 810?
PwC Interpretive Response: Yes. The option is a variable interest since it is
exercisable at a fixed price and as a result Company A absorbs the positive
variability from the change in the fair value of the venture.
We believe that if the strike price of the option is at true fair value, then such
an option is not to be a variable interest since the option price fluctuates with the
change in the fair value of the entity. Caution should be exercised with respect to
fair value call options to ensure that the definition of fair value in the agreement
is consistent with true fair value. Some agreements may define formulas for
the strike price of the call option designed to mimic fair value or expectations of
fair value (e.g., formulas based on trailing earnings before interest, depreciation
and taxes). In many cases, these formulas may be close to fair value, but do not
represent fair value.
Non-refundable Deposits
Question 3-5: Company A (reporting entity) enters into a purchase and sale
agreement with Company X (entity) under which Company A will buy from Company
X and Company X will sell to Company A land and building. Company Xs sole asset
is the land and building under the agreement. As part of the agreement, Company A
is required to pay a non-refundable deposit to Company X. Company A also has the
right to terminate the contract, subject to the loss of its deposit. Does Company A
have a variable interest in Company X due to the purchase and sale agreement?
PwC Interpretive Response: Generally yes. This situation is common with land
deposits for homebuilders but is equally relevant to many purchase and sale
agreements for real estate.
A plain vanilla purchase and sale agreement for real estate that provides for
conditions precedent to closing generally would not be considered a variable
interest since it typically does not transfer to the buyer the usual risks and rewards
of ownership, primarily as a result of the many substantive conditions that
exist and that result in the purchase being contingent upon satisfaction of such
conditions. Some relevant considerations include:
Does the execution of the purchase and sale agreement transfer the risk of
loss with respect to the property to the prospective buyer?
Is sale contingent upon the existing lenders consent to the transfer of the
property and assumption of existing loan?
(continued)
Is seller required to comply with specific title and zoning requirements,

specified violations that must be cured prior to closing, obtain estopper
certificates, etc.?
Is buyer allowed to terminate contract upon certain specified material events?
In the fact pattern in this example, the purchase and sale agreement of real estate
requires Company A (buyer) to make a non-refundable deposit to Company X
(seller) where Company Xs sole asset is the real estate subject to the agreement,
The non-refundable deposit absorbs some of the Company Xs variability
and transfers to the buyer some of the usual risks and rewards of ownership.
Therefore, the purchase and sale agreement in this fact pattern is a variable
interest that Company A holds in Company X.
In circumstances in which the selling entity has other assets (outside of the real
estate subject to the purchase and sale agreement), a careful analysis under
ASC 810-10-25-55 must be performed in order to determine whether or not it
represents a variable interest in specified assets and therefore not a variable
interest in the entity overall.
Question 3-6: Similar fact pattern as in Example 3-6 above except that Company
As deposit is a conditionally refundable deposit. The purchase and sale agreement
states that Company A is obligated to purchase the land and building only if (i)
Company X gets the zoning for the property changed; or (ii) Company X obtains
written consent from its lenders permitting Company A to assume existing nonrecourse debt encumbering the property. There is a time limit on the resolution of the
contingencies and if the contingencies are met, Company A must either purchase the
land and building or forfeit the deposit. Does Company A have a variable interest in
Company X due to the purchase and sale agreement? Should the purchase and sale
agreement be re-evaluated if and when the contingencies are met?
PwC Interpretive Response: It depends on the nature of and status of the
contingency. To determine whether or not a purchase and sale agreement is a
variable interest, the agreement must be evaluated to determine whether or not
it transfers to the buyer (reporting entity) the obligation to absorb some or all of
the variability of the selling entity. For instance, if a purchasers rights to terminate
an agreement to purchase real estate and receive a refund of its deposit are
substantive, an acceptable view would be that such a contingently refundable
deposit is not a variable interest, primarily because neither the seller nor the
purchaser has control over these contingent events, and therefore, the deposit
could be seen as a contingent forward contract.
The determination of whether the purchasers rights are substantive should be
based on facts and circumstances. In the fact pattern under consideration, the
buyers rights to terminate the contract and receive a refund of its deposit are
substantive since the contingencies are not within the control of either the buyer
or seller and involve some uncertainty relating to obtaining third party action. If the
contingency were solely in control of the buyer or seller, such provisions may not
be substantive and the arrangement should be evaluated as if the amount was
non-refundable.
(continued)
Furthermore, the resolution of whether the conditionally refundable deposit

is a variable interest would need to be re-evaluated if a reconsideration event
occurred ASC 810-10-35-4. For example, in the circumstances described above,
if the contingencies were met (i.e., zoning approval obtained or lender approval
received) and no remaining contingencies existed, a reconsideration event may
have occurred. The deposit should then be viewed as a non-refundable deposit
and re-evaluated per Example 3-6 above.
Chapter 4:
Determining Whether an Entity is a VIE
Determining Whether an Entity is a VIE / 4 - 1
Executive Takeaway
One of most critical steps in applying the VIE model is assessing whether or
not an entity is a VIE. The overall objective is to identify those entities for which
voting interests are not effective in determining whether the holder of the voting
interests or another party has a controlling financial interest in the entity. The VIE
model assumes that voting equity holders do not have traditional characteristics
of control (and therefore that the entity is a VIE) if any of the following conditions
exist:
The entity is thinly capitalized (i.e., the equity is not sufficient to fund the entitys
activities without additional subordinated financial support).
The equity holders as a group have one of the following four characteristics:
Lack the power to direct the activities that most significantly impact the entitys
Possess nonsubstantive voting rights.
Lack the obligation to absorb the entitys expected losses.
Lack the right to receive the entitys expected residual returns.
To determine whether the characteristics of a VIE are present, it is necessary to
identify which investors and investments are considered at risk, as described in
the VIE model.
The VIE model requires the reporting entity to determine whether an entity is a VIE
at the time of its creation and/or design (or on the reporting entitys first date of
involvement with that entity) and to re-evaluate whether or not that entity is a VIE if
certain events occur.
4 - 2 / Determining Whether an Entity is a VIE
Chapter 4: Determining Whether an Entity is a VIE

4.1 First Step: Identifying the Holders of the Equity Investment at Risk
The definition of an equity investment at risk (or equity at risk) in the VIE model
must be used to determine whether or not any of the characteristics of a VIE are
present. Equity investments that are recorded in the equity section of the entitys
GAAP financial statements are the starting point for this evaluation. However, just
because an investment is labeled as equity in the entitys financial statements does
not necessarily mean that it is at risk. A careful analysis is necessary to ensure that
an equity investment meets the conditions of being at risk. An equity investment at
risk is defined as follows:
For this purpose, the total equity investment at risk has all of the
following characteristics:
1. Includes only equity investments in the legal entity that
participate significantly in profits and losses even if those
investments do not carry voting rights
2. Does not include equity interests that the legal entity issued in
exchange for subordinated interests in other VIEs
3. 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
4. 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.
Examples of equity instruments that do not qualify as equity at risk include the
following:
Equity that, due to its legal rights, does not participate significantly in income and
losses of the entity. For example, nonparticipating, fixed-rate, preferred stock
would not qualify, since it does not participate in the income of the entity.
Equity provided to the equity investor in the form of fees, such as sweat equity
or certain management or development fees that were received by the equity
investor from the entity or from other involved parties.
Equity that was issued in exchange for a note from the equity investor that is
payable in the future after the entity was created (refer to VE 4.1.1).
4.1.1 Starting Point: GAAP Equity

As noted above, the starting point for identifying equity at risk is identified as follows:
Equity investments in a legal entity are interests that are required to
be reported as equity in that entitys financial statements.
An analysis should be performed to understand the nature of the investments
and to ensure that they would be reported as GAAP equity in the entitys
financial statements. For example, if an entity was created after the effective
date of the guidance in FAS 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity (FAS 150 now codified in ASC
480, Distinguishing Liabilities from Equity (ASC480)), and the entity issued datecertain redeemable preferred stock, those interests (the preferred stock) would
not be recorded as GAAP equity and therefore would be excluded from equity at
risk. However, temporary equity pursuant to EITF Topic D-98, Classification and
Measurement of Redeemable Securities (codified as ASC 480-10), does represent
and could be included in equity at risk provided that it meets all of the requirements
described later in this section.
Changes in GAAP since the determination date do not affect the VIE analysis unless
a VIE reconsideration event has occurred (refer to VE 4.3).
Slight changes in the form of the equity (especially certain preferred stock
investments) may result in different consolidation conclusions. In addition, if a
reconsideration event occurs (refer to VE 4.3) and if GAAP has changed since the
prior determination date, an entity previously considered a voting interest entity may
become a VIE. For example, upon adoption of the VIE model, the determination date
for many entities created prior to February 1, 2003 preceded the effective date of the
guidance in FAS 150. A VIE reconsideration event occurring after the adoption of the
guidance in FAS 150 may cause certain equity previously to be deemed at risk to be
reclassified as debt and no longer considered equity at risk for purpose of evaluating
VIE status.
Often, entities are established with investments that economically are very similar to
equity (e.g., subordinated debt), but are not reported as equity for GAAP purposes.
These investments cannot be considered part of the equity investment at risk.
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.
In addition, commitments to fund the future operations of the entity, or promises to
provide cash in the future in exchange for an equity interest (i.e., a stock subscription)
are generally not considered GAAP equity, as they would not be reported as equity in
the entitys financial statements and should be excluded from the equity investment
at risk. Additionally, since an equity subscription receivable is generally accounted for
by recording an equal and offsetting debit in the equity section of the entitys financial
statements, it would reduce the equity investment.
Whats Next: Is it at Risk?
After an identification of the components of GAAP equity, the next step is to assess
whether the equity is considered at risk for purposes of the analysis under the VIE
model. There are four conditions (see VE 4.1.2.5) that the reporting entity must
consider to conclude that GAAP equity is at risk under the VIE model. If there is more
than one investor, the reporting entity must evaluate each investment separately
against the four conditions.

4.1.2 Equity Must Participate Significantly in the Entitys Profits and Losses
Excerpt from ASC 810-10-15-14(a)(1):
Includes only equity investments in the legal entity that participate
significantly in profits and losses even if those investments do not carry
voting rights.
Based on our discussions with the FASB staff, the terms profits and losses refer
to GAAP profits and losses (as opposed to expected losses and expected residual
returns). This means that the equity investment must share (or participate) in the net
income or loss of the entity. Some equity investments may share only in the profits
of the entity and are not exposed to the losses of the entity. In that case, the equity
investment would not be considered at risk. For example, while equity investors that
receive a minimum guaranteed return of their investment participate in the profits of
the entity, they may not necessarily participate in the losses of the entity. Thus, such
equity may not be at risk.
Even if the equity investment shares in the profits and losses of the entity, the
participation must be significant. The final determination of whether an equity
investment participates significantly in profits and losses is based solely on the
specific facts and circumstances. The following key factors should be considered
when making this assessment:
Fixed Rates of Return or Low Levels of Returns or Loss
Generally, investments with a fixed rate of return do not participate significantly
in profits and losses. However, there may be circumstances whereby the
substance should govern over form. If the fixed rate of return is substantial to
the overall equity return, the fixed rate of return could be viewed in essence as
participating significantly in profits and losses. For example, preferred stock with
a fixed dividend of 10 percent in an entity expected to generate a rate of return
of 15 percent on its invested capital would generally be considered to participate
significantly in the profits. Conversely, preferred stock with a fixed dividend of
8 percent in an entity expected to generate a rate of return of 35 percent
is generally considered to be more debt-like in its return and would not be
considered to participate substantively in the profits.
In addition, an equity investment that participates at a level that is consistent with
its equity ownership (e.g., a 1 percent general partnership interest that participates
in 1 percent of the entitys profits and losses) would participate significantly in
profits and losses.
Guaranteed Returns
Generally, when an equity investors returns are guaranteed by another party
involved with the entity, the investors equity investment does not participate
significantly in the losses of the entity.
Certain Put or Redemption Rights
Oftentimes, investors can redeem or put their equity interests at fixed prices
or prices determined based on a formula. Generally, when an investment has
these puttable characteristics (i.e., the investor has the ability to put an equity
investment back to other investors or the entity), it would not participate
significantly in the losses of the entity. However, it is important to consider whether
these put features substantively protect the investors investment or limit exposure
to risks and rewards.
Other factors to consider include the following:
Whether the length of the period during which the put option may be exercised
varies.
Terms associated with the put option, including the price at which the investment
may be sold or bought (e.g., fixed, variable, or fair market value).
Sometimes equity interests are issued for a de minimis amount and, as a result, that
investor may not participate significantly in losses. For example, consider a situation
where a general partner purchases a 1 percent general partner interest for $1,000,
while the limited partners contribute $1,000,000 for each of the remaining 1 percent
interests. Under this scenario, the general partners interest would not be viewed
as participating significantly in the losses of the entity. In making this assessment,
we believe that both the dollar amount of the investment and the percentage of the
investment to the total equity investments should be considered.

4.1.3 Equity Investments Issued in Exchange for Subordinated Financial Support

in Another VIE
Does not include equity interests that the legal entity issued in exchange
for subordinated interests in other VIEs.
The objective of this provision is to ensure that a particular equity investment is not
used to capitalize two entities (i.e., the equity investment should count only once).
For example, if Reporting Entity X uses cash to capitalize Entity A (a VIE), and then
uses its equity interest in Entity A to capitalize Entity B (a VIE), the equity investment
that Reporting Entity X holds in Entity B is not at risk because it was capitalized with
a beneficial interest in Entity A.
4.1.4 Equity Investments Provided to the Equity Investor by Other Parties

Involved with the Entity
Does not include amounts provided to the equity investor directly or
indirectly by the legal entity or by other parties involved with the 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.
An equity investment is not at risk if the cash (or other assets) used to make the
investment was funded through fees, a charitable contribution or other form of
payment made to the investor from another party involved with the entity. Stated
differently, only an equity investor that has skin in the game is considered to be at
risk.
The guidance provides the following examples of factors that can result in a
reduction in an investors at risk equity:
Fees: Paid either upfront or over time (i.e., structuring, syndication, management,
development fees, etc.).
Charitable contributions: Specifically, those made on behalf of an investor.
Payments and fees paid by any party that is involved with the entity need to be
evaluated to determine whether they disqualify the investors equity investment from
being at risk.
A literal reading of the guidance suggests that all fees paid to equity investors by the
entity itself, or by others involved with the entity, would reduce the equity investment
at risk. We believe that the facts and circumstances must be evaluated to determine
whether such fees are, in substance, a return of the capital and therefore reduce the
amount of equity at risk.
We believe that the following factors should be considered in this evaluation:
Upfront Fees and Unconditional Fees Paid Over Time: Generally, fees that are paid
concurrent with the formation of an entity (or shortly thereafter) or unconditional
fees to be paid over time would be considered a return of the amounts invested by
the equity investor. This would be true even when the fee paid is commensurate
with the fair value of the services performed (and can be objectively verified).
For example, Reporting Entity X contributes $15 in cash to form Entity A. Entity
A obtains $85 of nonrecourse debt and pays Reporting Entity X $10, which
represents a fair-value fee for the development services Reporting Entity X will
perform in the future. The total equity investment at risk would be $5 ($15 less the
$10 fee). Another example is a syndication fee that a general partner may receive
when it forms and syndicates an entity. Assume that the general partner receives
a $1,000 syndication fee and then contributes $10 for a 1 percent general partner
interest. In this case, the general partners investment would not qualify as equity
at risk.
Third-Party Reimbursements: Generally, payments that an equity investor receives

from the entity and uses to pay an unrelated third party for a service that the
unrelated third party performed for the entity would not affect the amount of the
investors equity investment at risk. In these cases, the investor does not benefit
from the monies received, so the amount invested in the entity is still at risk.
Fees Paid in the Future Not at Fair Market Value: Some fees paid over time may
be considered a reduction of the equity investment at risk. Generally, if the present
value of future fees exceeds the fair value of the services that are to be provided,
then the excess payment reduces the equity investment at risk. We believe that in
most cases, it is difficult to justify off-market fees as anything other than a return
of capital.
Fees Paid in the Future at Fair Market Value: Generally, fees that are paid in the
future and represent the fair value for services to be provided in the future are not
considered a reduction of the equity investment at risk.

4.1.5 Equity Investments Financed for the Equity Investor by the Entity or Other
Parties Involved with the Entity
Excerpt from ASC 810-15-14(a)(4):
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.
The purpose of this condition is to exclude from the equity at risk amounts funded
from sources other than the equity investor. The burden of the investors to absorb
potential losses decreases when the entity, or other parties that are involved with the
entity, provide loans or guarantees of loans to the equity investors.
In these circumstances, the funding that supports the entity is provided by parties
other than the equity investor. The guidance specifically states that such interests are
not considered equity at risk.
In addition, a party that receives its interests as a contribution or a loan from the
reporting entity is a de facto agent of the reporting entity. This may have significant
ramifications. For example, assume that Investor A loans Investor B $500 and
Investor B uses the $500 to acquire a 50 percent interest in Partnership X. Investor
A contributes $500 in cash and also receives a 50 percent interest in Partnership X.
Investor B would not have an equity investment at risk because Investor A provided
the financing for that investment. In addition, Investor A and Investor B would be
considered as related parties (de facto agents) under the VIE model.
4.1.6 Consideration of Activities Around the Entity

Transactions that occur outside the potential variable interest entity should be
considered to determine whether the equity investment is at risk.
Jane Poulin of the SEC Staff has shared this view at the 2004 AICPA Conference on
SEC and PCAOB Developments. Although her comments were made in the context
of the earlier VIE model, the general premise is also applicable to the guidance in the
VIE model. In her comments, Ms. Poulin stated the following:
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 (ASC 810).
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 an entity 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 (ASC 810). The short answer is no. First, FIN 46R (ASC
810) specifically requires you to consider loans between investors as well as those
between the entity and the entity 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 (ASC 810-10-15-14). 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 46R (ASC 810) include equity investments between investors, puts and calls
between the entity and other investors and non-investors, 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 46R (ASC 810) including the assessment of whether an entity is a VIE as
well as who is the primary beneficiary.

4.2 Next Steps: Assessing the Five Characteristics of a VIE
4.2.1 Characteristic 1: Insufficient Equity Investment at Risk

One characteristic that must be assessed to determine whether an entity qualifies as
a VIE focuses on the sufficiency of the VIEs equity at risk. This assessment entails
evaluating whether or not the entity is thinly capitalized (i.e., whether the amount of
equity at risk is sufficient for the entity to finance its own activities). If the total equity
investment at risk is insufficient, the entity is a VIE. This condition is premised on the
notion that if the total equity investment at risk is insufficient to finance an entitys
activities, the parties providing the additional financing would restrict or even prohibit
the equity investors from making decisions that are counter to the interests of the
providers of additional financing. Consequently, placing primary reliance on voting
rights, as prescribed by the voting interest model, may result in flawed conclusions
when determining which party holds a controlling financial interest. This section
discusses how to determine whether the equity investment at risk is sufficient for the
entity to finance its operations, which entails the following:
Considering the initial presumption of insufficiency of equity (or the 10 percent
presumption).
Overcoming the 10 percent presumption (and other qualitative and quantitative
considerations).
Special considerations relating to development-stage enterprises.

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. Includes only equity investments in the legal entity that
participate significantly in profits and losses even if those
investments do not carry voting rights
2. Does not include equity interests that the legal entity issued in
exchange for subordinated interests in other VIEs
3. 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
4. Does not include amounts financed for the equity investor
(for example, by loans or guarantees of loans) directly by the
legal entity or by the 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.
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.
The VIE model includes a method for assessing the sufficiency of the equity
investment at risk that is based on the potential negative variability in the returns of
the entityits expected losses. The equity investment at risk must be large enough
to absorb the potential downside variability of the entitys activities in order to be
sufficient. The guidance indicates that either a qualitative and quantitative analysis (or
both) may be used to evaluate the sufficiency of the total equity investment at risk.

4.2.1.1 Calculating the Equity Investment at Risk

The following table provides an overview of how the amount of equity investment at
risk in an entity is calculated:
GAAP equity investment (i.e., fair value of the equity)
Less:
Equity investments that do not participate significantly in the entitys profits
and losses (see ASC 810-10-15-14(a)(1))
Less:
Equity investments in an entity that are the source of subordinated financial
support for another VIE (see ASC 810-10-15-14(a)(2))
Less:
Equity investments provided to the equity investor by the entity or other
parties involved with the entity (see ASC 810-10-15-14(a)(3))
Less:
Equity investments financed for the equity investor by the entity or other
parties involved with the entity (see ASC 810-10-15-14(a)(4))
Equals: Equity investment at risk (at fair value)
We believe that to determine the amount of the equity investment at risk, the
securities included in GAAP equity should be evaluated based on their fair value on
the determination date. That date may be different from the entitys formation date.
Also, the book value of the entitys equity will not often represent the fair value of
the equity. In addition, there are cases when, even at formation, the fair value of the
equity is different from its book value (e.g., entities that are required by GAAP to carry
over historical cost to record equity contributions such as in the formation of a joint
venture). The concepts of variable interests and expected losses are based on fairvalue assumptions about the entitys activities and potential returns, thus using the
fair value of equity will provide for consistent comparisons when evaluating whether
an entity is a VIE.
Equity Investors and Commitments to Fund Equity, Loans, and Guarantees
An equity investment that is issued in return for an equity investors obligation to
provide additional capital is not generally considered equity at risk, as the receivable
recorded in equity is an offset to GAAP equity. If an investor is obligated to fund
an entitys activities on a continual basis, the entity may be a VIE. Additionally, an
equity investors personal guarantee of an entitys debt(s) is not part of the equity
investment (i.e., it is not GAAP equity). However, the guarantee generally is a variable
interest that may be called to provide financial support to the entity and the existence
of such guarantees may be indicative of insufficient equity at risk.

4.2.1.2 Assessing the Sufficiency of the Equity Investment at Risk

The VIE model establishes a rebuttable presumption that all entities with an equity
investment at risk of less than 10 percent of an entitys total assets (at fair value) are
VIEs. However, the guidance allows for that presumption to be overcome and states
that either qualitative or quantitative evidence can be used to support an assertion
that the equity investment at risk of less than 10 percent may be sufficient.

An equity investment at risk of less than 10 percent of the legal entitys
total assets shall not be considered sufficient to permit the 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. The legal entity has demonstrated that it can finance its activities
without additional subordinated financial support.
b. 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.
c. The amount of equity invested in the legal entity exceeds the
estimate of the legal entitys expected losses based on reasonable
quantitative evidence.
This does not necessarily mean that equity at risk of more than 10 percent is
automatically deemed sufficient.
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 entitys
assets or liabilities. The presumption in the preceding paragraph does
not relieve a reporting entity of its responsibility to determine whether
a particular 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.
In practice, 10 percent is not a bright line, and the sufficiency of equity needs to be
assessed based on the facts and circumstances of each entity under analysis.
4.2.1.3 Qualitatively Demonstrating That the Equity Investment at Risk Is Sufficient

The VIE model does not include rules for determining what amount of equity is
sufficient. The 10 percent presumption sets a high hurdle and does not provide a
safe harbor for all equity investments that are equal to or greater than 10 percent of
the entitys total assets. Reporting Entities involved with entities must demonstrate
that the equity investment at risk is sufficient, even if the equity exceeds 10 percent
of the assets.
If equity at risk is less than 10 percent of the entitys assets, the qualitative and
quantitative factors should be assessed to overcome the presumption of insufficiency
of the equity investment at risk. If equity at risk is more than 10 percent, these factors
should also be assessed to ensure its sufficiency. The qualitative analysis must
be performed before the quantitative analysis. However, we believe that in certain
cases the qualitative analysis may not, in and of itself, provide sufficient substantive
evidence to support a conclusion that the equity investment at risk is sufficient,
particularly, when an entitys capital structure is complex. Therefore, although the
sufficiency of equity at risk guidance might seem easy to overcome, it is in reality
often difficult to demonstrate the adequacy of the equity based on a qualitative
assessment of the existing structure. For example, it is clear that numerous
arrangements between reporting entities and an entity (or parties involved with the
entity) can be variable interests. When an entity has a simple capital structure for
which the only variable interests are debt and equity, this qualitative analysis may
be straightforward. This qualitative analysis will be more difficult for more complex
capital structures in which there are numerous variable interests (e.g., derivatives,
guarantees, etc.).
Often, entities obtain nonrecourse financing as their only means of purchasing
assets. This does not necessarily demonstrate that the equity investment at risk is
sufficient.
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.
Financing obtained which is other than equity (e.g., through debt) may demonstrate
the sufficiency of the equity. However, since debt may function as a surrogate for
additional equity investment, the quality of the debt and associated interest rate are
important factors to consider in this analysis. We believe that the ability to obtain
investment-grade debt (at least a rating of BBB by Standard and Poors or Baa by
Moodys) may be evidence that the equity investment at risk is sufficient and that the
lenders risk of loss is remote. On the other hand, higher-risk financing may indicate
that the lender (or other parties) shares in the risks of the entitys activities (i.e.,
absorbing some or all of the entitys expected losses). What makes this assessment
more difficult is that debt is not the only type of variable interest that may provide
additional subordinated financial support. The existence of guarantees on the
value of assets, non-fair value options to put an equity investment to other parties,
and similar arrangements are also variable interests that often provide additional
subordinated financial support and may even impact the quality of the debt that the
entity can procure.
We believe that depending on the facts and circumstances of the arrangement, the
existence of guarantees of an entitys debt may indicate that the equity investment
at risk is insufficient. For example, if a personal guarantee was necessary for the
entity to receive financing from a third-party bank, the equity investment at risk may
not be sufficient. Otherwise, the bank would not have negotiated for such guarantee
or the equity investors would not have been willing to provide the guarantor if such
guarantees were not necessary for receiving the financing under the terms provided.
Traditionally Viewed SPEs
Historically, special purpose entities (SPEs) were thinly capitalized, and most SPEs
were structured under the previous accounting rules, which stated that the total
equity investment only needed to be 3 percent of the entitys total assets. Instead of
equity investments that were exposed to the residual risks and rewards of ownership
in an SPE, other arrangements with the entity, or other parties associated with the
entity, bore most of the risk of loss related to the entitys activities and often received
most of the residual benefit of the SPEs activities (i.e., these contracts functioned in
a manner that is often associated with an equity investment). SPEs will often be VIEs
because the equity investment at risk will be insufficient.

4.2.1.4 Quantitatively Demonstrating That the Equity Investment at Risk

IsSufficient
If the qualitative assessment is not conclusive, reporting entities must perform a
quantitative analysis, comparing the entitys equity investment at risk to its expected
losses. The equity investment at risk can be presumed to be sufficient if it exceeds
the estimate of the entitys expected losses based on reasonable quantitative
evidence.
As discussed earlier, a significant factor in the quantitative analysis is the calculation
of the entitys expected losses. If the expected losses of the entity are greater than
the fair value of the total equity investment at risk, the entity is a VIE. The calculation
of expected losses is discussed in VE 1.6.
If neither the quantitative nor qualitative analysis is conclusive, the results from each
analysis should be considered in combination so that a reasonable assessment can
be made.
4.2.1.5 Development Stage Entities

The VIE model includes special provisions for entities that are in the developmental
stage.
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 810-10-35-4, for example, if the legal entity undertakes
additional activities or acquires additional assets.
ASC 915, Development Stage Entities (ASC 915), (specifically ASC 915-10-05-2)
provides guidance on identifying development stage entities. The FASB allows
the use of a different model when assessing the total equity investment at risk for
development stage entities. When evaluating a development-stage entity, only the
current phase of development (i.e., the phase for which financing has already been
obtained) should be considered. Thus, in order for entities in the development stage
to avoid being considered VIEs, the entity must have equity that is sufficient to
permit it to finance the activities in its current phase (i.e., the activity in which the
entity is currently engaged). Additionally, provisions in its governing documents must
enable the entity to obtain additional equity capital that will allow it to finance future
phases. Thus, some development stage entities may be VIEs if the entitys governing
documents do not provide for additional equity investments in subsequent phases.
Other points to consider regarding development stage entities include the following:
This exception applies to only the sufficiency of equity at risk criterion. Thus all of
the other characteristics of a VIE must also be assessed to determine whether a
development stage entity is a VIE.
Although some development stage entities may not be deemed VIEs when initially
evaluated, subsequent events may occur that cause such entities to become VIEs.
If reconsideration events specified in the VIE model occur, such entities must be
re-evaluated to determine if they have become VIEs as of the reconsideration date
(refer to VE 4.3).
4.2.2 Characteristic 2: Equity Lacks Decision Making Rights

One of the characteristics of a VIE is that the equity holders at risk lack decision
making rights. The guidance under the VIE model aligns the analyses of whether
the equity holders at risk lack decision making rights with the qualitative analysis of
determining the primary beneficiary. Consequently, an entity would be a VIE if, as
a group, the holders of the equity investment at risk lack the power, through voting
rights or similar rights to direct the activities of an entity that most significantly impact
the entitys economic performance.
Excerpt from ASC 810-10-15-14(b)(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 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.
Kick-out rights are 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 are the ability to block the actions through which a
4.2.2.1 Key Consideration of whether Equity Lacks Decision Making Rights

The underlying principle of this characteristic acknowledges that if the equity
investors at risk do not possess the power to direct the activities that have the most
significant impact on the economic performance of the entity, it can be concluded
that a party other than the equity investor(s) most likely controls the entity. As a
result, the FASB included this characteristic of a VIE to capture entities where
the power to direct those decisions that most significantly impact the economic
performance of the entity are not held by the equity investors at risk. Specifically, the
issue centers on whether, as a group, the equity investors at risk have embedded in
their rights the key decisions of the entity that can impact its economic performance.
Fundamentally, if the economic interests in the entity that are outside of the equity
investment at risk (e.g., debt interests or management contracts) also provide the
holders of those interests with a substantive power to direct the activities that have
the most significant impact on the economic performance of the entity, the entity
would generally be considered a VIE.

4.2.2.2 Which Parties Should Be Evaluated Under this Characteristic?

The reporting entity must analyze this characteristic as it analyzes each of the five
VIE characteristics. The following tasks should be included in this analysis:
Identify the investments that qualify as equity investment at risk.
Group those equity investments at risk together, as if they were held by a single
party.
Evaluate whether the grouped equity investments at risk have the power through
their voting rights or similar rights to direct the activities of the entity that most
significantly impact the entitys economic performance.
If one member of the equity investors at risk group holds the decision making rights
through the terms of equity (e.g., as general partner or managing member of a limited
liability corporation), then the decision making rights would be considered to be held
by the entire group.
Our experience suggests that complex capital structures pose unique challenges
and, as a result, require careful analysis. There might be situations in which interests
that are not considered equity at risk possess voting rights, but nevertheless do not
cause the entity to qualify as a VIE as illustrated below.
Example 4-1: Assume that in a newly formed corporation 40 percent of the
common shares were granted to a third party as a contribution. As discussed
in VE 4.2.5, the third partys equity would not be considered part of the equity
investment at risk. The remaining 60 percent of the common shares reside
with the holders of the equity investment at risk. Each investor has voting
rights in proportion to its equity-ownership percentage. Since all decisions
that significantly impact economic performance are made by equity holders
based upon a simple majority vote of their shares, the existence of the 40
percent voting interest held by a party that does not have equity at risk would
not cause the entity to be considered a VIE with respect to this characteristic.
4.2.2.3 How to Evaluate Whether the Equity Holders as a Group Have Power
Determining which activities most significantly impact the entitys economic
performance may require significant judgment. In certain circumstances, an
entitys operations may be straightforward or one dimensional. In those instances,
determination of whether or not the holders of the equity investment at risk meet the
power criterion may not require significant judgment. Critical to this analysis is to
identify the decisions of the entity and how the decisions could affect the economic
performance of the entity. It is important to consider the design of the entity in
making this determination. Once the key decisions are determined, it must then be
ensured that the decisions are made by the group of equity investors at risk rather
than by parties outside of that group.
As mentioned in VE 1.8, the VIE model introduced a new definition of participating

rights that are not applicable to transactions accounted for under other authoritative
guidance. If any participating rights are predetermined and/or provided to parties
other than the holders of the equity investment at risk (such as a lessee or a lender),
it would be difficult to conclude that the equity group at risk controls the entitys
operations. For example, if debt holders have the ability to veto operating and capital
decisions (including decisions that establish an entitys budgets) and the corporate
entity does not have the right or ability to refinance the debt, substantive decision
making ability would not rest with the equity group at risk. As a result, the corporate
entity would likely be considered a VIE.
For the purposes of assessing whether the holders of the equity investment at
risk lack power to make decisions with respect to activities that most significantly
impact the entitys economic performance, kick-out rights (which for the purposes
of the VIE model only include removal rights and do not generally include liquidation
rights) and participating rights are ignored unless those rights can be exercised by
one party (including its related parties and de facto agents) and are substantive.
This approach to removal rights is consistent with the guidance for determining the
primary beneficiary of a VIE as discussed in VE 5. However, it is inconsistent with the
evaluation of substantive kick-out rights under the voting-interest model (i.e., ASC
810-20-25) which includes liquidation rights and also respects kick-out rights that are
held by more than one party as long as they are substantive.
Example 4-2: Entity XYZ owns and operates a theme park. Assume that
the decisions that significantly impact the performance of the entity include
making capital investments such as incurring capital expenditure for new
rides to continue to attract visitors to the theme park. Entity XYZ typically
funds it capital investments via a mix of equity and debt financing. However,
all capital investment decisions involving new rides need the lenders approval
(one party).
In this example, since the lender is one party that has the ability to exercise
a participating right relating to an activity of the entity which has a significant
impact on the entitys performance, Entity XYZ would be considered to be a
VIE under Characteristic 2: Equity Lacks Decision Making Rights.
It is important to note that a service arrangement that provides an entity the power
to direct the activities of an entity that significantly impact the entitys performance
but is not a variable interest in the entity, such interest will not cause the entity to
become a VIE under Characteristic 2. The FASB concluded that if the power to direct
the activities of an entity that significantly impact the entitys performance are made
by a fiduciary, then such decisions merely are to the benefit of the equity investors.
As a result, fiduciary service contracts (i.e., those that are not variable interests under
the VIE model) would not cause the entity to become a VIE under Characteristic 2.
Example 4-3: Entity ABC owns and operates data centers in several
locations. The data centers house their customers servers, provide Internet
connectivity and are contractually committed to have the servers operational
for 99.97 percent of the time otherwise Entity ABC would be subject to
payment of heavy penalties. A reporting entity provides maintenance services
to the data center that are critical for the data centers operations. Under
the maintenance agreement, the reporting entity makes all the decisions to
maintain the data centers and keep them up and running for at least 99.97
percent of the time. The reporting entity has no other interest in the entity. The
maintenance arrangement meets all the conditions in ASC 810-10-55-37 such

that the maintenance fee paid to the reporting entity is not a variable interest.
In this example, even though the reporting entity makes all the critical
decisions that have a significant impact on the performance of Entity ABC,
the maintenance fee is not a variable interest and Entity ABC will not become
a VIE under Characteristic 2: Equity Lacks Decision Making Rights.
While the model for determining the primary beneficiary and determining whether the
equity investors as a group have this characteristic are aligned, we believe that the
FASB intended that entities that have limited decisions based on their design and
governance documents would not be VIEs under this characteristic.

4.2.2.4 Evaluating Limited Partnerships and the Impact of Kick-Out Rights

In evaluating whether a general partner is required to consolidate a limited
partnership under the voting model (ASC 810-20 and ASC 970-323-25-3 through
25-8), the general principle is that the general partners in a limited partnership are
presumed to control that limited partnership regardless of the extent of the general
partners ownership interest in the limited partnership. As stated in ASC 810-20
and ASC 970-323-25-3 through 25-8, the assessment of whether the rights of the
limited partners should overcome the presumption of control by the general partners
is a matter of judgment that depends on facts and circumstances. The general
partners do not control the limited partnership when it is a voting interest entity if
the limited partners have either (a) the substantive ability to dissolve (liquidate) the
limited partnership or otherwise remove the general partners without cause (known
collectively as ASC 810-20 kick-out rights) or (b) substantive participating rights.
Under the voting interest model, ASC 810-20 and ASC 970-323-25-3 through 25-8
offer additional guidance on this evaluation and on the following related topics:
Assessing whether ASC 810-20 kick-out rights are substantive and whether
they can be exercised by a single limited partner or a simple majority (or a lower
percentage) of the limited partners voting interest held by parties other than the
general partner as well as barriers to exercise such vote, and
Distinguishing between protective and participating rights for which the guidance
is generally consistent with ASC 810-10-25.
In certain fact patterns, it may be determined that the general partner equity interest
may not be considered at risk. In those fact patterns, under the VIE model, an
evaluation of limited partner investments at risk must be undertaken to determine
whether those limited partners as a group have the controlling financial interest of
the entity. The VIE model requires that in order for the limited partners as a group
to possess a controlling financial interest, a single limited partner (including its
related parties and de-facto agents) whose equity is determined to be at risk has
to possess the ability to remove the general partner (whose equity is not at risk).
Further, while the model in ASC 810-20 and ASC 970-323-25-3 through 25-8 is not
specifically designed for the evaluation of whether a limited partner has a controlling
financial interest, the use of this guidance by analogy can be helpful in making the
assessment of whether such removal right is substantive. If that removal right is
determined to be substantive under ASC 810-20 and ASC 970-323-25-3 through
25-8, it would be determined that the limited partners as a group hold the controlling
financial interest (i.e., the ability to make decisions that could have a significant effect
on the entity).
Some believe that substantive liquidation rights, as defined in ASC 810-20, held by a
single limited partner (including its related parties and de-facto agents) whose equity
is at risk, automatically represents a controlling financial interest. We do not believe
that a single limited partner (including its related parties and de-facto agents) whose
equity is at risk with substantive liquidation rights, as defined in ASC 810-20 and
ASC 970-323-25-3 through 25-8, holds a controlling financial interest, unless those
liquidation rights are designed in a manner that is consistent with removal rights.
Substantive liquidation rights would only indicate that a controlling financial interest
exists if the liquidation rights are designed so that the limited partner could liquidate
the entity and establish a new limited partnership with a new general partner to own
the same assets and pursue the same objectives of the previous partnership. Given
these circumstances, the right and ability of the limited partner to liquidate would
be, in substance, no different than a removal right. However, this is generally not the
case, as the limited partner generally would not have the ability to retain ownership
of the same assets of the entity through liquidation. Accordingly, the entity would be
considered a VIE with respect to the second characteristic. See VE 5.1.2 for kick-out
rights.
Lastly, the mere fact that a single limited partner holds substantive participating
rights is not sufficient to conclude that the limited partner has a controlling financial
interest, since such limited partner will only have the ability to block or participate in
decisions made by the general partner.
Given below is a summary that is helpful in evaluating when a limited partnership is a
VIE and in case it is not a VIE, the evaluation under the voting interest model:
Substantive
Kick-OutRights
Held byOne Limited
Partner Investor
Substantive
Kick-Out Rights
Held by Multiple Limited
Partner Investors
No Substantive
Kick-Out Rights
General
Partner Equity
Considered at
Risk
Not a VIE under

Characteristic 2.
If the entity is not
deemed a VIE
after assessing all
of the remaining
characteristics (i.e.,
Characteristic 1, 3,
4, and 5), General
Partner does not
consolidate under
ASC 810-20.
Not a VIE under

Characteristic 2.
If the entity is not deemed
a VIE after assessingall of
the remaining characteristics
(i.e., Characteristic 1, 3, 4,
and 5), the General Partner
does not consolidate under
ASC 810-20.
Not a VIE under

Characteristic 2.
deemed a VIE
after assessing all
of the remaining
Characteristic 1,
3, 4, and 5), the
General Partner
consolidates under
ASC 810-20.
General Partner
Equity NOT
Considered at
Risk
Not a VIE under

Characteristic 2.
deemed a VIE
after assessing all
of the remaining
Characteristic 1, 3,
4, and 5), General
Partner does not
consolidate under
ASC 810-20.
VIE under Characteristic2.

General Partner likely
consolidates under the
VIE model as it has power
(decision making) and
benefits/losses.
VIE under
Characteristic 2.
General Partner
likely consolidates
under the VIE model
as it has power
(decision making)
and benefits/losses.
Note: The above chart does not take into account the effect of related parties on
the evaluation as to whether the general partners equity is considered at risk (see
VE 4.2.2.4.1). In addition, the phrase Substantive Kick-Out Rights Held by Multiple

Limited Partner Investors is meant to be those kick-out rights that comply with ASC
810-20-25-8 through 10.
In assessing who may hold the controlling financial interest in a limited liability
corporation (LLC), the corporation model or the limited partnership model should
be considered depending on whether the entity is the functional equivalent of a
limited partnership as described in ASC 810-20. To understand an entitys underlying
governance structure and to conclude whether it functions like a limited partnership
or a corporation, a detailed analysis should be performed based on the facts and
circumstances specific to a particular entitys formation and governing documents.
The evaluation of an LLC should consider whether a managing member or some
other member of the LLC has significant decision making (or other) rights regarding
the operation of the entity that are similar to the rights held by the general partner
of a limited partnership. In some cases, a board is used instead of a managing
member. Much like a corporations board of directors, this board would vote on all
significant decisions. An evaluation of an LLC might also take into account how
voting percentages are allocated to the investors and what decision making rights
are granted to parties that hold limited-partnership interests.

4.2.2.4.1 General Partners Interests in a Limited Partnership

Questions have arisen regarding how the presence of a general partner that does
not hold a substantive equity investment in a limited partnership, but that has related
parties that hold investment(s) in the fund should be evaluated under the VIE model.
Consider the following fact pattern:
The general partner in a limited partnership is required under the terms of the
partnership agreement to hold a 0.1 percent investment in the limited partnership.
However, the general partner did not make any contribution for its interest in the
$10,000,000 limited partnership. In addition, the general partner or related parties of
the general partner may also hold a substantive investment in the limited partnership
through a limited partner interest in the entity, which were obtained on a basis similar
to other limited partners investors. This is commonly done for marketing purposes
to align the interest of the sponsor group with the limited partners by requiring them
to have skin in the game. All substantive decision making rights are held by the
general partner, and no kick-out rights are held by the limited partners (i.e., there is
no ability for the limited partners to remove the general partner).
Since the general partner did not make an investment in the limited partnership, the
general partners interest would not normally be considered equity at risk under the
VIE model. This fact pattern would generally result in the limited partnership being
a VIE because the holders of the equity investment at risk (i.e., the group of limited
partners) do not have decision making rights or the ability to kick-out the general
partner.
However, because related parties of the general partner have made a substantive
investment in the entity, the analysis becomes more complex. The specific facts of
the structure must be carefully evaluated to determine whether the holders of the
equity investment at risk have decision making abilities through their relationship with
the decision maker (i.e., the general partner in this particular fact pattern).
When determining whether the economic interest held by related parties of the
general partner should be combined with the controlling interest of the general
partner to conduct the decision making test, the rebuttable presumption is that the
controlling interest should be combined with the economic interests of all related
parties. The combination of those interests will generally alleviate decision making
exception and cause the fund to be a voting interest entity, unless one of the other
characteristics of a VIE is met.
The presumption that the economic interests of a related party should be
combined with those of the general partner may be overcome based on facts and
circumstances. Consideration should be given to whether the general partner has the
ability to arbitrarily choose the legal entity that will hold the economic interest in the
fund and whether the economic risks and rewards associated with that interest will
ultimately revert to the general partner. If the economic interest held by the related
party is independent of the general partners influence (both from a control and
economic perspective), the presumption that combining interests is appropriate may
be overcome. For example, the presumption may be overcome if (1) management
or employees of the general partner make investments in the entity, (2) management
and the employees are able to invest and withdraw the fair value of their funds at
their own discretion, (3) the investments are made from compensation that is deemed
to be at fair value, and (4) investment returns have no impact on future compensation
levels.
Given the significant diversity in structure of partnerships and general partner
management agreements, specific facts and circumstances must be considered in all
such arrangements.
The above observation is consistent with a speech from Mark Mahar of the SEC Staff
at the 2006 AICPA Conference on SEC and PCAOB Developments, where he stated
the following:
We understand that certain general partner (GP)/limited partner (LP) arrangements
have become common in which the partnership might be considered a variable
interest entity (VIE).
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, i.e., the LPs, do not have the ability to make decisions about the
entitys activities that have a significant effect on its success.
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 a group, the FIN 46R [ASC 810] 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) [ASC 810-10-15-14 (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.
(continued)
If the GP and LP are considered a group, the FIN 46R [ASC 810] 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, we understand that some of these structures may have been designed
specifically to circumvent EITF 04-5 [ASC 810-20], which would generally result
in consolidation by the GP if the partnership is not a VIE. This gives me a chance
to make the point that using professional judgment is not a cover or license to
engineer around the intent of accounting literature. Frankly, its attempts like this
that often lead to restatements and more accounting standards as the standard
setters seek to close the door on abusive transactions. I do not like complex
standards any more than you. With more restatements and complex standards, no
one is a winner, investors, preparers and auditors alike.

4.2.2.5 Decision Making Must Reside within the Equity Instrument

As a group, the equity holders at risk must have both the power to direct the
activities that most significantly impact the entitys economic performance and the
obligation to absorb expected losses or the right to receive the expected residual
returns of the entity.
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.
It is also important to consider that the objective of this characteristic is to identify as
VIEs those entities in which the total equity investment at risk does not provide the
holders of that investment with the characteristics of a controlling financial interest.
Therefore, a reporting entity must evaluate the rights of the equity group at risk,
which includes those that are embedded in the groups equity interests. However,
if the equity group has rights that are not embedded in their equity interests in the
entity, those rights would be considered rights outside of the groups equity interests.
For example, if an equity holder at risk has significant decision making abilities
pursuant to a management contract, rather than through its equity interests, and the
equity group at risk cannot remove the manager, the rights under the management
contract should not be attributed to the equity group at risk. Consequently, the entity
would likely be considered a VIE.
This form-based distinction can lead to inconsistent conclusions when the substance
of the transactions is similar. Therefore, this analysis should be carefully performed.
Specifically, the existence of decision making outside of the equity instruments
should be evaluated to determine if there is commercial substance in structuring
the arrangements in this manner. If decision making outside of the equity at risk
instruments is deemed a formality, this would suggest that the decision making
ability may be held by the equity investors.
For example, super-voting common stock that gives a noncontrolling shareholder
control of the entity would not cause the entity to be a VIE with respect to this
characteristic (provided that such investors equity is at risk). However, if the
noncontrolling shareholder obtained control of the entity through a management
contract, the entity might be considered a VIE. Similarly, we believe that if decision
making is determined by a shareholders agreement (i.e., a separate contractual
arrangement among the shareholders that gives voting control to some of the
shareholders and not to others) and all parties to the shareholder agreement are
holders of equity investment at risk, the entity would not necessarily be considered a
VIE. In contrast, the existence of contractual decision making service arrangements
between an entity and an equity investor may cause the entity to be considered a VIE
with respect to this characteristic.
In many fact patterns, determining whether decision making rights are held
within the equity interest can be difficult in practice. This is particularly true in
assessing whether a general partners interest holds the decision making rights in
a limited partnership when there are separate management contracts held by the
general partners related parties. In such cases, the following questions should be
considered:
What is the ownership structure of/relationship between the general partner and
the related party that holds the investment management agreement (i.e., whether
the entities are commonly controlled)? In the event that the general partner and
investment manager are controlled by the same parent and the substance of the
arrangement is that the investment decisions are effectively made by an equity
investor at risk (due to the common control relationship of the investment manager
and the general partner), it could be determined that the significant decision
making rights remain within the equity group at risk.
Does the general partner have the legal right to sell/transfer its decision making
rights to an unrelated entity? Specifically, the reporting entity should consider
whether the right to appoint the investment manager remains with the general
partner interest, if the general partners interest is sold to an outside party. If the
legal right to appoint the investment manager always remains with the general
partners interest, the substantive decision making rights may still reside with the
equity holders as a group, and no decision making exception would be present
(i.e., the entity would not be considered a VIE with respect to Characteristic 2).
Does the general partner have the legal right to terminate the investment
management agreement? If the general partner holds the legal right to terminate
the investment management agreement at any time and at its sole discretion,
the equity group at risk has most likely retained the substantive decision making
rights of the entity. All factors including penalties associated with early termination
should be considered to determine whether or not the termination right is
substantive.

4.2.3 Characteristic 3: Equity with Nonsubstantive Voting Rights

The equity investors as a group also are considered to lack
characteristic (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
(continued)
2. 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)(1).
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.
An entity is considered a VIE under this characteristic if both the following criteria are
met:
Criterion 1: The voting rights of some investors are not proportional to their
economic interest (i.e., obligations to absorb the entitys expected losses and
rights to expected residual returns).
Criterion 2: Substantially all of the entitys activities either involve or are conducted
on behalf of the investor(s) with disproportionately fewer voting rights.
This characteristic is intended to identify entities that are structured so that an entity
can avoid consolidation under the voting interest model by providing nonsubstantive
voting rights to another party. In essence, this provision is meant to catch potential
abuses of the voting interest model (i.e., to avoid consolidation). This notion was
emphasized by Eric Schuppenhauer of the SEC Staff at the 2003 AICPA National
Conference on Current SEC Developments, where he stated:
The intent of this provision is to move the consolidation analysis from the voting
interests model to the variable interests model in those instances where it is
clear that the voting arrangements have been skewed such that the investor with
disproportionately few voting rights, as compared to its economic interest, derives
substantially all of the benefits of the activities of the entity. In other words, it is
an abuse-prevention mechanism intended to identify instances where there is
something occurring in the relationship that indicates the voting arrangements are
not useful in identifying who truly controls the entity.

4.2.3.1 Criterion 1: Disproportionate Voting and Economics

Under Criterion 1, each equity investor should be evaluated to determine whether its
obligation to absorb the entitys expected losses and/or receive the entitys expected
residual returns are in proportion to that investors voting rights. Characteristic 3 is
different from the other four characteristics in that all variable interests held by the
equity investors at risk must be considered, not just the voting rights and economics
of each investors equity investment. The FASB has clarified that related parties and
de facto agents should not be considered in the evaluation of Criterion 1, but should
be considered in an evaluation of Criterion 2 (discussed further below).
We believe that for the purposes of examining the proportionality of the voting rights
relative to the economics of the entity, these amounts do not necessarily need to be
exactly equal. Judgment should be applied based on the facts and circumstances.
Generally, the two amounts only need to be approximately the same to be
considered proportional (e.g., 75 percent voting rights, which would result in control
of the entity, and 80 percent economics). However, when the two amounts straddle
50 percent (i.e., 48 percent voting rights and 52 percent economics), the amounts
should not be considered proportional, regardless of the magnitude of the difference
between the amountseven 49.9 percent vote and 50.1 percent economics should
be considered non-proportional. This conclusion is a result of the reporting entitys
possession of control, but not of a majority of the economics (or vice versa). In
practice, joint ventures and partnerships frequently meet this criterion, as equity
investors typically have other variable interests in the entity, which create economics
that are disproportionate to voting rights.
Based on the literal wording, evaluation of this criterion would require a comparison
of each participants variable interests to their voting interest, which would
necessitate the determination of all expected losses and expected residual
returns for the entity and for each participant. However, in some circumstances,
detailed analyses may not be necessary. For example, if one party clearly has an
economic participation of 60 percent or greater, but only has 50 percent of the vote,
Criterion 1 would be met (i.e., the voting interests and economic interests would be
disproportionate). Criterion 2 would then need to be evaluated to determine if the
entity should be considered a VIE. Conversely, if one party has 50 percent of the vote
and 40 percent of the equity, but also has a variable interest via a long-term purchase
contract, a detailed calculation may be required to determine if the equity plus the
purchase contract results in more than 50 percent of the entitys expected losses and
residual returns.
The determination of the level of voting rights may require considerable judgment,
since, in many cases voting percentages are not defined by the underlying
agreements. For example, many partnerships and limited liability companies do
not define voting percentages. Rather, they operate under provisions whereby both
parties must agree on all (or substantially all) of the major decisions (i.e., neither
party has voting control). In such cases, we believe that the entity is under joint
control, with both parties having 50 percent voting interests for the purposes of this
characteristic, even though the percentages of legal ownership may be different.
In essence, the focus should be on whether the governance of the entity would be
substantively different if voting rights had been equal to economic rights.
To further understand the application of Criterion 1, consider the following examples:
Example 4-4: Assume that Reporting Entity A holds a 65 percent equity
interest in Entity 1 and that Reporting Entity B holds the remaining 35 percent
equity interest. Each equity interest holder shares in the entitys profits
and losses in proportion to the holders equity investment. The governing
documents include specific provisions granting Reporting Entity B rights that
provide it with joint control over the substantive operating decisions of Entity
1 (i.e., voting rights). As a result, Reporting Entity As voting rights (i.e., 50
percent) are disproportionately low in relation to its exposure to the risks (i.e.,
65 percent) and Criterion 1 is met. If Criterion 2 is met (i.e., substantially all of
the entitys activities either involve or are conducted on behalf of Reporting
Entity A), Entity 1 would be considered a VIE.
Example 4-5: Assume that Reporting Entity ABC is an investor in Corporation

X, holding 55 percent of the voting interests (and control of the entity) and
60 percent of the profits and losses of Corporation X. Although Reporting
Entity ABCs voting rights of 55 percent are not equal to its obligation to
absorb the expected losses and receive the expected residual returns (i.e.,
60 percent), control of the entity resides with Reporting Entity ABC because
it holds a majority of Corporation Xs voting rights. In this scenario, the voting
and economic interests would be proportional, since control resides with
the investor that has the majority financial stake in the entity, even though
the voting rights of the investors are not exactly equal to the investors
economics.
Example 4-6: Assume that Company A and Company B each contributed
$20 million in cash for 50 percent of the common stock in Corporation X (i.e.,
50/50 ownership). In addition, Company A loaned $50 million to Corporation
X in return for a note. Company A may therefore have two variable interests
in Corporation X: (1) its equity investment and (2) its loan to Corporation X. In
this scenario, Company As obligation to absorb the expected losses may be
greater than its voting rights of 50 percent and if so, Criterion 1 will have been
met with respect to disproportionate voting rights.

4.2.3.2 Criterion 2: Evaluating the Substantially All Concept

For an entity to be considered a VIE with respect to this characteristic, Criterion
2 must also be met. Meeting this criterion requires substantially all of an entitys
activities to involve or to be conducted on behalf of the investor that has
disproportionately few voting rights. We believe that an evaluation of whether this
criterion has been fulfilled should be consistent with the evaluation performed under
the business scope exception test, since the terminology is consistent (refer to VE
2.2.1 for discussion of the business scope exception).
As a general rule, we believe that this assessment is primarily qualitative. Some have
suggested that the phrase substantially all should be interpreted to mean that 90
percent or more of the economics of the entity relate or accrue to the benefit of a
particular party. We do not share this view. Rather, we believe that such a quantitative
measure is only one of many factors that should be considered in evaluating this
criterion. However, we recognize that there may be circumstances where the
economics of the arrangement are so skewed in the direction of one reporting entity
that a quantitative analysis may override other considerations in and of itself. We
often use the following list of indicators in our evaluation (this is the same list of
indicators that VE 2.2.1 includes):
Strong Indicators*
Other Indicators*
The reporting entity sold assets to the entity The reporting entity sold assets to the
in an effort to remove underperforming
entity.
assets from the reporting entitys balance
sheet.
substantially all of its products to the
reporting entity under long-term contracts.

a majority of its products to the reporting
entity, and such relationship is expected
to continue either because of long-term
contracts or for other reasons.
(continued)
Strong Indicators*
Other Indicators*

purchasing substantially all of its purchased
purchasing a majority of its purchased
The reporting entity holds a non-reciprocal,
fixed-price or in the money call option
on the other investors equity investments,
and/or the other investors have a fixedprice or in the money put option whereby
they can put their investments to the
reporting entity.
The reporting entity holds a non-reciprocal

(or fair-value) call option on the other
investors equity investments, and/or the
other investors have a similarly priced,
non-reciprocal put option.

substantially all of any additional capital

a majority of any additional capital

entity has an economic interest (e.g.,
through a purchase option) in the results of
the research that constitutes substantially
all of the entitys activities.

entity is in a business that could capitalize
on the results of the research that
constitutes a majority of the entitys
activities.
The reporting entity has outsourced

operations to the entity, constituting
substantially all of the entitys activities.
The reporting entity has outsourced to the

entity operations that constitute a majority
of the entitys activities.
Substantially all of the entitys assets are

leased to the reporting entity.
A majority of the entitys assets are leased

to the reporting entity.
The principal activity of the entity is to

provide financing (e.g., loans or leases) to
A majority of the entitys activities involve

providing financing (e.g., loans or leases) to
The principal purpose of the entity is

to conduct a business that is uniquely
complementary to a significant business
operation of the reporting entity and is not
similar to activities of other participants in
the entity.
The principal purpose of the entity is to

conduct a business that is more closely
related to a significant business operation
of the reporting entity and only broadly
similar to activities of one or more of the
other participants in the entity.

participation in profits, etc.) are heavily
skewed (e.g., close to 90 percent or
greater) toward the reporting entity.

participation in profits, etc.) are weighted
(e.g., greater than 60 percent) toward the
reporting entity.
* With respect to evaluating these indicators, the term reporting entity covers the reporting entitys related
parties (as defined in ASC 810-10-25-43).
When evaluating whether substantially all of the activities either involve or are
conducted on behalf of the investor that has disproportionately few voting rights, the
investor must combine interests held by its related parties and de facto agents with
its own interests (refer to VE 1.7 for a detailed description of related parties and de
facto agents).
There are no broad rules of thumb that can be used to shortcut the evaluation
required under Criterion 2. Instead, reporting entities will need to evaluate the
relevant facts and circumstances surrounding each individual situation. Absent
mitigating factors (e.g., indicators that point to a different conclusion), we believe that
the presence of a single item from the Strong Indicators column may be sufficient
to support a conclusion that substantially all of the activities of the entity either
involve or are conducted on behalf of the reporting entity. At other times, multiple
strong indicators may need to be present to reach the same conclusion. There
are no bright lines. This assessment requires judgment. We also believe that the
SEC shares this view as indicated by Eric Schuppenhauer of the SEC Staff at the
December 2003 AICPA National Conference on Current SEC Developments, where
he stated the following:
In the event that a registrant concludes that it has disproportionately few voting
rights compared to its economics, there must be an assessment of whether
substantially all of the activities of the entity either involve or are conducted on
behalf of the registrant. There is no bright-line set of criteria for making this
assessment. All facts and circumstances, qualitative and quantitative, should be
considered in performing the assessment.
If the reporting entity includes several of the Other Indicators, it may need to
consider seriously whether or not the requirements of Criterion 2 have been met. In
this instance, consultation with an accounting professional who is familiar with these
provisions may be appropriate.

4.2.4 Characteristic 4: Lacking the Obligation to Absorb an Entitys

ExpectedLosses
The VIE model indicates that an entity is considered a VIE if, as a group, the holders
of the equity investment at risk lack the following:
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 810-10-55-42) for a discussion of expected losses.
The general principle underlying this characteristic is the need to identify equity
interests that do not behave in a traditional manner. Many transactions are structured
so that the party with the most significant exposure to an entitys expected losses is
not the equity investor(s).
Any assessment of whether the holders of the equity investment at risk possess this
characteristic must be premised on a first-dollar loss concept. The reporting entity
should determine whether the equity investors as a group are obligated to absorb
the entitys expected losses on a first-dollar basis until the equity is depleted (i.e.,
neither the entity itself nor other parties that are involved with the entity can protect
the equity holders from the risk of loss on any portion of their investment). We believe
that the FASB included this characteristic to identify entities designed to protect the
group of equity investors from suffering expected losses caused by the predominant
risks of the entity (not risks associated with unusual events) through arrangements
or contracts that are associated with the entity that reside outside the equity at risk
instruments. The FASB believes that when such protection exists, the traditional
consolidation model (which is based on voting control) is ineffective. Therefore, the

entity is considered a VIE and should be subject to the VIE model. This concept is
illustrated in the excerpt below:

4.2.4.1 How to Evaluate this Characteristic in Practice

In making this evaluation, it is necessary to consider any contractual or monetary
arrangement that may protect the equity investors at risk from absorbing a significant
amount of the entitys expected losses (e.g., other variable interests) on a first dollar
loss basis. In most cases, we expect that a qualitative assessment can be made
about whether an entitys expected losses are or are not fully absorbed by the group
of equity at risk.
A guarantee generally would be considered a variable interest under the VIE model
because a guarantee may absorb some portion of the entitys expected losses. As a
result, a reporting entity must determine whether the guarantee protects the equity
investment at risk from absorbing the entitys losses on a first-dollar basis up to the
point at which the equity is depleted. Since debt guarantees are generally not called
upon until the equity interests are depleted, such guarantees would not cause the
entity to be a VIE with regard to this characteristic.
A residual value guarantee is provided by the lessee of the entitys only asset. The
residual value guarantee would be a variable interest (refer to VE 3 for discussion
of variable interests). Typically, the residual value guarantee will protect the equity
interests from any decline in the value of the leased asset and consequently will
absorb losses prior to the equity. As a result, the existence of this guarantee would
cause the entity to be considered a VIE with respect to this characteristic.
There is another consideration in applying this provision. The evaluation should focus
only on the equity interests themselves, and not on the identity of the investor. For
example, if an equity investor guarantees the value of an asset that the entity holds,
even though the investor may have the economic obligation to absorb the entitys
first losses, the arrangement may result in the entitys qualification as a VIE. This is
because the obligation resides in the guarantee contract and is not inherent in the
investors equity interest.
Disproportionate sharing of expected losses amongst equity investments at risk does
not cause the entity to be considered a VIE under Characteristic 4 since it represents
a mere sharing of expected losses amongst the group of equity investments at risk.
4.2.4.2 Impact of Implicit Variable Interests

ASC 810-10-25-48 through 25-54 address if and when a reporting entity should
consider whether it holds an implicit variable interest in a VIE or in a potential
VIE. The existence of an implied variable interest may affect the determination of
whether the potential VIE should be considered a VIE, particularly with respect to
Characteristic 4. For example, if an implied variable interest exists that represents an
implied guarantee of the only asset of an entity, the entity would be considered a VIE
under Characteristic 4 since the equity investors at risk are protected by this implied
variable interest. See VE 3 for a further discussion of implicit variable interests.

4.2.4.3 Additional Examples: Evaluating an Entity under Characteristic 4

The following are additional examples, illustrating how to determine whether the
entity in question is considered a VIE with regard to this characteristic:
Insurance Contracts
Entities often enter into insurance arrangements to protect their assets from
unforeseen events (e.g., fires, storms, etc.) or their businesses from unplanned
interruptions. Applying Characteristic 4 to these contracts on a literal basis would
cause many traditional companies to be considered VIEs. Based on discussions with
the FASB, we understand that the intent of this characteristic pertains to risks that
are an entitys predominant risks and that are absorbed by non-equity interests as
part of the conceptual design of the entity (i.e., risks that result in losses occurring in
the normal course of business), not to risks that are related to unusual type events.
Consequently, we do not believe that property and casualty insurance or business
interruption insurance would cause an entity to be considered a VIE with respect to
this characteristic.
Total-Return Swaps
Total-return swaps are an example of variable interests that generally would cause
the entity to be a VIE with regard to this characteristic. If the total-return swap
protects the equity investors at risk from expected losses on an entitys assets, the
entity would be considered a VIE.
Example 4-6: Consider an entity that (1) issues debt of $250 and common
stock of $50, and (2) acquires a bond with a fair value of $300. Assume that
the entity enters into a total-return swap with an investment bank. The terms
of the arrangement provide that the entity will pay 85 percent of the total
return of the bond in exchange for a LIBOR-based return. If the assets value
declines by one dollar, the investment bank will pay the entity 85 cents. The
equity interests are protected from 85 percent of the assets losses. As a
result, the entity would be deemed a VIE under this characteristic.
Cost-Plus Sales Contracts
When evaluating whether an entity is a VIE with regard to this characteristic, there
may be situations in which the equity interests are directly or indirectly protected
from absorbing losses that are incurred by the entitys customers. For example, a
third-party customer might purchase goods or services from the entity at a price
that would effectively cover all of the entitys costs associated with those goods or
services plus a fixed margin.
Such cost-plus arrangements may cause an entity to be a VIE under this
characteristic, if they protect the equity investors from absorbing the entitys
expected losses. The determination is based on the facts and circumstances of the
arrangement and requires an analysis of whether the contract serves to insulate the
company from losses that it otherwise would incur. If the contract serves to eliminate
variability in the entity, the equity at risk interests would be protected and the entity
would be considered a VIE.
Other Instruments That Provide Protection to the Equity Investment at Risk

Several other examples of variable interests in an entity that would cause an entity to
be a VIE under Characteristic 4 are as follows:
Guaranteed returns on an equity investment at risk by the entity itself or by other
parties that are involved with the entity.
Guarantees of the entitys assets, only if the guarantee is a variable interest in the
entity and not in specified assets (refer to VE 3 for discussion of variable interests
in specified assets).
A put option held by the entity (i.e., written by a reporting entity) or similar
arrangement on the entitys assets (if the fair value of the options underlying
assets comprises more than 50 percent of the fair value of the entitys total
assets).
A purchase agreement or option with a non-refundable deposit which can protect
equity at risk from a portion of the market decline to the extent of the deposit.

4.2.5 Characteristic 5: Lacking the Right to Receive an Entitys Expected

Residual Returns
The VIE model indicates that an entity is considered a VIE if, as a group, the holders
of the equity investment at risk lack the following:
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.
We believe that this characteristic is based on the principle that the investors
that have equity interest at risk in a voting interest entity should have the rights
to the entitys residual profits. If the residual cash flows are shared or capped,
the controlling financial interest in the entity may be held by persons other than
the equity holders at risk. Therefore, an entity is considered a VIE in the following
circumstances:
The return to an equity investor at risk is capped.
Other variable interest holders share in the residual cash flows at an amount that
is considered significant relative to the level of expected residual returns (refer to
VE 3.3.9.3, VE 3.3.9.5 and VE 5.1.3 for a more detailed discussion of what may be
considered significant).
We expect that in most cases, a qualitative assessment is sufficient for determining
whether the equity investors at risk have the rights to the entitys expected residual
returns.
The evaluation should only focus on the equity ownership interests themselves, and
not on the investors. For example, an equity investor may also hold participating
debt that provides rights to a portion of the entitys residual returns. Since that right
resides in the participating debt agreement and is not inherent in the investors
equity interest at risk, the entity may be considered a VIE if the participating debt
participates in the residual profits at an amount that is large relative to the entitys
expected residual returns. We believe that this is what the FASB intended as
illustrated in the excerpt below:
Disproportionate sharing of expected residual returns among equity investments at
risk does not cause the entity to be considered a VIE under Characteristic 5, since
it merely represents sharing of expected residual returns among the group of equity
investments at risk.

4.2.5.1 Examples
There are many contracts that may or may not meet Characteristic 5. The following
are some examples:
Call Option on the Entitys Assets
Assume that an entity writes a call option on its sole asset and therefore the call
option is a variable interest in the entity (refer to VE 3 for a discussion of variable
interests). We believe that such a call option may function as a cap to the equity
investors right to receive residual profits. Whether the call option actually functions
as a cap depends on the specific facts and circumstances. Relevant factors will
include whether or not the option price is fixed, formula-based, or at fair market
value. A call option with a fair market value price would not meet Characteristic 5,
while a call option that is formula-based may or may not meet Characteristic 5.
Equity Investments That Are Not Considered At Risk
In some situations, equity may be issued in return for the promise to provide services
to the entity. Consider an entity that is capitalized with equity investments from two
parties: Party A and Party B. Assume that Party A contributes cash for its 65 percent
ownership interest and that Party B receives its 35 percent ownership interest in
return for services. Further assume that all cash flows are distributed among the
parties in accordance with their ownership percentages. The equity held by Party B
would most likely not be considered at risk. Since Party B participates in the entitys
expected residual returns, Characteristic 5 may be present, and if so the entity would
be considered a VIE.
Other Contracts Tied to an Entitys Performance
Many operating entities have contracts that allow for some sharing in the entitys
expected residual returns. We believe that the following types of contracts should be
considered in making this assessment assuming that they are variable interests (see
VE 3 for a discussion on variable interests):
Service contracts that are indexed to the entitys performance.
Decision maker fees.
License, royalty and other similar arrangements.
We believe that in an assessment of these contractual agreements, profits should be
interpreted more broadly, and not limited to items such as net income or earnings
before taxes. Other performance measures (e.g., revenue, operating income, EBITDA)
should also be considered. However, only those arrangements that share in amounts
that are large relative to the level of expected residual returns would result in the
presence of this characteristic. In most entities, these contracts would not cause
the entity to be considered a VIE with respect to this characteristic. However, in
assessing this characteristic, the reporting entity should evaluate the terms of each
contract and the entitys level of sharing in the entitys returns.

4.3 Reconsideration Events: VIE Status

Simply determining whether an entity is a VIE at its creation or at the reporting
entitys first date of involvement with the entity is considered insufficient practice.
Certain events may occur that would require a reporting entity to re-evaluate whether
or not an entity is, in fact, a VIE. In the VIE model, the FASB lists specific events that
would require the reconsideration of an entitys VIE status as follows:
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. 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.
b. 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.
c. 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.
d. 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.
e. 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
A reporting entity must re-evaluate whether or not an entity is a VIE upon the
occurrence of one of the reconsideration events only if the event is significant.
Generally speaking, if the reporting entity concludes that the VIE status of the entity
would change upon the occurrence of one of these events, the event would be
considered significant enough to merit reconsideration under the VIE model.
Note that the VIE model as amended by ASU 2009-17 removed the exception for
troubled debt restructurings as a VIE reconsideration event. Previously troubled debt
restructurings were exempted from triggering a reconsideration event because ASC
310-40, ReceivablesTroubled Debt Restructurings by Creditors (ASC 310-40) and
ASC 470-60, DebtTroubled Debt Restructurings by Debtors (ASC 470-60) were
essentially the only accounting guidance for debtors and creditors. However, any
debt restructuring that did not qualify as a troubled debt restructuring was evaluated
to determine whether it represented a reconsideration event under the VIE model.
Now a troubled debt restructuring is no longer exempt from being a reconsideration
event. The FASBs removal of the troubled debt restructuring exemption may
significantly impact banks and other lenders. In most instances, if the entity becomes
a VIE upon a troubled debt restructuring, banks/lenders may conclude that they are
not the primary beneficiary, however, they may become subject to the disclosure
requirements (see VE 7 for a discussion about disclosure requirements).

4.3.1 Reassessment of the Design of an Entity upon a Reconsideration Event

As discussed in VE 3, ASC 810-10-25-21 through 25-36 provides guidance regarding
how an entitys design should be evaluated to determine the nature of the entitys
variability for the purposes of evaluating the entity under the VIE model. The
guidance must be considered upon the occurrence of any reconsideration event
described in the VIE model. This might require a reporting entity to consider in its VIE
assessment new or different risks (e.g., interest rate risk) that face the entity.
The following sections discuss each of the reconsideration events described in the
VIE model in detail.
4.3.2 Losses That Reduce the Equity Investment

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 first concept discussed is the notion that operating losses in excess of the
expected losses that reduce the equity investment will not trigger a reconsideration
of an entitys VIE status. The rationale behind this concept seems to focus on
the design of the entity. Merely incurring operating losses does not affect the
characteristics of the equity investment at risk or the relationship among the equity
investors at risk and other variable interest holders. If the equity at risk was deemed
sufficient in the initial analysis of the VIE, and no events that could be considered
a redesign of the entity have occurred (such as the events included above), there
would be no basis to conclude that the entity has become a VIE, just because it has
incurred losses. It should be noted, however, that if one of the reconsideration events
does occur, the entitys VIE status will need to be re-evaluated as of that date, and
a prior history of operating losses that have reduced the equity investment at risk
will need to be considered as part of that analysis. Note that irrespective of whether
or not a VIE reconsideration event has occurred, the primary beneficiary analysis
is required to be carried out every reporting period by the reporting entity if such
reporting entity has a variable interest in a VIE (see VE 5.1.1 for details).

4.3.3 Change in Governing Documents or Contractual Arrangements

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.
This reconsideration event focuses on the redesign or restructuring of an entitys
governing documents or contractual arrangements among the parties involved with
the entity. The clarifying phrase that changes the characteristics or adequacy of the
entitys equity investment at risk will help preparers and auditors determine whether
a change in these documents/arrangements would trigger a reconsideration of
the entitys VIE status. Only significant modifications that affect the characteristics
or adequacy of the entitys equity investment at risk would be considered
reconsideration events.
Changes in the Characteristics of the Entitys Equity Investment at Risk
It will be easier to determine whether a modification of the governing documents
or contractual arrangements affects the characteristics of the entitys equity
investment at risk than to determine changes to its adequacy. Consider a situation
where the equity investors at risk in a VIE cede certain voting rights to another
variable interest holder. The reporting entity (investor) would need to contemplate
whether the modifications in the governing documents were significant and whether
or not those modifications changed the characteristics of the equity investment. In
this example, the following two factors may be considered by the reporting entity to
assess whether a reconsideration event has occurred:
1. Consider whether the rights ceded to the other variable interest holders were
participating or protective rights.
2. Consider whether the entitys VIE status would change if this event was
considered a reconsideration event. (i.e., was the modification so significant that
the entity would now be considered a VIE?)
If the modification is significant and changes the characteristics of the entitys equity
investment at risk, it would be deemed a reconsideration event under the VIE model.
Changes in Adequacy of the Entitys Equity Investment at Risk
Determining whether or not a modification of the governing documents or contractual
arrangements affects the adequacy of the entitys equity investment at risk will be
more difficult. This difficulty arises from the need to determine what caused the
change in the adequacy of the equity investment at risk and whether equity at risk
investors as a group lost the power over the entity. Only significant modifications that
directly impact the adequacy of the equity investment at risk or cause the equity at
risk investors as a group to lose power over the entity would be considered triggering
events under the VIE model.
Immediately Before
Modification
Immediately After Modification
Reconsideration
Event?
Sufficient Equity
Sufficient Equity and the equity at risk

investors as a group continue to hold
power over the entity
No
Sufficient Equity
Insufficient Equity
Yes
Insufficient Equity
Insufficient Equity and the equity at risk

investors as a group continue to hold
power over the entity
No
Insufficient Equity
Sufficient Equity
Yes
In the table above, the notions of sufficient and insufficient equity refer to whether or
not the entity qualifies as a VIE under Characteristic 1: Insufficient Equity Investment
at Risk. Sufficient equity indicates that the entity would not possess Characteristic
1, while insufficient equity indicates that the entity would possess this characteristic.
By evaluating the sufficiency of the equity immediately before and immediately after
the modification and whether equity at risk investors as a group lost power over the
entity, the reporting entity can assess the effect of that modification on the adequacy
of the equity without the impact of prior operating losses.

4.3.4 Return of Investment to Equity Investors

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.
A return of equity investment (that qualifies as equity at risk) to the investor would
also constitute a redesign of the entity. Since one of the five characteristics of a VIE
focuses on the sufficiency of the equity at risk, a reduction in that amount would
generally trigger a reconsideration event that pertains to an entitys VIE status.
Although a reduction in the equity investment caused by operating losses would not
indicate that redesign of the entity has occurred, a return of some or all of an equity
investment to the investor(s) would indicate that a redesign has occurred, as long
as other interests have become exposed to the entitys expected losses. Again, the
reporting entity should consider whether or not the return of the equity investment is
significant before concluding that the reduction constitutes a reconsideration event.
This reconsideration event (i.e., return of investment to equity investors) is intended
to focus on situations in which a voting interest entity may become a VIE.
Example 4-8: Consider an entity that was capitalized with 85 percent debt
and 15 percent equity on a fair value basis at formation date. The reporting
entity concluded that the equity investment at risk was sufficient such that
the entity was not a VIE with respect to Characteristic 1: Insufficient Equity
Investment at Risk at the time it made the investment. Suppose that six
months later the entity returns a portion of the equity investment to the
investor (the investor is also the reporting entity) and consequently causes the
new capital structure to become 99 percent debt and 1 percent equity on a
fair value basis at recapitalization date. Since this return of capital causes the
debt to be exposed to additional expected losses, the reporting entity should
re-evaluate the entitys VIE status.
4.3.5 Entity Undertakes Additional Activities

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.
This reconsideration event is also intended to focus on situations in which a voting
interest entity (not previously subject to consolidation under the VIE model) may
become a VIE. When analyzing this reconsideration event, consider whether there
has been a redesign of the entity. During the initial VIE analysis, the reporting entity
is required to assess the sufficiency of the equity investment at risk by evaluating
the entitys current and anticipated activities and by determining the equity
amounts needed (either quantitatively or qualitatively) to finance those activities.
In a quantitative analysis, that assessment would involve calculating the expected
losses of the entitya calculation that would be derived from the variability or
risk associated with the current and anticipated future activities of the entity. This
reconsideration event suggests that if the reporting entity had anticipated the
undertaking of new activities or the acquisition of additional assets in its initial
assessment under the VIE model, the actual undertaking or acquisition itself would
not be considered a reconsideration event. Only an undertaking/acquisition that
was not anticipated at the date of the original analysis would trigger reconsideration
under this provision.
The reconsideration event focuses on whether or not the unanticipated activities or
newly acquired assets actually increase the entitys expected losses. Consider the
following example:
Example 4-9: Assume that an entity holds two financial assets, one share of
stock in a Blue Chip utility company and one share of stock in a high-tech
start-up company. At the entitys inception, the reporting entity determined
that the entity was not a VIE. Six months later, the entity sells its share of
stock in the utility company and buys an additional interest in the start-up
company. If the acquisition of this new asset was not anticipated at the
entitys inception and the entitys expected losses have increased (as a result
of the increased risk), it would be considered a reconsideration event. Now
suppose that the entity sold its share of stock in the start-up company and
bought an additional share in the utility company. If the portfolio of assets
has become less risky, thus decreasing the expected losses of the entity, the
acquisition of the new asset would not be considered a triggering event under
the VIE model.
We believe that the difficult task of assessing whether the acquisition of additional
assets or the undertaking of additional activities constitutes a reconsideration event
will often be driven by specific facts and circumstances, and will depend heavily
on the entitys current business activities (e.g., an operating joint venture versus an
SPE that holds financial assets). We believe that the threshold for concluding that
a reconsideration event has occurred will be higher for an operating joint venture
than an SPE. In those situations, the reporting entity should consider whether the
acquisition/undertaking represents a significant change in the business activities of
the entity. When a reporting entity evaluates whether a reconsideration event has
occurred in an SPE that holds financial assets, the reporting entity should emphasize
the significance of new acquisitions/undertakings relative to the current portfolio of
the SPEs assets, including changes in the volatility or risk of the overall portfolio
resulting from the new acquisitions/undertakings.

4.3.6 Entity Receives Additional Equity Investment or Decreases

ExpectedLosses
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.
Although this reconsideration event may initially appear to be the inverse of the
events described in VE 4.3.4 and VE 4.3.5, it is not. The previous two reconsideration
events are focused on events that may cause a voting interest entity to become a
VIE. However, the FASB acknowledged that there may be situations in which a VIE
could become a voting interest entity. This reconsideration event considers those
situations in which an entity receives additional equity investment that potentially
increases the sufficiency of the equity at risk. Additionally, if the entity modifies its
activities in a way that decreases its expected losses, an equity investment once
deemed insufficient may become sufficient under Characteristic 1: Insufficient
Equity Investment at Risk. However, this is not the only possible outcome; a
recapitalization of an entity may cause it to become a VIE.
4.3.7 Holders of Equity Investment at Risk Lose Power

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.
Under the VIE model, an entity will become a VIE if, as a result of changes in facts
and circumstances, its holders of equity investment at risk lose the power through
voting or similar rights to direct the activities of the entity that most significantly
impact its economic performance. The FASB included this reconsideration event
to capture situations in which the equity investors at risk lost power over the entity
which may not have been a reconsideration event under the previous requirements.
For example, they were troubled by the lack of reconsideration under the previous
VIE model for circumstances in which an entity suffered from severe losses such that
the holders of the equity investment at risk as a group lost the power to direct the
activities of the entity that most significantly impact its economic performance.
4.3.8 Bankruptcy
Generally, when an entity files for bankruptcy, the equity at risk holders as a group
lose the power to make decisions that have a significant impact on the economic
performance of the entity because this decision making would typically transfer
to the bankruptcy court. Therefore, we believe that the act of filing for bankruptcy
typically constitutes a reconsideration event under the VIE model. Note that the
primary beneficiary analysis is required to be carried out every reporting period by
the reporting entity if such reporting entity has a variable interest in a VIE (see VE
5.1.1 for details).

4.3.9 Decision Maker or Service Provider Arrangements

As discussed in VE 3.3.9.6, the VIE model does not specify reconsideration of
whether or not a decision maker or service provider arrangement is a variable
interest should be based on reconsideration events or should be carried out on a
continuous basis. We believe that reconsideration of whether or not a decision maker
or service provider arrangement is a variable interest is a policy choice (see Question
3.2). If such arrangements are evaluated on a continuous basis, changes in the
determination can impact all of the reconsiderations events described above.

Identifying the Holders of the Equity Investment at Risk
Question 4-1: Does a hybrid equity instrument that contains an embedded derivative
requiring bifurcation pursuant to the provisions of ASC 815-15-25, qualify as part of
the total equity investment at risk?
PwC Interpretive Response: The embedded derivative that must be separated
from the host contract per the provisions of ASC 815-15-25 must be classified
as an asset or liability and thus would be excluded from the assessment of
the total equity investment at risk. However, the value ascribed to the host
contract that would be accounted for in GAAP equity might qualify for inclusion
in the assessment of the total equity investment at risk, assuming that the host
contract meets the other requirements of qualifying as equity investment at risk.
Specifically, one must determine whether the host contract meets the requirement
to participate significantly in profits and losses with other equity investors at risk.
That requirement would not be met, for example, if the separated derivative were
a fixed price put option that was determined to protect the host contracts investor
from expected losses of the entity.
Question 4-2: Under certain arrangements, an entity may grant sweat equity to
certain parties at the date on which an entity is established. Rather than granting this
equity in exchange for cash, the equity may be granted for recognition of the partys
past or potential future efforts in the arrangement. For example, entities established
for the acquisition, development, or construction of real estate or technology startups often grant sweat equity to developers/builders/founders for their efforts after
the inception of the arrangement.
Would this sweat equity meet the criteria for being included in the equity
investment at risk?
PwC Interpretive Response: No. Consistent with the conclusion in SAB 103,
Topic 1.1 (originally concluded upon in the AICPAs February 1986 notice to
practitioners entitled ADC Arrangements and subsequently reprinted without
modification as exhibit I of the AICPAs Practice Bulletin 1, dated November 1987),
sweat equity is not considered at risk for the purposes of determining the equity
investment at risk. In effect, sweat equity is financed for the equity holder by
the entity itself. The VIE model specifically precludes such amounts from being
considered part of the equity investment at risk for the purposes of determining
whether there is sufficient equity at risk in the entity. Therefore, the equity holder
that received the sweat equity would not be included in the group of equity
investors at risk for purposes of evaluating the characteristics of qualifying for
equity investment at risk. As a result, in an evaluation of whether the group of
holders of the equity investment at risk has the characteristics of a controlling
financial interest, Characteristic 2: Equity Lacks Decision Making Rights, would
potentially be met if the equity holder that received sweat equity also received
voting shares. Similarly, Characteristic 4: Lacking the Obligation to Absorb an
Entitys Expected Losses would be potentially met because the equity holder that
received sweat equity shares would have a right to the expected residual returns
of the entity.
Question 4-3: Company A is occasionally included in legal actions alleging that it
has infringed patents. Company A expects the volume of these claims to increase
as its business grows. As a result, the Company obtains a 49.5 percent limited
partnership interest in a private-equity fund (the PEF), which effectively operates
like a patent troll (i.e., it uses invested funds to acquire patents in certain industries
and then seeks license fees by enforcing these patents).
In order to obtain the limited partnership interest, Company A paid $4 million,
which included an upfront license fee. The upfront license fee was $2.4 million and
the terms of the partnership agreement call for the license fee to be immediately
distributed to the PEFs limited partners (including Company A) based on their
ownership interests (with the amount being limited to each partners capital
contribution amount). These fees would be considered unconditional in nature.
Company A is assessing the impact of the VIE model on this transaction. How does
the distribution of the upfront license fee impact the calculation of the equity at risk?
PwC Interpretive Response: The VIE model states that equity investment
at risk does not include amounts provided to the equity investor directly or
indirectly by entity or other parties involved with the entity. Generally, fees that
are paid concurrent with the formation of an entity (or shortly thereafter) and are
unconditional in nature would be considered a return of the amounts invested by
the equity investors. Therefore, the distribution of the upfront license fees would
result in a reduction of equity investment at risk for both Company A and the other
parties in the limited partnership.
Question 4-4: The general partner of a limited partnership investment fund makes
no initial cash contribution to the partnership interest but has the right to elect that
investment management fees earned in the future be allocated to its partnership
interest. The following two questions arise, assuming that the entity is a VIE due to
meeting Characteristic 2: Equity Lacks Decision Making Rights on day 1:
1. As fees are earned, will the fair value of the general partners equity interest
qualify as equity at risk under Characteristic 1: Insufficient Equity Investment at
Risk?
2. If so, does the general partners earning of management fees paid to its
partnership interest qualify as a reconsideration event under the VIE model?
PwC Interpretive Response:
Answer 1: Investment management fees earned and allocated by the general
partner to its equity interest will be considered equity at risk whenever the
following conditions are met:
i. The fees are commensurate with the fair value of the service rendered; and
ii. If
a. the general partner has the right to elect cash or have its fee allocated to
its equity interest, the services provided are substantive and the fees are
conditional upon the performance of the general partner (i.e., fees are not
earned unless prescribed duties are carried out to the satisfaction of the
limited partners); or
b. the general partner does not have the right to elect cash and its fee is
allocated to its equity interest, the limited partners by simple majority
vote hold substantive kick-out rights with respect to removing the general
partner. If the limited partners do not have substantive kick-out rights
exercisable by simple majority vote, the fees earned by the general partner
would be considered unconditional and therefore not equity at risk.
If the foregoing conditions are met, the allocation of fees earned should be
considered the same as if the fees were paid out in cash and then re-invested by
the general partner into the limited partnership fund.
Answer 2: Yes, if the fees are considered to be equity at risk, the reallocation
of capital between the limited partners and the general partner with respect to
investment management fees earned represents the infusion of equity capital into
the entity and will result in a reconsideration event under the VIE model, unless
the reconsideration event is insignificant. At the date on which the allocated fees
represent an amount that will participate significantly in the profits and losses of
the entity, the general partners equity interest will be considered at risk. Refer to
VE 4.3 for a discussion of reconsideration events.
Characteristic 1: Insufficient Equity Investment at Risk

Question 4-5: The VIE model lays downs three conditions to determine whether
equity at risk is sufficient when neither a qualitative assessment nor qualitative
assessment when taken alone is conclusive (see VE 4.2.1.2 and VE 4.2.1.3 for
details). In practice, how should one demonstrate the three conditions in the
sufficiency of equity at risk test with respect to overcoming the presumption that an
equity investment of less than 10 percent is insufficient?
PwC Interpretive Response: To demonstrate one of the three conditions in the
sufficiency of equity at risk test, each individual equity investment must meet all
the criteria to qualify as equity investment at risk to be considered part of the
total equity investment at risk. After one has identified the equity investment
that is considered at risk, one or all three conditions in the sufficiency of equity
at risk test can be utilized to demonstrate that the at risk equity is sufficient.
However, we believe that it may be difficult for many entities to demonstrate the
circumstances specified in the three criteria.
Ability to finance activities without additional subordinated financial support:
The FASB staff believes that entities which have issued investment-grade senior
debt may be able to demonstrate that the entity can finance its operations
without additional subordinated financial support (i.e., the entity has been able to
obtain financing that is low-risk, with an interest rate that is commensurate with
those low-risk activities). The FASB staff also indicated that there may be certain
circumstances in which the entity can demonstrate that it has sufficient equity,
even if the entity has issued subordinated debt that is also investment grade.
However, the grade and related interest rate of the subordinated debt must be
evaluated to determine whether it is comparable with what is typical for low-risk
investments. Depending on the nature and grade of the entitys debt and other
financing, the entity may not necessarily demonstrate the sufficient equity at risk
condition, even if it has diversified assets and risks.
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: It may be difficult to find another
entity (1) with assets that are similar in quality and located in similar amounts
and (2) without additional subordinated financings in its capital structure. For this
reason, it will be difficult to demonstrate this condition.
Amount if equity invested in the entity exceeds the entitys estimated
expected losses based on reasonable quantitative evidence: If the above two
conditions cannot be evaluated, only the last criterion can be used as a basis for
concluding that an equity investment of less than 10 percent is adequate (i.e., that
the equity exceeds the expected losses of the entity). Assessing whether the last
criterion can be demonstrated could necessitate a complex and time-consuming
effort, particularly for operating entities, since they would have to project operating
results and cash flows well into the future. Further, this criterion requires that the
estimate of the entitys expected losses be based on reasonable quantitative
evidence. Entities lacking reliable information will be unable to fulfill that criterion.
Finally, the ability to demonstrate any one of the three conditions does not
automatically indicate that the entity is not a VIE. There are four other requirements
that must be evaluated before one can determine whether the entity is a VIE.
Question 4-6: In determining whether a development-stage enterprise has sufficient

equity, what is meant by the phrase the activities it (the development stage
enterprise) is currently engaged in?
PwC Interpretive Response: Based on discussions with a FASB member, and
as clarified in the FASBs discussions during deliberation of the guidance, it
is our understanding that the Board did not intend for the guidance regarding
development-stage entities to be interpreted as a scope exception. Rather, the
Board intended to provide guidance on how the concepts of the VIE model
should be applied in the unique circumstances surrounding such entities. This
exception applies only to the sufficiency of equity at risk criterion. As a result, all
other characteristics of a VIE must also be assessed to determine whether an
entity is a VIE. Many development-stage entities go through several phases of
existence before they are considered substantive operating entities. For example,
the phases of a pharmaceutical research-and-development entity might be
divided into milestones, such as initial research, clinical trials, FDA approval, etc.
Consequently, a key question arises: Should the expected losses and expected
residual returns be estimated based on the development-stage entitys current
phase only or on its entire life cycle?
When evaluating a development-stage entity, only the current phase of
development (i.e., the phase for which financing has already been obtained)
should be considered. Thus, in order for entities in the development stage to avoid
being considered VIEs, the entity must have equity that is sufficient to permit it
to finance the activities in its current phase (i.e., the activity in which the entity
is currently engaged). Additionally, provisions in its governing documents must
enable the entity to obtain additional equity capital that will allow it to finance
future phases. Thus, some development stage entities may be VIEs and have
to be consolidated by another party if the entitys governing documents do not
provide for additional equity investments in subsequent phases.
Characteristic 2: Equity Lacks Decision Making Rights
Question 4-7: At the formation of a limited partnership (the Partnership), it was
determined that the general partner (GP) made a non-substantive equity investment
in the Partnership. Additionally, the GP holds all substantive decision making rights
in the Partnership and the limited partners do not hold any ability to remove the GP.
However, related parties of the GP made substantive limited partner investment in
the Partnership. It was determined, based on the guidance in VE 4.2.2.5, that the
economic interest held by the related parties of the GP should be combined with
the controlling interest of the GP. The combination of those interests did not result in
the entity being a VIE under Characteristic 2 and the Partnership was considered a
voting interest entity, as no other characteristics of a VIE in the VIE model were met.
Subsequently, the related parties sold their economic interest in the Partnership to an
unrelated third-party.
Should the related parties subsequent sale of their economic interest cause the GPs
equity to be no longer considered at risk and result in the Partnership becoming a
VIE?
PwC Interpretive Response: The partial sale of the interest would not in and of
itself cause the GP to reconsider whether or not the Partnership is a VIE under the
VIE model. We believe that the initial combination of the GPs controlling interest
and the related parties economic interest should be viewed as one interest in
the Partnership for evaluation of whether or not the entity is a VIE. Given that at
inception the combined interest was determined to be equity at risk for evaluation
under the VIE model, the remaining portion of that interest after the partial sale
would continue to be considered equity at risk. Effectively, the remaining GP
interest would be considered equity at risk.
Characteristic 3: Equity with Nonsubstantive Voting Rights
Question 4-8: Consider a reporting entity whose economic interest in an entity
is greater than its voting interest in the same entity. Is the disproportionate voting
interest and economic interest criterion met if the voting interest held by that
reporting entity would not be substantively different if those voting rights were
proportionate to its economic rights?
PwC Interpretive Response: The disproportionate voting interest and economic
interest criterion was included to identify entities designed with nonsubstantive
voting rights and to subject those entities to the economic risk and rewards model
established in the VIE model. In situations where a technical disproportionality
exists, it is not automatically assumed that the disproportionate voting interest
and economic interest criterion is met. Rather, the focus should be on whether the
governance of the entity would be substantially different had voting rights been
equal to economic rights.
For example, if an entity had 25 percent of the economic risks and rewards of an
entity, but held only 15 percent of the voting rights (as determined through review
of the investors ability to vote on the substantive operating decisions of the
entity), whether the investor would be able to participate in additional substantive
operating decisions through voting or veto rights at the 25 percent voting level
should be considered. If the investor would not have any additional rights at the
increased voting percentage, no substantive disproportionality would be assumed
under the disproportionate voting interest and economic interest criterion.
However, when the two amounts straddle 50 percent (i.e., 48 percent voting rights
and 52 percent economics), the amounts should not be considered proportional,
regardless of the magnitude of the difference between the amountseven 49.9
percent vote and 50.1 percent economics should be considered non-proportional.
If additional voting or veto rights would be achieved at the increased level,
whether the investor meets the substantially all criterion should be considered.
Characteristic 4: Equity Lacks the Obligation to Receive an Entitys

ExpectedLosses
is the land and building under the agreement. As part of the agreement, Company
A is required to pay a non-refundable deposit to Company X. Company A also has
the right to terminate the contract, subject to the loss of its deposit. Assuming that
Company A has a variable interest in Company X due to the purchase and sale
agreement (see Example 3-6 for details), will Company X be considered to be a VIE?
PwC Interpretive Response: Yes. In the fact pattern in this example, the
purchase and sale agreement of real estate requires Company A (buyer) to make a
non-refundable deposit to Company X (seller) where Company Xs sole asset is the
real estate subject to the agreement, The non-refundable deposit absorbs some of
the Company Xs variability and transfers to the buyer some of the usual risks and
rewards of ownership. In essence, the protection provided to the seller from the
non-refundable deposit would cause Company X to be a VIE under ASC 810-1514(b)(2) because the non-refundable deposit absorbs significant variability in the
entity by providing protection to the equity holders of Company X from first dollar
losses with respect to changes in value of the underlying asset.
Characteristic 5: Equity Lacks the Right to Receive an Entitys Expected
Residual Returns
Question 4-10: A JV is created, whereby Company A and Company B each
contributes $50 million in cash to the JV in exchange for a 50 percent equity
ownership in the JV. The JVs board of directors consists of 4 directors. Company A
and Company B each has equal representation on the board and decisions require a
unanimous vote. Company A has an option to purchase Company Bs equity interest
in the JV for $60 million 2 years from the JV inception date. Assume that the option
to purchase Company Bs equity interest is a variable interest at inception under the
VIE model because (a) it is a fixed price option and Company A absorbs the positive
variability from the change in the fair value of the JV; and (b) there are no significant
barriers for Company A to exercise the option. Does the option cause the JV to be a
VIE?
PwC Interpretive Response: Yes. If the option is determined to be a variable
interest that is not embedded in the equity, (e.g., Company A and/or Company Bs
shares can be transferred without the transfer of the option), then it is likely that
the JV may be a VIE if the option holder is able to acquire more than 50 percent
of the equity interest in the JV upon exercise. This is because the equity holders
at risk may not have the right to receive the expected residual returns of the JV
because the option holder would be in a position to absorb positive variability
through the exercise of the option. However, if the option is determined to be
embedded in the equity interest, (e.g., Company A and/or Company Bs shares
cannot be transferred without the transfer of the option), then the JV will not be a
VIE.
Reconsideration Events: VIE Status

Question 4-11: The VIE model requires that reporting entities initially determine
whether an entity is a VIE at the date on which they became involved with that
entity. Would future changes in GAAP affecting the classification of instruments be
considered triggering events under the VIE model? If so, would they necessitate a
reassessment of the entitys VIE status?
PwC Interpretive Response: No. We believe that a change in GAAP is not a
triggering event under the VIE model and therefore we believe that such a change
in GAAP would not require a reconsideration of the entitys VIE status. However, if
other events that qualify as triggering events (as described in the VIE model) occur
and a reporting entity is required to re-evaluate whether an entity is a VIE, any
changes in GAAP that occurred since the last triggering event must be considered.
Question 4-12: Similar fact pattern as in Question 4-10 above except that Company
As deposit is a conditionally refundable deposit. The purchase and sale agreement
states that Company A is obligated to purchase the land and building only if (i)
Company X gets the zoning for the property changed; or (ii) Company X obtains
written consent from its lenders permitting Company A to assume existing nonrecourse debt encumbering the property. There is a time limit on the resolution of the
contingencies and if the contingencies are met, Company A must either purchase the
land and building or forfeit the deposit. Should the purchase and sale agreement be
re-evaluated if and when the contingencies are met?
PwC Interpretive Response: Generally yes. In the circumstances described
above, if the contingencies were met (i.e., zoning approval obtained or lender
approval received) and no remaining contingencies existed, a reconsideration
event may have occurred. The deposit should then be viewed as a non-refundable
deposit and re-evaluated per Question 4-10 above.
Chapter 5:
Identifying the Primary Beneficiary of a VIE
Identifying the Primary Beneficiary of a VIE / 5 - 1
Executive Takeaway
The primary beneficiary is the reporting entity that is required to consolidate the
VIE.
The VIE model is predominantly a qualitative model for determining which entity
has a controlling financial interest and is the primary beneficiary of a VIE. However,
for VIEs subject to the deferral of ASU 2010-10, the primary beneficiary analysis is
based upon absorption of a majority of expected risks and rewards.
The primary beneficiary is the variable interest holder that has (1) the power to
direct activities that most significantly impact the economic performance of the
VIE, and (2) the obligation to absorb losses or the right to receive benefits of the
VIE that could potentially be significant to the VIE.
Individual parties within a related party group (including de facto agents) should
first separately consider whether any party within the related party group is the
primary beneficiary on a stand-alone basis (which may frequently be the case). If
no party within the related party group is the primary beneficiary on a stand-alone
basis, the determination of the primary beneficiary within such group is based on
an analysis of the facts and circumstances with the objective of determining which
party is most closely associated with the VIE (i.e., the related party tiebreaker).
A reporting entity is required to reconsider whether it is the primary beneficiary of a
VIE on an ongoing basis.
5 - 2 / Identifying the Primary Beneficiary of a VIE
Chapter 5: Identifying the Primary Beneficiary of a VIE

5.1 Identification of the Primary Beneficiary

Once a reporting entity determines that it has a variable interest in a variable interest
entity (VIE), it must determine whether or not it is the primary beneficiary and should
consolidate the VIE.
5.1.1 What Is a Primary Beneficiary?

A primary beneficiary (PB) is the reporting entity that is required to consolidate the
VIE. The VIE model requires a reporting entity with a variable interest in a VIE to
qualitatively (and not quantitatively) assess whether it has a controlling financial
interest in the entity and, if so, whether it is the primary beneficiary. In other words,
a majority share of risks and rewards is not required to be the primary beneficiary.
The approach is intended to encourage the use of judgment in determining which
reporting entity controls a VIE.
38A: A reporting entity shall be deemed to have a controlling financial
interest in a VIE if it has both of the following characteristics:
a. The power to direct the activities of a VIE that most significantly
impact the VIEs economic performance
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. 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 the VIE that most significantly impact
the VIEs economic performance.
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.
The reporting entity is deemed to be the primary beneficiary if it meets both criteria
below:
Power Criterion: Power to direct activities of the VIE that most significantly impact
the VIEs economic performance (power criterion).
Losses/Benefits Criterion: Obligation to absorb losses from or the right to receive
benefits of the VIE that could potentially be significant to the VIE (losses/benefits
criterion).
In assessing whether a reporting entity has both the power criterion and the losses/
benefits criterion in an entity, it should consider the entitys purpose and design,
including the risks that the entity was designed to create and pass through to its
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 meet the losses/
benefits criterion, 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.
The VIE model calls for increased skepticism in situations where a reporting entitys
economic interest in a VIE is disproportionately greater than its stated power to
direct the activities of a VIE that most significantly impact the entitys economic
performance. As the level of disparity increases, the level of skepticism about a
reporting entitys lack of power is expected to increase.
Excerpt from ASC 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
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.
The VIE model requires an ongoing reconsideration of whether a reporting entity is
the primary beneficiary of a VIE due to changes in facts and circumstances.
In establishing this requirement, the FASB noted that requiring reconsideration in
response to changes in facts and circumstances would provide benefits to users that
would outweigh the anticipated costs to comply with the requirement. For example,
if a party has a variable interest in a VIE in the form of a guarantee and over time the
VIEs performance declines significantly, then the guarantor may become the primary
beneficiary. Further, the FASB also expects that the ongoing qualitative assessment
would require less effort and be less costly than the quantitative assessment of
expected losses and expected residual returns required under the earlier model.
When a reporting entity identifies a change in the primary beneficiary of a VIE, it will
need to determine the date within the reporting period when the change occurred
and recognize the effects as of that date.
Because of the requirement for ongoing assessment of a VIEs primary beneficiary,

the assessment of related parties (and de facto agents) must similarly be assessed
on an ongoing basis.
Will a VIE Always Have a Primary Beneficiary?
Under certain scenarios none of the variable interest holders may be deemed to
be the primary beneficiary and therefore no one would consolidate the entity. For
example:
The party that meets the power criterion does not hold a variable interest in the
VIE, or does not meet the losses/benefits criterion.
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
Power is not shared, but multiple unrelated parties perform the same activities
that most significantly impact the entitys economic performance and no party has
power over the majority of these activities.
Examples illustrating the above scenarios will be discussed in further detail later in
this chapter.

5.1.2 Power Criterion

For a reporting entity to determine whether it has the power to direct the activities
of the VIE that most significantly impact the VIEs economic performance, it must
(1) identify which activities most significantly impact the entitys economic
performance, and then (2) identify who has power over those activities.
Identifying the Power of an Entity
Determining which activities most significantly impact the entitys economic
performance may require significant judgment. In certain circumstances, an entitys
operations may be straightforward. Certain entities that are traditionally VIEs may
have activities that are significantly limited and may not function in a manner that is
similar to an operating business. In those instances, determination of which entity
meets the power criterion may not require significant judgment. However, other more
complicated structures involving multiple parties or highly structured securitizations,
asset-backed financing arrangements or other typical SPE structures may require
a significant level of judgment to determine which variable interest holder has the
power to direct the activities of the VIE that most significantly impact the VIEs
The ability to exercise power over activities that most significantly impact the VIEs
economic performance must be considered even if a reporting entity does not
exercise its power. For example, the consideration of a reporting entitys ability to act
only when certain circumstances or events occur is likely to be more relevant in the
case of entities that have no or limited day-to-day decision-making (e.g., the right
to mitigate losses in the event of default of a financial asset); whereas, contingent
power may be less relevant to the overall economic performance of an operating
business.
A reporting entitys assessment of power should consider the power to direct

activities through its variable interest that may impact any of the entitys variable
interest holders, not just the equity holders. It is, therefore, possible that a variable
interest holder may have power through a contract.
When determining which activities most significantly impact the economic
performance of an entity, a reporting entity must focus on all of the risks that the
entity was designed to create and pass through to its variable interest holders. In
other words, the risks that the entity was designed to create and pass through to its
variable interest holders should be based on the VIE model (rather than solely based
on the economics that are created for the equity investors or residual holders).
Factors to Consider in Evaluating Which Decisions Most Significantly Impact
Performance
Once the risks that the entity was designed to create and pass along to its variable
interest holders have been identified, an analysis over the key decisions that could
be exercised relating to those risks should be performed. A careful consideration of
the following factors may prove helpful in deciding which activities most significantly
impact economic performance:
How each decision impacts the risks that the entity was designed to create.
How the decisions impact the cash flows of the entity created for the benefit of
How the decisions impact margins of the entity.
Whether the decisions could increase revenue of the entity.
How the decisions could affect the overall fair value of the entity.
The nature of the entitys assets and how the decisions could impact the fair value
of those assets.
Expectations regarding the life of the entity and expectations regarding which
decisions will be made over the life of the entity.
If the activities that impact the entitys economic performance are directed by
multiple unrelated parties and if the nature of the activities that each party is directing
is not the same, then an entity will have to identify which party has the power to
direct the activities that most significantly impact the entitys economic performance.
One party, if any, will have this power, and that party will be deemed to meet the
power criterion. It is also possible that this conclusion can change over timeeither
by the contract terms, through passage of time or upon specific events in which case
the primary beneficiary can change.
Example 5-1: Fruit Co. and Bottle Co., unrelated parties, form an entity Juice
Co. Both Fruit Co. and Bottle Co. contribute an equal amount of cash and
receive a 50 percent equity interest in Juice Co. Fruit Co. is an agricultural
company specializing in the production of organic fruit used in high-end fruit
drinks. Bottle Co. bottles and distributes beverages throughout the U.S. Fruit
Co. and Bottle Co. formed Juice Co. for the purpose of manufacturing organic
fruit juices for distribution to retailers throughout the U.S. Juice Co. has been
determined to be a VIE. Apart from their equity interest, neither Fruit Co. nor
Bottle Co. holds any other variable interest in Juice Co. How should Fruit Co.
determine if it meets the power criterion?
First, Fruit Co. must determine the purpose and design of Juice Co., including
the risks it was designed to create and pass through to its variable interest
holders. Juice Co. was created to provide Fruit Co. access to Bottle Co.s low
cost bottling process as well as its distribution network while providing Bottle
Co. access to Fruit Co.s supply of organic fruit. Profits and losses of Juice
Co. will be allocated equally to Fruit Co. and Bottle Co. based on their equity
ownership percentages.
Next, Fruit Co. must determine which activities of Juice Co. most significantly
impact its economic performance and determine whether it has the power
to direct those activities. The party with the power to direct those activities
would meet the power criterion.
Fruit Co. has determined the activities which most significantly impact Juice
Co.s economic performance are as follows:
Activity
Agricultural
Production/Bottling
Distribution
Next, Fruit Co. must determine which party has the power over the activities
which most significantly impact the economic performance of Juice Co. Fruit
Co has determined the parties with the power to direct activities which most
significantly impact Juice Co.s economic performance as follows:
Activity
Responsible Party
Agricultural
Production/Bottling
Distribution
Fruit Co.
Bottle Co.
Bottle Co.
If each of the significant activities identified above carried the same

importance in determining Juice Co.s economic performance (which may be
very difficult to demonstrate in practice), Bottle Co. would likely be deemed
to meet the power criterion as it has the power to direct the majority of the
activities (production/bottling and distribution) which most significantly impact
the economic performance of Juice Co.
Example 5-2: Assume the same facts as Example 5-1, except Fruit Co. has
determined the agricultural activities (i.e., the growth of the core ingredient in
Juice Co.s primary product) have a more significant impact on the economic
performance of Juice Co. than the production/bottling and distribution
activities combined.
Following an analysis process similar to that in the previous example, Fruit Co.
must determine which party has the power over the activities which most
significantly impact the economic performance of Juice Co. In this example
decisions made during the agricultural activities by Fruit Co. are the most
significant activities impacting Juice Co.s economic performance. Therefore,
Fruit Co. would likely meet the power criterion as it has the power over the
most significant activities of Juice Co. regardless of the number of activities
directed by each reporting entity.
Power Exists in a Fiduciary Contract

There can be circumstances where the power that most significantly impacts
economic performance is held through a fiduciary service contract (e.g., a service
contract that is not a variable interest under the entity). In this circumstance, there
would be no primary beneficiary since the contract is not a variable interest. We
believe it would be unusual for the power to be truly vested in a party or parties
(including related parties) which have no participation in the variability of the entity in
some form.
Example 5-3: Reporting Entity A holds a small senior interest in a VIE and
is a servicer to a VIE that is a securitization vehicle which holds mortgage
loans. It is determined that Reporting Entity A through its contract as servicer
has power to make decisions that most significantly impact economic
performance of the VIE. Reporting Entity A has determined that its service
contract is not a variable interest despite the additional senior interest it holds
in the entity when assessing under ASC 810-10-55-37 (see VE 3.3.9).
In this fact pattern, since the power exists in a contract that is not a variable
interest, Reporting Entity A is not deemed the primary beneficiary since its
senior interest alone does not provide Reporting Entity A with power to make
decisions that most significantly impact economic performance.
Impact of Contingent Decisions in Identifying the Power of the VIE
In identifying the decisions that most significantly impact the economic performance
of a VIE, decisions that are contingent upon a future event should be considered in
assessing the power criterion. In some situations, the power that most significantly
impacts the economic performance of the VIE may not be able to be acted upon until
a contingent event occurs. In fact, in some entities, all actions are predefined and self
contained and there are no substantive decisions to be made unless certain specific
contingent events occur.
ASC 810-10-55-96 through 55-109 includes an example which is useful in
understanding this concept. The example is a commercial mortgage backed
securitization in which the VIE funds the purchase of commercial mortgage loans
by issuing fixed rate debt to third-party investors and equity to a third-party who
also performs special servicing function. The transferor to the VIE performs primary
servicing activities. Upon default of a mortgage loan, the administration of that loan
is transferred to the special servicer. In this example, it is concluded that the power
that most significantly impacts the economic performance of the VIE is the power
to manage the defaulted assets. This power is held by the special servicer and the
special servicer is deemed to hold the power under the power criterion, even though
the power cannot be executed until a contingency (i.e., default or delinquency of an
asset) occurs.
This analysis becomes more difficult when there are significant activities that are
performed during the period before the contingent event occurs. For example, if
it is determined that the activities performed before the contingent event occurs
are significant to the economic performance of the entity, then there could be a
different variable interest holder who meets the power criterion before and after the
occurrence of the contingent event. In other words, a change in power occurs
upon the occurrence of the contingent event. However, if it is determined that the
events which occur prior to the contingent event are not significant to the entitys
economic performance, it may be determined that the activities which occur after
the contingent event may drive the determination of power criterion even prior to the
occurrence of the contingent event. In other words, the contingent event triggers
the most significant activities of the entity.
If it is determined that the activities which occur both before and after the contingent
event may significantly impact the economic performance of the entity, the
power criterion analysis should focus on the purpose and design of the entity, the
significance of the activities throughout the life of the entity, the ability of the variable
interest holders to impact the occurrence of the contingent event and the likelihood
of the contingent event occurring. The assumptions about which activities most
significantly impact the economic performance of the entity may change as of each
reassessment date. For example, if an entity appears to have significant activities
that are linear (i.e., in stages) such that each significant activity is contingent upon
the prior significant activity, the focus may be on the uncertainty of completing the
initial stage and each subsequent stage as well as which stage will most significantly
impacts the economic performance over the life of the entity based on assumptions
at the date of the assessment.
Example 5-4: An entity is formed by Company A and Company B for the
purpose of constructing a manufacturing facility. Company A and Company
B each own 50 percent of the equity ownership of the entity. The entity is
determined to be a VIE. Once construction is complete, the VIE will operate
the facility and sell the manufactured goods to third parties unrelated to
Company A and Company B. Company A is responsible for directing the
significant activities during the construction of the manufacturing facility, while
Company B will direct the significant activities related to manufacturing and
sales of the finished product after construction of the facility is complete. All
the appropriate approvals for the manufacturing site have been obtained (e.g.,
permits) and Company A has constructed similar facilities in the past.
The decisions made during both the construction phase and the subsequent
manufacturing and sales stage are determined to have a significant impact on
the economic performance of the entity. Neither Company A nor Company B
have any other variable interest in the VIE.
In this example, the variable interest holder that meets the power criterion
during the construction stage and after may be different. The VIE was
created with two separate and distinct phases, both of which will significantly
impact the economic performance of the entity. Company A and Company
B have entered into similar projects in the past with each party having the
responsibility for similar activities. In each case, the construction phase was
successfully completed in accordance with the business plan and approvals
have been obtained to construct the facility and Company B was able to
begin manufacturing and selling the finished product in accordance with the
entitys original business plan.
In this example, given Company As positive historical experience in
completing similar projects and the expectation that construction will be
successfully completed, Company B may be deemed to meet the power
criterion throughout the lifecycle of the entity (even during the construction
phase) since the activities over which it has power (manufacturing and sales)
are truly the drivers of the entitys economic performance.
If on the other hand, significant uncertainties existed (such as zoning and
design issues) with respect to the construction and/or Company A did not
have a positive historical experience in successfully completing similar

projects, then Company A may be deemed to meet the power criterion during
the construction phase and the power would shift to Company B at or near
completion.
Example 5-5: An entity is formed for the purpose of developing,
manufacturing and distributing a pharmaceutical drug candidate. The entity
is determined to be a VIE. The VIE obtains legal title to the drug candidate
and the objective of the entity is to perform further research and development
on the drug candidate with the goal of obtaining approval from the FDA
for commercialization of the drug. Company A, a variable interest holder, is
responsible for all decisions regarding the activities of the VIE throughout
the FDA approval process. Company B, a variable interest holder, will
be responsible for all significant activities post FDA approval, including
manufacturing, marketing and distribution of the drug. It is determined that
the activities performed during both the initial stage (FDA approval) and
subsequent stage (manufacturing, marketing and distribution) will have a
significant impact on the economic performance of the VIE.
Both Company A and Company B have the power to direct significant
activities of the VIE which will impact its economic performance. However,
Company Bs power is contingent upon the successful development of the
drug and receipt of required approvals. The drug is currently in Phase I clinical
trials and there is significant uncertainty regarding the likelihood of the drug
reaching FDA approval.
Since there are significant uncertainties which exist as of the assessment date,
the determination of power should be based on the significant activities that
exist during the initial stage. Therefore, it is likely that Company A would meet
the power criterion since it has the power to direct the activities that will have a
significant impact on the VIEs economic performance during the initial stage.
However, once the uncertainty regarding the receipt of FDA approval has
lapsed, the determination of which variable interest holder meets the power
criterion should focus on which party has the power to direct the significant
activities during the remaining life of the entity (i.e., manufacturing, marketing
and distribution) which is likely to be Company B in this example. In other
words, once the FDA approval contingency has been met it is likely that the
party determined to meet the power criterion will change.
Shift in Who Holds the PowerReconsideration Events
In some circumstances, the party that meets the power criterion may change over
time. For example the decisions that impact the economic performance of the entity
may be consistent throughout an entitys life, but when certain contingencies are
met, power may shift from one party to another. One example of such a scenario
is if an event of default occurs and one of the parties in an entity can take over
key decisions of an entity. In contrast to the previously discussed examples, these
scenarios involve the same on-going significant activities throughout an entitys life
cycle, and the contingent event determines which entity will have the power to direct
those significant activities. In these situations, we have referred to the impact of the
contingent event as a shift in power in the same power versus a change in power
as illustrated in the previous examples. Since the VIE model requires an ongoing
reconsideration of the primary beneficiary, events involving shift in power will
require special consideration.
In situations involving shift in power, determining which party meets the power
criterion will likely require significant judgment during the initial assessment of power
as well as during each subsequent reassessment. The basic model for determining
which entity meets the power criterion does not change in these situations. However,
if it is determined that the activities performed both before and after the contingent
event occurs are significant to the economic performance of the entity, which will
likely be the case in the context of a power shift, then the party who meets the power
criterion may change after the contingent event occurs.
Some examples of when power may shift from one party to another and thereby
change the determination of the primary beneficiary include:
The expiration of kick out rights or participating rights.
The trigger of a contingent event that causes kick-out rights or participating rights
to become exercisable.
Acquisition of interests or contractual arrangements which allow a party to now
exercise power over the entity.
Example 5-6: Company A and Company B purchase output from Company
X that owns and operates a power plant under a power purchase agreement
(PPA). Company X is determined to be a VIE and both Company A and
Company Bs PPAs are determined to be variable interests. The estimated
life of the power plant is 30 years. Company As PPA provides it with the
contractual right to operate the power plant for the first 15 years of the power
plants life, while Company Bs PPA provides it with the contractual right to
operate the power plant for the remaining 15 years. The power granted to
Company A and Company B through their PPAs is determined to provide
them with the power to direct the activities of Company X that will most
significantly impact the economic performance of Company X during the
effective periods of their contracts.
While both Company A and Company Bs variable interest provide them
with the power to direct the significant activities of Company X. However,
Company Bs power is contingent upon the passage of time and does not
become effective until Company As power ceases. In these situations it
may likely be determined that Company A meets the power criterion during
its contractual period, while Company B will meet the power criterion once
Company As contract has expired and Company A no longer has a variable
interest in Company X.
Example 5-7: A VIE is created for the purpose of purchasing fixed-rate
residential mortgage loans from a Transferor. The entity finances the purchase
of the mortgage loans by issuing three tranches of securities, a senior tranche
that is guaranteed by a financial guarantor (FG Company), a subordinate
tranche and a residual interest. The Transferor retains servicing responsibilities
over the mortgage loans. Upon a predefined event of default (which is
triggered based upon a significant amount of delinquencies of the underlying
assets), Transferor is automatically removed as the servicer of the entity and
FG Company assumes the role of servicer.
As servicer, the Transferor is responsible for servicing the non-performing
loans, which includes contacting defaulting borrowers, determining if
and when a borrower should be granted a loan modification, as well as
determining when to foreclose on the collateral underlying a delinquent
mortgage loan. Servicing of non-performing loans is determined to have

the most significant impact upon the economic performance of the entity.
Therefore, the Transferor in its role as servicer meets the power criterion.
However, if an event of default occurred and FG Company takes over
servicing responsibilities (which conveys power), FG Company would be
the entitys primary beneficiary since power shifted. FG Company would
also meet the losses/benefit criterion as it would potentially be exposed to
significant losses.
Evaluation of Call Options in Assessing the Power Criterion
Call options (i.e., the right to purchase the interests of an entity) often exist in VIEs.
For example, one of the two parties to a joint venture may often provide the other
party the right to purchase its interest in the entity for a fixed price or at a fixed
formulaic price. The VIE model does not specifically address how physically or net
share settled call options that give the holder of the call option power over the entity
if exercised should be considered. Some have considered that in the case of a call
option, the holder has the ability to seize power from other parties with respect
to the entity. As a result, some believe that a call option should be viewed similar
to a kick-out right as described further in this section (VE 5.1.2). We believe that
while there are similarities to kick-out rights since the holder of a kick-out right has
the ability to seize power from another party making decisions, the holder of a call
option generally is required to make a significant cash outlay (or economic value in
cases in which there is a cashless exercise feature). Therefore, call options are not
economically the same as kick-out rights.
In many cases, the existence of the call option will not impact the analysis of power
however, we do believe that call options should be carefully considered to determine
if the substance of the call option gives the holder the power to make decisions that
most significantly impact the economic performance of the VIE. If the call is currently
exercisable, we believe that the following factors should be considered in making this
evaluation:
The strike price and other key terms of the call option. If the call option has an
exercise price at fair value instead of an exercise price based on a fixed price
or formula, it would be highly unlikely that the call option in and of itself would
provide the holder with power. However, if the options exercise price is based
a fixed amount or on a formula, the intrinsic value of the option should be
considered. In situations in which the option is deep-in-the money, it may be likely
that the substance of the arrangement is that the holder of the option has power
over the entity.
The significance and importance of the holder of the options potential ownership
in the entity. If the VIEs activities are of the utmost importance to the holders
ongoing business, there is a greater potential for the holder to effectively influence
the entity. However, in most cases, the level of influence will not be so great as
to allow the holder to have the ability to make decisions that most significantly
impact the economic performance of the VIE.
The overall level of control held by the holder of the option. Based on the
existence of the call option by itself or with other variable interests held by the
holder (including its related parties/de facto agents), the holder may have the
ability to make decisions that most significantly impact the economic performance
of the VIE.
The overall importance of the holders operations to the ongoing business

activities of the VIE. The VIEs dependence on the holder to conduct its business
activities may effectively provide the holder with power over the VIE.
The existence of barriers to exercise the option. A careful consideration of factors
that could prevent or limit the ability of the holder to exercise the call option (e.g.,
due to illiquidity, regulatory concerns or other factors) may lead to a conclusion
that the holder does not have the power over the VIE through its call option.
The existence of conditions such that it would not be prudent, feasible and
substantially within the control of the holder of the call to exercise the call option.
For example, the counterparty to the call option controls technology that is critical
to the VIE or the counterparty to the call option is the principal source of funding
for the VIE.
If the call option can only be exercised when a substantive contingency occurs, we
do not believe that such call options should be considered in the power criterion
evaluation until the contingency is resolved (i.e., at the point in time that the call is
exercisable). Additionally, if the call option is not currently exercisable merely due
to the passage of time (e.g., call option that is exercisable after 5 years), then it is
not considered in the power criterion evaluation until it is exercisable. Both these
scenarios would be situations in which it is important to perform an ongoing analysis.
In all of the scenarios described above, it is assumed that the call option gives the
holder the right to obtain power upon exercise. There can be some limited situations
in which the holder of the call option may have voting rights or other decision making
rights that legally exist in the call option itself (e.g., upon executing the call option,
the holder may be granted the ability to elect board of directors of the VIE). In those
cases, the rights granted should be considered in the evaluation of the power
criterion.
Additionally, cash settled call options should not impact the power criterion analysis
since these options do not give the holder any rights to make decisions that
significantly impact the economic performance of the VIE.
Shared Power
In certain situations the VIE model allows a reporting entity to determine that power is
shared with other unrelated parties such that no one party meets the power criterion.
In a shared power situation, no party, including the reporting entity, is deemed to be
the primary beneficiary.
If a reporting entity determines that power is, in fact, shared among
multiple unrelated parties such that no 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
Power is considered to be 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. In addition, each of the parties is required to consent
to the decisions relating to those activities. The requirement to consent must be
substantive. This principle is illustrated in the examples included in ASC 810-10-55182 through 55-198. In this example, two unrelated companies are each responsible
for manufacturing, distributing, and selling a product and are required to obtain each
others consent with respect to the decisions relating to those activities. We believe
that if there are more than two unrelated parties that participate in making decisions
that have a significant impact on the economic performance of the entity by simple
majority vote, power is still considered to be shared.
When a joint venture qualifies as a VIE, provided that each of the joint ventures
partners consent to the activities that most significantly impact the VIEs economic
performance, neither party would be required to consolidate the VIE unless the
partners are considered related parties or de facto agents (see VE 5.1.4).
In determining if power is shared, a reporting entity must not only focus on whether a
requirement to consent is present, but also needs to identify at what level within the
entity the significant decisions reside. For example, if an entity establishes a board of
directors consisting of representatives unilaterally approved by each equity holder (all
unrelated parties), and the board of directors holds the power to direct the significant
activities of the entity, power must be analyzed at the board level. In some cases,
however, while the decisions of the board of directors may be shared, there may be
significant decisions made by one of the venture partners through other contractual
arrangements such as service or management contracts. The decisions made
through those contracts should be considered in the analysis. A careful consideration
of the decision making below the board should be performed when assessing the
power criterion.
Additionally, a reporting entity should careful consider what happens when a
deadlock occurs. For example, in many circumstances, two parties may be
required to consent to an activity of an entity. Contractual clauses may exist to clarify
what happens in the event that the parties do not agree to the decision at hand.
If one of the parties has the ability to break the deadlock by voting a tie-breaking
vote, it may be deemed to have the power over the entity and power would not be
considered shared.
In other situations, the decisions that most significantly impact economic
performance of the VIE may be required to be approved by a majority of the parties
involved in the entity rather than by unanimous consent. It is our understanding that
the FASBs focus on the words consent was not to necessarily require unanimous
consent in order to determine whether power is shared. Rather the FASBs intent was
to clarify that shared power would not exist if there were key decisions of an entity
and there were separate parties that could make such decisions unilaterally without
requiring consent of the other parties (either majority or unanimous).
Example 5-8: ABC Co., DEF Co. and XYZ Co., all unrelated parties, each hold
a variable interest in Oak Co., a manufacturer of oak furniture for wholesale
distribution to retail furniture stores. ABC Co., DEF Co. and XYZ Co. each
obtained 33.33 percent of the equity of Oak Co. through equal contributions
of cash upon formation of the entity. All profits and losses of Oak Co. are
allocated to the equity investors pro-rata to their equity ownership. Apart from
the equity interest, neither party holds any other variable interests in Oak Co.
The board of directors is comprised of the six directorstwo each appointed

by ABC Co. DEF Co. and XYZ Co respectively. All decisions related to Oak
Co.s significant activities require approval by a two-thirds majority vote of the
board of directors (i.e., four of the six directors).
Oak Co. has determined the activities which most significantly impact Oak
Co.s economic performance are:
1. purchasing raw materials,
2. manufacturing, and
3. sales.
In this scenario, it may likely be determined that ABC Co., DEF Co. and XYZ
Co. have shared power of Oak Co. through their representation on the board
of directors. Since all decisions regarding the significant activities of Oak Co.
require approval by ABC Co., DEF Co and XYZ Co. through their appointed
directors, neither ABC Co., nor DEF Co. nor XYZ Co. can independently make
decisions regarding the Oak Co.s significant activities. Therefore, neither
party is deemed to meet the power criterion since power is shared.
Example 5-9: Assume the same facts as Example 5-8, except for the following:
ABC Co. holds 50 percent, while DEF Co. and XYZ Co. each hold 25 percent
of the outstanding equity of Oak Co. Each party holds two Board of Director
seats and a two-thirds vote is required to make the decisions that most
significantly impact the economic performance of the entity.
In this scenario, the assessment of power would not differ from the conclusion
in Example 5-8. The VIE model requires the determination of which party
has the power to direct the activities that most significantly impact the VIEs
economic performance. Even though the equity interests held by ABC Co., DEF
Co. and XYZ Co. are not equal, all decisions regarding the significant activities
of Oak Co. are directed by the board of directors which effectively require
approval by ABC Co., DEF Co. and XYZ Co. through their appointed directors.
Therefore, no single party can independently make decisions regarding the
significant activities, and none of the parties would meet the power criterion.
However, the VIE model does call for increased skepticism in situations where an
entitys economic interest in a VIE, is disproportionately greater than its stated power
to direct the significant activities of the VIE. While disproportionality itself may not
be determinative, additional consideration should be given in those situations as the
level of a reporting entitys interest may be indicative of the amount of power that a
reporting entity holds.
Power over Same Activities but Not Shared
If a conclusion is reached that power is not shared, but the same activities that most
significantly impact the VIEs economic performance are performed by multiple
unrelated parties, then the party with the power over the majority of those activities
will be considered to have met the power criterion. However, if no party has power
over the majority of the activities, then no party will be deemed to meet the power
criterion.

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 characteristics in paragraph 810-10-25-38A(a).
This principle is illustrated in the example included in ASC 810-10-55-194 through
55-196 where two unrelated companies are each responsible for manufacturing,
distributing, and selling a product in different locations and are not required to obtain
each others consent to decisions relating to those activities. If neither company
performs a majority of these activities, then the VIE does not have a primary
beneficiary.
Another example of when this principle may be applied is in securitization vehicles
wherein there may be three separate parties servicing separate and distinct pools of
the underlying assets of an entity. Consider a situation in which Company A, B and
C each perform servicing of the mortgage loans in a mortgage loan securitization.
Additionally, each company can make servicing decisions independently (i.e., without
the consent of any other party). Servicing of the financial assets is determined to be
the power that most significantly impacts the economic performance of the entity.
If neither Company A, B or C perform servicing for a majority of the assets of the
vehicle, then it may be concluded that no party has the power of the entity.
In practice, we believe that this principle will not be applied frequently since very few
entities have multiple parties performing the same activities without requiring consent
of others.
The VIE model does not specify how majority should be determined in making
this assessment. In other words, how should one measure whether a reporting
entity holds power over a majority of decisions that are significant to the economic
performance of the entity. In some circumstances, it may make sense to base
such judgment on the effect each decision may have on the ongoing cash flows of
the entity. For example, when two unrelated companies are each responsible for
manufacturing, distributing, and selling a product in different locations and are not
required to obtain each others consent to decisions relating to those activities, one
may evaluate majority based upon the expectation of sales or profits to the entity. We
believe that judgment should be applied in those circumstances, and conclusions
should be consistent with the principles of identifying whether a party has the most
significant decisions that could impact economic performance of the VIE.
Impact of Implicit or Explicit Financial Responsibility in Assessing the Power Criterion
The VIE model requires that implicit and explicit financial responsibilities be
considered in the primary beneficiary analysis. The VIE model provides an example
of a sponsor that has an implicit or explicit financial responsibility to ensure that an
entity operates as designed thereby giving the sponsor an incentive to establish
arrangements that give it power to direct the activities that most significantly impact
the economic performance of the entity.
Excerpt from ASC 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.
Determining whether a reporting entity has an implicit financial responsibility to
ensure that an entity operates as designed will require judgment. We believe that the
determination of what constitutes an implicit financial responsibility should consider
all potential eventsirrespective of how unlikely they are to occur.
In VIEs where there are no ongoing activities that have a significant impact on the
VIEs economic performance, the activities involved in setting up the entity (e.g.,
the selection of the assets for purchase by the entity, what occurs when the entity
is dissolved, the rights of the various parties, etc.) are likely to be more important to
this analysis. While such involvement in the design of an entity does not establish a
reporting entity as its primary beneficiary, it could provide the reporting entity with the
incentive and ability to be the primary beneficiary.
Impact of Kick-Out Rights or Participating Rights in Assessing the Power Criterion
A reporting entitys determination of whether it meets the power criterion shall not
be affected by the existence of kick-out rights or participating rights unless a single
reporting entity, including its related parties or de facto agents, has the unilateral
ability to exercise those rights. Kick-out rights are defined for the purposes of this
amendment as the ability of a reporting entity to remove, without cause, another
reporting entity which holds the power to direct the activities of a VIE that most
significantly impact the entitys economic performance (see VE 4.2.2.4 for discussion
with respect to liquidation rights). The FASB believes that many entities within the
scope of the VIE model are highly structured and although substantive kick-out rights
or participating rights might exist, they are not typically exercised and therefore
should not be considered until exercised.
25-38C: A reporting entitys determination of whether it has 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 kickout rights or participating rights. A single reporting entity
(continued)
(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.
20:
Protective rights: Rights are 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.
2. 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.
b. 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.
c. Limitations on the operating activities of an entity. For
example, a franchisee agreement for which the entity is the
franchise 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.

Kick-Out Rights: The ability to remove the reporting entity with the
VIEs economic performance.
Participating rights: The ability to block the actions through which a
Excluding the consideration of substantive kick-out rights is inconsistent with the
voting interest model as described in ASC 810-20-25-8. As a result, the evaluation
of kick-out rights under the VIE model and the voting interest model may lead to
different consolidation conclusions. For example, consider a general partnership
where the general partner has the power to direct matters that significantly impact
the activities of the partnership, while the limited partners have substantive removal
(kick-out) rights. Under the VIE model, if the entity under consideration is a VIE,
the general partner would likely be deemed to meet the power criterion because
substantive kick-out rights are not held by one party and are effectively ignored
under the model. In contrast, if the entity is not a VIE and must be evaluated under
the voting interest model, the general partner would be precluded from consolidating
the partnership due to the existence of those substantive kick-out rights.
Evaluating Whether a Kick-out Right is Substantive
We believe that kick-out rights should only be considered under the guidance when
the kick out right is substantive. In making the evaluation of whether or not a kick out
right is substantive, we believe that a determination should be made as to whether
there are any barriers to exercise such rights. A careful consideration of the following
types of potential barriers to exercise should be made to ensure that there are no
barriers to exercise the kick out rights (note this is not meant to be an all inclusive
list).
ContractualConditions that make it unlikely that a kick-out right can be
exercised (e.g., conditions that narrowly limit the timeframe in which the right may
be exercised).
CommercialFinancial penalties or operational barriers that act as significant
disincentives for replacing the party.
CommercialAn inadequate number of qualified replacements for the party are
available or compensation is inadequate to pay a qualified replacement.
Procedural or InformationalThe absence in the applicable agreements (or in the
applicable laws or regulations) of an explicit, reasonable mechanism that allows
the holder to exercise those rights or to obtain the information necessary to
exercise them.
Consideration of Participating Rights
The guidance clarifies that protective rights should not be considered in assessing
whether a reporting entity has the power to direct activities that most significantly
impact a VIEs economic performance. Consistent with kick-out rights, only
substantive participating rights that can be unilaterally exercised by a single reporting
entity (including related parties and de facto agents) should be considered in
determining which reporting entity, if any, meets the power criterion. Participating
rights are defined as 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
entitys economic performance.
Excluding the consideration of participating rights is inconsistent with the approach
taken for voting-interest entities under ASC 810-20-25-11 through 18. Consequently,
the evaluation of participating rights under the guidance and under the votinginterest model may lead to different consolidation results.
See VE 2.3 for the deferral of the VIE model as amended by ASU 2009-17, for
certain investment entities that have the attributes of entities subject to ASC 946 (the
investment company guide).
5.1.3 Losses/Benefits Criterion

If a reporting entity has met the power criterion, it will then need to determine
whether it has the obligation to absorb losses of the entity that could potentially be
significant to the variable interest entity or the right to receive benefits from the entity
that could potentially be significant to the variable interest entity. Both the power
criterion and the losses/benefits criterion are required for the reporting entity to be
the primary beneficiary of the VIE.
Qualitative Analysis
Under the VIE model, determining whether a reporting entity has the obligation to
absorb losses of or the right to receive benefits from the VIE that could be potentially
significant to the VIE is not based on a quantitative expected loss/expected residual
return calculation required under the previous model. Rather, this assessment is
intended to be a qualitative judgment-based analysis which considers all of the facts
and circumstances about the terms and characteristics of the variable interest(s), the
design and characteristics of the VIE and the other involvement that the reporting
entity may have with the VIE.
VE 3 outlines the concept of a variable interest and determination of whether the
reporting entity has a variable interest or potentially multiple variable interests in the
entity. The qualitative analysis performed to determine if the reporting entity has the
obligation to absorb losses or receive benefits that could potentially be significant
to the VIE considers all variable interests identified in that analysis. However, this
analysis would not include other involvement of the reporting entity with the VIE that
are not considered to be variable interests.
The losses/benefits criterion only requires that either the benefits received or losses
absorbed through a reporting entitys variable interest (not both) have the potential
to be significant. This is a different concept from the previous guidance since it is
not focused on variability from an expected result. For example, consider a variable
interest holder which holds a 100 percent equity interest in a VIE, but the equity
interest is small in comparison to the entitys overall capitalization. While the investor
may only be exposed to losses up to the amount invested, the investor has the
ability to receive benefits that could potentially be significant to the VIE. In another
circumstance, if a variable interest holder holds the majority of the capital of the
VIE, but is a senior interest holder and the VIE is non-performing, then such variable
interest holder may incur a larger loss compared to the subordinate investors or
could potentially be required to provide additional funding. In this case, even though
the interests held by the variable interest holder are senior to the interests held
by other variable interest holders, such senior interests and obligations could be
potentially significant to the VIE.
Although multiple entities could have obligations or rights that could potentially be
significant, only one reporting entity is expected to meet the power criterion.
Probability
All scenarios, irrespective of probability, should be considered in assessing whether
the right to receive benefits or the obligations to absorb losses could be potentially
significant to the VIE. The losses/benefits criterion also requires the reporting entity
to consider that although it may not have rights or obligations that are currently
significant, its variable interest may provide it with obligations or rights that may be
significant to the VIE in the future even under seemingly improbable scenarios. The
FASB concluded that these considerations were critical because obligations or rights
that could potentially be significant often identify the reporting entity that explicitly
or implicitly has the power to direct the activities that most significantly impact the
economic performance of the VIE.
Significance
During the standard setting process, the FASB received requests for additional
guidance on the losses/benefit criterion, specifically in interpreting potentially
significant to the VIE. The FASB decided not to provide additional guidance based
on the rationale that any such guidance would provide bright lines that would be
used in practice as the sole factor when determining whether such obligations or
rights could potentially be significant to the VIE. The determination of whether the
losses/benefits of a VIE which are absorbed/received by a reporting entity could
potentially be significant to the VIE can vary and should be based on the individual
facts and circumstances presented. The VIE model contains examples that illustrate
the principles to be considered when determining the party that is the primary
beneficiary. These examples do not include explicit information on how a reporting
entity concludes whether or not it has the obligation to absorb losses or the right to
receive benefits that could potentially be significant to the VIE, but rather confirm that
all variable interests should be analyzed in determining if a reporting entity meets the
losses/benefits criterion.
Consistent with the FASBs determination, we expect that each analysis will be based
on individual facts and circumstances and will require judgment to be applied. There
are certain relationships that we expect will result in a reporting entity concluding that
it has the obligation to absorb losses or right to receive benefits that could potentially
be significant to the VIE. For example, if an entity has a decision maker or service
provider contract which is considered a variable interest based on the criteria listed in
the VIE model (refer to VE 3.3.9 for further details), particularly if the decision maker
or servicer would absorb more than an insignificant amount of the entitys expected
losses or receive more than an insignificant amount of the entitys expected residual
returns, it is likely that the reporting entity has the obligation to absorb losses or right
to receive benefits that could potentially be significant to the VIE.
We believe that the following factors may assist in the determination of whether
potential losses or benefits could be potentially significant to the VIE:
Overall design of the VIE including the terms of the interests and capitalization
structure. For example, the primary risks or sources of variability of the VIE.
Whether the reporting entitys exposure to the entity losses or its benefits from
the entitys gains are economically capped. For example, in situations whereby
the reporting entitys rights to upside benefit is unlimited (e.g., through an equity
or residual interest in the entity) it is more likely to provide benefits compared to a
senior interest that is provided a fixed return and has no rights to earnings of the
entity above that fixed return.
Subordination of the variable interest. Variable interests that are more subordinate
in the entity would be expected to be exposed to potentially more significant
benefits and losses of the entity. In other words, the level of interest held as a
percentage of the class of interests that could potentially be significant to the VIE
decreases based on the interests standing in the waterfall.
The percentage of the class of interest held by the reporting entity.
Understanding the reasons as to why the interest is held by the reporting entity.
For example, if the reason is important to the overall design of the entity from
a marketing or other perspective, it may indicate that the reporting entity has
potentially significant benefits and losses.
Additionally, at the 2009 AICPA SEC Conference, Arie Wilgenburg of the SEC staff
stated:
So what is a significant financial interest? Well, Statement 167 describes such
an interest as one that either obligates the reporting enterprise to absorb losses
of the entity or provides a right to receive benefits from the entity that could
potentially be significant. That description leaves us with an important judgment
to make regarding what could potentially be significant. In the past few weeks,
the staff has been thinking about this concept. While there is no bright-line set
of criteria for making this assessment, I thought it would be helpful to provide
some thoughts in this area. First, similar to how we have talked in the recent past
about materiality assessments being based on the total mix of information, we
believe that assessing significance should also be based on both quantitative and
qualitative factors. While not all-inclusive, some of the qualitative factors that you
might consider when determining whether a reporting enterprise has a controlling
financial interest include:
The purpose and design of the entity. What risks was the entity designed to
create and pass on to its variable interest holders?
A second factor may be the terms and characteristics of your financial interest.
While the probability of certain events occurring would generally not factor into
an analysis of whether a financial interest could potentially be significant, the
terms and characteristics of the financial interest (including the level of seniority
of the interest), would be a factor to consider.
A third factor might be the enterprises business purpose for holding the
financial interest. For example, a trading-desk employee might purchase a
financial interest in a structure solely for short-term trading purposes well after
the date on which the enterprise first became involved with the structure. In
this instance, the decision making associated with managing the structure is
independent of the short-term investment decision. This seems different from
an example in which a sponsor transfers financial assets into a structure, sells
off various tranches, but retains a residual interest in the structure.
As previously mentioned this list of qualitative factors is neither all-inclusive nor
determinative and the analysis for a particular set of facts and circumstances still
requires reasonable judgment.
5.1.4 Identifying the Primary Beneficiary within a Related Party GroupRelated

Party Tie Breaker
In situations in which a reporting entity concludes that neither it nor
one of its related parties has the characteristics in paragraphs 81010-25-38A 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. The existence of a principal-agency relationship between parties
within the related party group
b. The relationship and significance of the activities of the VIE to the
various parties within the related party group
c. A partys exposure to the variability associated with the
anticipated economic performance of the VIE
d. The design of the VIE.
When to Apply the Related Party Tie-Breaker
Related parties and de facto agency relationships can play a critical role in (i) the
determination of whether the entity is a VIE, and (ii) the determination of the VIEs
primary beneficiary, if one exists.
The VIE model requires that the individual parties within a related party group
(including de facto agents) are required to first separately consider whether there is
a single party in the related party group (including de facto agents) that meets both
the power and losses or benefits criteria on their own as though no related party
relationship existed. If one party within the related party group meets both these
criteria, such reporting entity is the primary beneficiary of the VIE and no further
analysis is needed. This is a significant change to the model that was introduced by
the previous VIE model. Under the prior guidance, all related party relationships were
aggregated as one and if the related party interests as a group were exposed to a
majority of the entitys expected losses and/or expected residual returns, the related
party tie-breaker was needed to be assessed. This change to the model is expected
to reduce the frequency with which the related party tie-breaker is employed.
Generally, we believe the related party tie-breaker would apply when the related party
group, rather than a single party in the group, meets the power and losses/benefits
criteria (i.e., group would be the primary beneficiary) in the following situations:
Power is shared among the related party group.
One of the parties in the related party group meets the power criterion on a
standalone basis but not the losses/benefits criterion. However, the related party
group collectively meets the losses/benefits criterion.
The same activities that most significantly impact the entitys economic
performance are performed by multiple related parties but no party has power
over a majority of the activities (but the related party group collectively has power
over the majority of the activities).
If no party within the related party group on its own meets both the power and
losses/benefits criteria, but the related party group does as a whole meets these
two criteria, the determination of primary beneficiary within the related party group
is based upon an analysis of the facts and circumstances with the objective of
determining which party is most closely associated with the VIE (i.e., the related party
tie-breaker must be performed).
Applying the Tie-Breaker
Determining the primary beneficiary under the tie-breaker requires significant
judgment. While the principle supporting the guidance is fundamental, (identifying the
party most closely associated with the VIE), its application requires care. Factors to
consider in making the assessment include:
the four key indicators described in the VIE model, and
the relative weighting of these indicators based on the individual facts and
circumstances of each transaction and structure.
The four key factors are explained in more detail below.
Principal/Agency Relationship
The first indicator for identifying the primary beneficiary from the related-party group
is the existence of an agency relationship among the parties. If one member of
the group was acting in the capacity of an agent of another member of the related
party group, this would be a strong indicator that the principal would be the primary
beneficiary. This type of relationship can take many forms, including de facto agency
relationships defined in the VIE model. Additionally, there may be situations beyond
those included in the VIE model in which an agency relationship may exist among
members of the related-party group.
When evaluating whether or not an agency relationship exists among members of
the related-party group, it may be helpful to analogize to other accounting guidance
relating to principal-agency relationships. ASC 470-50, DebtModifications and
Extinguishments, describes the appropriate accounting for modification of debt
instruments and lists several indicators that may be useful in determining when a
third-party intermediary is acting as an agent on behalf of a debtor. ASC 605-45,
Revenue RecognitionPrincipal Agent Considerations (ASC 605-45), describes the
appropriate revenue recognition in transactions depending on whether the reporting
entity is acting as an agent or a principal. The existence of any indicators listed
under Gross Revenue Reporting in ASC 605-45 may indicate that the reporting entity
is acting as a principal. The existence of any indicators listed under Net Revenue
Reporting in ASC 605-45 may indicate that the reporting entity is acting as an agent.
There may be situations in which two reporting entities are related parties under the
de facto agency provisions of the VIE model, but the identification of which party
is acting as the agent and which party is acting as the principal may not be clear.
For example, two reporting entities may share a common director. In situations
such as these, even though the reporting entities are related parties for purposes of
applying the VIE model, however, they may not be acting as agents of one another.
Accordingly, the reporting entity should place more weight on the other indicators.
Relationship and Significance of Activities
The second indicator for identifying the primary beneficiary in the related-party
group considers the relationship of the VIE to each of the members of the relatedparty group, as well as the significance of the VIEs activities to those members. The
member of the group that this indicator points toward will depend upon the point of
view of the reporting entity carrying out the evaluation. For example, two members
of a related party group may come to the opposite conclusion when evaluating this
indicator, as they may each have an inherent bias when evaluating their relationship
with the VIE.
The evaluation of the significance of the VIEs activities should be based on all the
relationships between the VIE and the various members of the related-party group.
This analysis should not merely focus on the size of the VIE in relation to the size of
the members of the related-party group. It should not be presumed that the activities
of the VIE are more significant to a smaller party than a larger one, merely because
one entity is smaller than the other. Rather, many factors should be considered, such
as:
whether one party is significantly dependent upon the VIE as a supply/distribution
source;
whether one party is the lessee of the sole asset of the entity;
whether the reporting entity funds research and development of the VIE that is
integral to a partys underlying operations;
the nature of the VIEs business activities and whether they are inherently aligned
with a related party;
the significance of VIE sales of product (or output) to a related party;
understanding the nature of service contracts, management contracts, or other
contracts entered into by the VIE with a related party and their importance to the
underlying business activities of the VIE;
whether any related party has a call option to acquire significant or major assets
from the VIE or another related partys variable interest; and
whether any related party has an option to put its variable interest to another
related party.
When evaluating this indicator, a reporting entity may also look to the indicators
provided in VE 2.
Variability Associated with Anticipated Economics
The third indicator for identifying the primary beneficiary from the related-party
group focuses on the economics of the arrangement. When analyzing this indicator,
consideration should be given to the member of the related party group, relative
to the others, that has the potential to receive additional benefits or absorb
additional losses of the VIE based on changes in the entitys anticipated economic
performance. Note that this analysis takes into account the members obligations
and rights throughout the lifecycle of the VIE and considers the extent to which the
members expected rights to receive benefits and obligation to absorb losses change
based on variation of the anticipated economic results of the VIE.
There may be situations in which one member of the group is exposed to such
a large portion of the variability associated with the VIEs anticipated economic
performance that it would be difficult not to conclude that the party is the primary
beneficiary. However, all qualitative factors, including principal/agency relationship
and the design of the entity should be considered. If the reporting entity that is
exposed to the variability of the VIEs anticipated economic performance is merely
acting as an agent of another reporting entity, the reporting entities must use
reasoned judgment in order to understand why such an arrangement exists and to
identify the appropriate primary beneficiary.
In determining how much weight to place on this indicator, we believe that the nature
of the related-party relationship should be considered. If, for example, the related
party relationship is that of a parent company and its wholly-owned subsidiary, the
contractual allocation of incremental benefits and losses generated because of
variability from the VIEs expected results is of little importance to the parties, and
therefore little weight should be placed on this indicator. However, if the relationship
is that of two independent companies investing in a joint venture where one of the
companies cannot sell or transfer its interest without the others prior approval, more
significant weight may be placed on this indicator. Varying degrees of weighting
should be applied between those two extremes.
Design of the VIE
The fourth indicator for identifying the primary beneficiary from the related-party
group focuses on the design of the VIE. When evaluating this indicator, reporting
entities should focus on the structure of the VIE in an attempt to identify the
appropriate primary beneficiary. There may be instances where it is clear that an
entity was designed or structured for the benefit of one member of the related-party
group. Examples of these types of relationships may include:
An entity established for the securitization of certain assets and the transferor of
those assets;
An entity established to own and lease a single-asset to the lessee of that asset;
and
An entity established to provide off-balance sheet financing and the beneficiary of
that financing.
Again, this indicator will be subject to the judgment of those evaluating the VIE and
the related-party group, and certain structures/transactions will be more obvious
than others.

5.2 Questions and Interpretative Responses

Question 5-1: If a party within a related party group is the primary beneficiary on
a standalone basis, but another party within that group receives the majority of the
economics, should the related party tiebreaker be applied?
PwC Interpretive Response: No. If one party in the related party group meets
both of the power and benefits/losses criteria, then that party is the primary
beneficiary. In this fact pattern, the power criterion should be carefully analyzed to
ensure any implied power due to one party receiving the majority of the economics
was appropriately considered in the determination of the primary beneficiary. To
the extent the power criterion is not clear and a reporting entity could potentially
conclude upon shared power between two parties within the related party group,
the related party tiebreaker should be performed. This analysis will require
significant judgment based upon individual facts and circumstances.
Question 5-2: Can a board of directors be viewed as one party when considering
whether one party has the unilateral ability to exercise substantive kick out rights?
PwC Interpretive Response: In virtually all cases, a board of directors will not
be considered as one party for determining if one party has the unilateral ability
to exercise a substantive kick-right under the VIE model. Generally, a board of
directors consists of directors who are elected by the shareholders of the entity
as a group. In essence, the board of directors is acting in a fiduciary capacity on
behalf of the shareholders of the entity and should not be viewed as being one
party in determination of whether a reporting entity meets the power criterion, or
in the assessment of whether an entity is a VIE (refer to VE 4). This view has been
discussed with both the FASB and SEC staff who agreed with this conclusion.
If, however, the board of directors is controlled by one controlling shareholder of
the entity, it may be acceptable to view the kick-out rights as being held by one
party if they are substantive. However, the facts and circumstances will need to be
carefully considered in those limited scenarios.
is the land and building under the agreement. As part of the agreement, Company
A is required to pay a non-refundable deposit to Company X. Company A also has
the right to terminate the contract, subject to the loss of its deposit. Assuming that
Company A has a variable interest in Company X due to the purchase and sale
agreement (see Example 3-6 for details), and that Company X is a VIE (see Question
4-10 for details), will Company A be considered to be the PB of Company X due to
its non-refundable deposit to Company X?
PwC Interpretive Response: Maybe, depending on an assessment as to whether
Company A has a controlling financial interest in Company X through an evaluation
of both the power and losses/benefits criteria in ASC 810-10-25-38. For example,
in land purchase option agreements, the buyer may have the rights to decide on
amenity and zoning density issues, or for rental property agreements, the buyer
may have rights to control leasing decisions. To the extent the purchase and
sale agreement transfers the rights to the activities that most significantly impact
the economic performance of the VIE to the buyer, where the buyer also has a
substantive non-refundable deposit, it is likely that such buyer could meet both
the power and losses/benefit criteria and would be required to consolidate the VIE.
5.3 Examples
The VIE model provides examples to illustrate the amended approach for determining
the primary beneficiary. The following table summarizes these examples:
Case
Description of Structure
Primary Beneficiary
Determination
A. Commercial
mortgage-backed
securitization (ASC
810-10-55-96
through 55-109)
An entity funds the purchase

of commercial mortgage loans
by issuing fixed rate debt with
the same maturity to third-party
investors and equity to a thirdparty who also performs the
special servicing function. The
transferor to the entity performs
the primary servicing activities.
Upon default of a mortgage
loan, the administration of that
loan is transferred to the special
servicer.
The special servicer (who is also

the equity holder) is deemed
to be the primary beneficiary
because:
1. It meets the power criterion
by managing the entitys
assets that are delinquent or
in default, and through being
able to approve budgets,
leases, and the property
managers of foreclosed
properties.
2. It meets the losses/benefits
criterion by having the
obligation to absorb losses
through its equity investment.
B. Asset-backed
collateralized
debt obligation
(ASC 810-1055-110 through
55-121)
An entity funds the purchase of

asset-backed debt securities
by issuing two tranches of fixed
rate debt to third party investors
and equity (the equity is held by
the manager and a third party
investor). The manager earns
both a fixed and a performance
fee for managing the assets and
can be removed by a majority of
the debt holders.
The manager (who is also an

equity holder) is deemed to be
the primary beneficiary because:
assets within certain
parameters and removal
rights are not held unilaterally
by one party.
through its equity interest
that could potentially be
significant, as well as right to
receive benefits that could
potentially be significant
through its performancebased fee.
C. Structured
investment vehicle
55-133)

floating rate debt and short-term
deposits by issuing short-term
debt and equity to third party
investors. Upon maturity of
the debt, the entity will either
refinance the debt with existing
investors or reissue the debt
to new investors. The sponsor
performs the investment
management, funding and
defeasance management
in return for a fixed and a
performance fee.
The sponsor is deemed to be the

primary beneficiary because:
investment, funding, and
defeasance activities, and
sponsored the entity.
criterion by receiving benefits
significant to the entity
through its performancebased fee arrangement and
that it has an implicit financial
responsibility (for reputation
risk).
(continued)
Case
Primary Beneficiary
Determination
D. Commercial paper
conduit (ASC 81010-55-134 through
55-146)
An entity funds the purchase of a

portfolio of medium-term assets
by issuing short-term debt and
subordinated notes to third
party investors. Upon maturity
of the debt, the entity will either
refinance the debt with existing
investors or reissue the debt
to new investors. The sponsor
provides credit enhancement in
the form of a letter of credit, and
a liquidity facility to fund cash
flow shortages. The sponsor
also establishes the terms of the
entity, approves the transferors
to the entity and the assets to
be purchased, makes funding
decisions, and administers the
entity. The sponsor receives
a fixed fee for providing these
services.
The sponsor is deemed to be the

investment, funding, and
sponsored the entity.
criterion by having an
significant to the entity
through its letter of credit and
liquidity facility, and through
its fee arrangement has the
right to receive benefits that
could potentially be significant
to the VIE.
E. Guaranteed
mortgage-backed
securitization
55-159)

fixed-rate residential mortgage
loans by issuing fixed rate
debt with the same maturity to
third-party investors. The entity
enters into a guarantee facility
that absorbs 100 percent of the
credit losses on the loans. The
loans acquired are underwritten
by the transferor in accordance
with the guarantors parameters.
The guarantor serves as master
servicer and is able to hire the
primary servicer. Upon default
of a mortgage loan, the primary
servicer can propose a default
mitigation strategy that the
guarantor can approve, reject, or
require another course of action.
The guarantor receives a fixed
fee.
The guarantor (who is also the

master servicer) is deemed to be
1. It meets the power criterion in
its role as master servicer (it
can appoint and remove the
primary servicer and direct
default mitigation).
through its guarantee
significant.
F. Residential
mortgage-backed
securitization (ASC
810-10-55-160
through 55-171)

residential mortgage loans by
issuing two tranches of fixed
rate debt in a senior and residual
tranche. The senior tranche debt
is held by third-party investors
while the transferor of the assets
holds the residual tranche debt
and also performs the primary
servicing function. The residual
tranche debt absorbs the first
dollar risk of loss. Upon default
of a mortgage loan, the primary
servicer has discretion in
deciding on a default mitigation
strategy.
The transferor (who is also the

primary servicer) is deemed to be
assets that are delinquent
or in default and no single
party is able to remove the
transferor as primary servicer.
significant through its residual
tranche debt investment.
(continued)
Case
Primary Beneficiary
Determination
G. Property lease
entity (ASC 81010-55-172 through
55-181)
An entity funds the purchase

of a property to be leased by
issuing fixed rate debt and
equity. The lessee has the rights
to use the property and retains
substantially all of the risks and
rewards from changes in value
of the property. The lessee has
a fixed-price purchase option
and provides a residual value
guarantee on the property.
The lessee is deemed to be the

by maintaining and operating
the property, and directing the
remarketing of the property.
criterion by having both
the right to receive benefits
through its purchase option
and the obligation to absorb
losses that could potentially
be significant through the
residual value guarantee.
H. Collaboration/
joint venture
arrangement
55-198)
Difference scenarios are

discussed where two companies
form an entity to manufacture,
distribute and sell a beverage.
In one instance, power is

determined to be shared as
both parties have power over
the significant activities and are
required to consent to decisions
on those activities. In other
situations, the two parties have
power over the same activities
but not shared power, or have
power over different activities.
I.
An entity is created to
manufacture and sell wooded
furniture and funded with equity
from a furniture manufacturer
and fixed-rate debt from a
financial investor. The furniture
manufacturer manages the day
to day activities of the entity and
has guaranteed the debt of the
financial investor.
The furniture manufacturer

is deemed to be the primary
beneficiary because:
by making all the ongoing
operating decisions of the
entity, and establishing the
sales and marketing strategy.
criterion by having both
the right to receive benefits
through its equity investment
and the obligation to absorb
losses that could potentially
be significant through the
debt guarantee.
Furniture
manufacturing
entity (ASC 81010-55-199 through
55-205)
Chapter 6:
Initial Consolidation and Subsequent Accounting
Initial Consolidation and Subsequent Accounting / 6 - 1
Executive Takeaway
Initial measurement upon consolidation is largely based on ASC 805, Business
Combinations (ASC 805), principles. However there are few differences when the
VIE and the primary beneficiary are under common control and when the VIE is not
a business.
Assets and liabilities transferred by the primary beneficiary to the VIE, at, after or
shortly before the consolidation date should be recorded at historical book value
with no gain or loss recognized.
Subsequent consolidation and deconsolidation procedures generally follow the
guidance in ASC 810, Consolidation (ASC 810).
6 - 2 / Initial Consolidation and Subsequent Accounting
Chapter 6: Initial Consolidation and Subsequent Accounting

6.1 Initial Measurement and Consolidation

Generally, the concepts underlying the accounting for the initial consolidation of a
Variable Interest Entity (VIE) are similar to the concepts underlying the accounting
for a newly acquired business under ASC 805. However, some nuances must be
considered when:
The VIE is not a business;
A primary beneficiary transfers assets to the VIE at, after or shortly before the date
it became the primary beneficiary; or
The primary beneficiary of the VIE is under common control with the VIE.
6.1.1 Initial Measurement upon Consolidation of a VIE

The measurement upon the initial consolidation of a VIE by a primary beneficiary
(except for those under common control) is addressed, as discussed below.
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.
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.
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. The fair value of any consideration paid
2. The fair value of any noncontrolling interests
3. The reported amount of any previously held interests
b. The net amount of the VIEs identifiable assets and liabilities
recognized and measured in accordance with Topic 805.
VIE is a Business
When initially consolidating a VIE, the primary beneficiary should only recognize
goodwill if the VIE is a business. ASC 805 provides the definition of a business
(refer to section 1.2 of the PwC Guide: A Global Guide to Accounting for Business
Combinations and Noncontrolling Interests: Application of the U.S. GAAP and IFRS
Standards (BCG)). As specified in ASC 805, if the fair value of the consideration given
is greater than the sum of the fair values of the identifiable net assets acquired, the
result is goodwill. If the fair value of the consideration given is less than the sum of
the fair values of the identifiable net assets acquired, the difference is considered a
bargain purchase gain and is accounted for in accordance with ASC 805-30-25-2.
VIE is not a Business
If the VIE is not a business the primary beneficiary will recognize a gain or loss for
the difference between (1) the fair value of any consideration paid, the fair value
of any noncontrolling interests, and the reported amount of any previously held
interests and (2) the net amount of the variable interest entitys identifiable assets and
liabilities recognized and measured in accordance with ASC 805. No goodwill shall
be recognized if the variable interest entity is not a business.

6.1.2 Asset and Liability Transfers from the Primary Beneficiary to the VIE
When consolidating a VIE, assets and liabilities transferred from the primary
beneficiary to the VIE at, after, or shortly before the date the reporting entity became
the primary beneficiary must be accounted for as discussed below.
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.
The overriding principle is assets or liabilities transferred from a reporting entity to a
VIE should not be remeasured if the reporting entity is the primary beneficiary. These
transactions are viewed similar to transactions between entities under common
control.
The assets and liabilities transferred should be measured at the 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 the transfer, even if the reporting entity
was not the primary beneficiary until shortly after the transfer.
6.1.3 Common Control

If the VIE is under common control, the primary beneficiary should reference the
guidance in ASC 805 with regards to accounting principles governing transactions
among parties under common control, as discussed below (refer to Appendix A
of the PwC Guide: A Global Guide to Accounting for Business Combinations and
Noncontrolling Interests: Application of the U.S. GAAP and IFRS Standards (BCG)).
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).
This paragraph requires that there be no remeasurement of a VIEs assets and
liabilities if the primary beneficiary and VIE are under common control. For example,
assume Entity A and Reporting Entity B are under common control of Company
XYZ (i.e., Company XYZ owns the majority of the voting common stock of each of
these entities). Also assume that Reporting Entity B and Company XYZ each issue
separate financial statements. Entity A is determined to be a VIE, and Reporting
Entity B is identified as its primary beneficiary. Thus, following the guidance above,
the net assets of Entity A would be recorded by Reporting Entity B at the amounts at
which they are carried under GAAP in Company XYZs financial statements. The net
assets would not be remeasured and thus, there would be no goodwill or gain or loss
resulting from this transaction.

6.2 Accounting after Initial Measurement

Once the primary beneficiary initially consolidates a VIE, it will then account for
the consolidated VIE in a manner that generally is consistent with the principles in
ASC 810. However, there is one difference which relates to the ability to allocate
intercompany profits between the parent (i.e., primary beneficiary) and noncontrolling
interests.
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.
After the initial consolidation of a VIE, the primary beneficiary should:

Follow any specialized accounting requirements that apply to the type of business
in which the VIE operates; and
Follow ASC 810-10-45-21 which provides guidance on the elimination of
intercompany balances and transactions, the allocation of intercompany profits
and losses to noncontrolling interests, consideration of income taxes, changes in a
parents (primary beneficiary) ownership interest, and deconsolidation.

6.2.1 Allocation of Losses to Noncontrolling Interest Holders

While the VIE model does not specifically address the manner in which losses should
be allocated to noncontrolling interest holders, we believe the principles in ASC 81010-45-21 apply. Such guidance requires that losses relating to the noncontrolling
interest be charged to the noncontrolling interest.
6.2.2 Elimination of Intercompany Profits

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.
The first concept above is relatively straight forward. Intercompany fees between
the primary beneficiary and VIE must be eliminated. When consolidating a VIE the
guidance specifically states that the effect of the elimination of any net intercompany
profit or loss may not be allocated to the noncontrolling interest. The FASB put this
restriction to address situations where the primary beneficiary may not have an
equity interest in the VIE. In such a situation, if allocation was allowed, the primary
beneficiary would not record any income from fees earned from the VIE. Historically,
while consolidation under the voting interest model permitted the allocation method,
this method was, however, generally only utilized by investors applying the equity
method of accounting.
The following examples illustrate the method that is required under the VIE model.
Example 1
Assumptions
Reporting Entity P purchases a 60 percent interest in Entity S for $120 cash
(book value) at the beginning of the year. Entity Ss total capital is $200. Entity S
is determined to be a VIE and Reporting Entity P is determined to be the primary
beneficiary. During the year, Reporting Entity P sells goods to Entity S which are in
Entity Ss inventory at year-end. The transaction results in a profit to Reporting Entity
P as follows:
Selling price
Cost of sales
$100
60
$ 40
No dividends were paid by Reporting Entity P and Entity S during the year. Reporting
Entity Ps beginning retained earnings is zero.
Sales and expense information for Reporting Entity P and Entity S on a separate
company basis, before giving effect to intercompany eliminations and noncontrolling
interest income (expense), are as follows:
Reporting
Entity P
Entity S
$1,100
(660)
440
176
$ 264
$ 300
(200)
100
30
$ 70
Sales
Cost of sales
Selling and administrative
Net income
Consolidation Entries
Journal entries to record intercompany eliminations when the entire profit is

eliminated and charged to Reporting Entity Ps interest for an entity that is not
accounted for under the equity method:
Dr Capital stockEntity S
Cr Investment in Entity S
$120
$120
To eliminate Reporting Entity Ps investment in Entity S.

Dr Sales
Cr Cost of sales
$100
$100
To eliminate intercompany sales.

Dr Cost of sales
Cr Inventory
$ 40
$ 40
To eliminate all intercompany profit in inventories at year end in accordance with the
guidance in the VIE model
Dr Capital stockEntity S
Dr Noncontrolling interest in income of Entity S
Cr Noncontrolling interest in Entity S
$ 80
$ 28
$108
To record initial noncontrolling interest in Entity S and the incremental noncontrolling

interest share of net income of Entity S (note that the noncontrolling interest in
income of Entity S is calculated as Entity Ss net income of $70 multiplied by the 40
percent noncontrolling interest in Entity S).
Reporting Entity Ps share of income reported by Entity S
Adjustments to eliminate intercompany profits in inventory
Equity in income of Entity S reported by Reporting Entity P
Income of Reporting Entity P
Consolidated net income
$ 42
(40)
2
264
$266
As a result of the above entries, the following amounts result in the consolidated
financial statements:
Inventory
Noncontrolling interest
Consolidated retained earnings
$ 60
108
$266
Example 2
Assumptions
Reporting Entity P makes a loan to Entity S and is a variable interest holder in Entity
S. Reporting Entity P does not hold any voting interest in Entity S. The other variable
interest holder in Entity S is its equity holder. Entity S is determined to be a VIE and
Reporting Entity P is determined to be the primary beneficiary. During the year,
Reporting Entity P charges Entity S $40 in interest. The consolidating adjustments
and consolidated income statement of Reporting Entity P under the VIE model are as
follows:
Reporting
Entity P
Revenues
Cost of revenues
Operating income
Interest income
Interest expense
Net income
Net income attributable to
non-controlling interest
controlling interest
$1,060
(700)
360
(150)
40
$ 250
$ 250
Entity S (VIE)
Adjustments Consolidated
$ 500
(320)
180
(90)
(40)
$ 50
$ 50
(40)
40
$ 0
$1,560
(1020)
540
(240)
$ 300
$ 50
$(50)
$ 250
50
If the effects of the intercompany eliminations had instead been allocated to the noncontrolling interest in proportion to equity ownership under the voting interest model,
then the consolidating adjustments and consolidated income statement of Reporting
Entity P under the voting interest model are as follows:
Reporting
Entity P
Revenues
Cost of revenues
Operating income
Interest income
Interest expense
Net income
non-controlling interest
controlling interest
$1,060
(700)
360
(150)
40
$ 250
$ 250
Entity S
Adjustments Consolidated
$ 500
(320)
180
(90)
(40)
$ 50
$ 50
(40)
40
$ 0
$1,560
(1020)
540
(240)
$ 300
$ 90
$(90)
$ 210
90
Thus, under the voting interest model, $90 of net income is attributed to the noncontrolling interest and $210 to Reporting Entity P. However, because Entity S is
consolidated pursuant to the VIE model, Reporting Entity Ps net income remains
unchanged as the effect of the interest income eliminated in consolidation has been
attributed entirely to the primary beneficiary (see below):
Separate net income of Reporting Entity P

Interest income attributed to non-controlling
interest
Net income attributable to controlling interest
Under Voting
Interest Model
Under VIE Model
$250
$250
40
$210
0
$250
6.2.3 Deconsolidation
A parent shall deconsolidate a subsidiary or derecognize a group of
assets specified in the preceding paragraph as of the date the parent
ceases to have a controlling financial interest in that subsidiary or group
of assets. See paragraph 810-10-55-4A for related implementation
guidance.
Excerpt from ASC 810-10-55-4A:
All of the following are circumstances that result in deconsolidation of a
subsidiary under paragraph 810-10-40-4:
a. A parent sells all or part of its ownership interest in its subsidiary,
and as a result, the parent no longer has a controlling financial
interest in the subsidiary.
b. The expiration of a contractual agreement that gave control of the
subsidiary to the parent.
c. The subsidiary issues shares, which reduces the parents
ownership interest in the subsidiary so that the parent no longer
has a controlling financial interest in the subsidiary.
d. The subsidiary becomes subject to the control of a government,
court, administrator, or regulator.
Refer to BCG 6.6 for more guidance with respect to deconsolidation.

Initial Measurement and Consolidation
Question 6-1: What guidance applies to the transfer of net assets between a VIE and
another entity that are under common control?
PwC Interpretive Response: ASC 805-50-30-5 applies to transfers of net assets
between entities under common control. Under that guidance, the transfer of
net assets results in a change in the reporting entity. Per ASC 805-50-05-5, the
accounting for the transfer is reflected in a manner similar to a pooling of interests.
Also, ASC 805-50-45-2 states that the transferees financial statements should
report results of operations for the period in which the transfer occurs as though
the transfer of assets occurred at the beginning of the period. The restatement of
prior period financial statements on a combined basis would be as of the date the
VIE and the other entity came under common control.
Question 6-2: How does a reporting entity that is determined to be the primary
beneficiary of a VIE account for the VIEs activities in its consolidated financial
statements if the reporting entity does not have an equity investment in the entity?
PwC Interpretive Response: The primary beneficiary must consolidate 100
percent of the balance sheet and income statement of the VIE and should
generally apply normal consolidation procedures as if it were the parent in a
normal parent-subsidiary relationship. The equity interests held by other parties in
the VIE should be reflected as noncontrolling interest. (ASC 323-10-35 and 10-55
may be useful in these situations, as may be the hypothetical liquidation at book
value.)
Question 6-3: If a reporting entity consolidates an entity which is a business and
is not under common control upon the adoption of the VIE model, should the
consolidation be carried out under ASC 805?
PwC Interpretive Response: A reporting entity should use applicable GAAP at
the time of consolidation of an entity under the VIE model. The initial consolidation
of a variable interest entity that is a business and not under common control
is treated as a business combination. Therefore, if FAS 141 (which has since
then been superseded by ASC 805 (FAS 141(R)) was applicable at the time of
consolidation, then the consolidation would be effected using the guidance
under FAS 141 (i.e., amounts would be allocated to assets and liabilities using
the purchase price allocation model in FAS 141 and the minority interest would
be fair valued). If however ASC 805 (FAS 141(R)) was applicable at the time of
consolidation, then the consolidation would be effected using the guidance under
ASC 805 (FAS 141(R)) i.e., amounts would be allocated to assets and liabilities
using the purchase price allocation model in ASC 805 (FAS 141(R)) and the
noncontrolling interest would be fair valued.
Accounting after Initial Measurement

Question 6-4: If a primary beneficiary consolidates a VIE under the VIE model, can
the consolidated balance sheet show a negative noncontrolling interest position
(debit balance) if the subsidiary generates losses that would cause the noncontrolling
interest balance to drop below zero?
PwC Interpretive Response: Under ASC 810, the parent (primary beneficiary)
should show a negative noncontrolling interest position (debit balance) related to
its consolidated subsidiary if the consolidated subsidiary generates losses that
would cause the noncontrolling interest balance to drop below zero. That is, the
noncontrolling interest should continue to be attributed its share of losses even
if that attribution results in a deficit noncontrolling interest balance. Any losses
that were previously attributed to the parent because those losses exceeded the
noncontrolling interest investment in the subsidiary should remain attributable to
the parent and not be re-attributed to the non-controlling interest.
The VIE model does not change this guidance regarding noncontrolling interest
balances. ASC 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 consolidated as if the VIE
were consolidated based on voting interests.
Question 6-5: If a subsidiary generates losses that would cause the noncontrolling
interest balance in the consolidated balance sheet to be reduced below zero, but the
parent company determines that the fair value of its subsidiary is greater than book
value, should the consolidated balance sheet show a negative noncontrolling interest
position (debit balance) related to the subsidiary?
PwC Interpretive Response: Yes. The parent should show a negative
noncontrolling interest position (debit balance) related to its subsidiary if its
subsidiary generates losses that would cause the noncontrolling interest balance
to drop below zero.
Under ASC 810, losses attributable to the parent and the noncontrolling interest in
a subsidiary may exceed their interests in the subsidiarys equity. The excess, and
any further losses attributable to the parent and the noncontrolling interest, shall
be attributed to those interests. That is, the noncontrolling interest shall continue
to be attributed its share of losses even if that attribution results in a deficit
noncontrolling interest balance.
Accordingly, the parent is required to allocate losses to noncontrolling interest
even after the noncontrolling interest balance is reduced to zero since this
conclusion is not based on whether or not the fair value of the noncontrolling
interest is greater than its book value. ASC 810 does not specify any particular
method for attributing earnings between controlling and noncontrolling interests. If
there are contractual arrangements that determine the attribution of earnings, such
as a profit sharing arrangement, then the attribution specified by the arrangement
is used. If there are no such contractual arrangements, then the relative ownership
interest should be used as the basis for attribution of earnings between controlling
and noncontrolling interests.
Question 6-6: If the equity holders of a VIE are also employees of the primary
beneficiary, how should the VIEs distributions to those equity holders be reflected in
the consolidated financial statements?
PwC Interpretive Response: Depending on the facts and circumstances,
such distributions could be considered as being compensatory (therefore
requiring expense recognition) or, could be considered no different than what an
independent investor would receive. The following factors are indicative of the
distributions being similar to those that an independent investor would receive:
Real value for value cash payment (i.e., the relationship between invested
capital and distributions should be considered).
There is no linkage between the distributions to be made and the employment
of the common shareholders of the VIE.
Distributions are pari pasu with each investors ownership interest.
Distributions are made to all residual equity holders of the entity.
There are no agreements between the primary beneficiary and the residual
equity holders that expressly guarantee distribution to the investors.
The noncontrolling interests qualify for equity classification under applicable
GAAP.
Question 6-7: How does a primary beneficiary of a VIE record the acquisition of the
variable interests held by the entitys noncontrolling interest holders?
Consider the following fact pattern:
Parent became the primary beneficiary of a variable interest entity (Entity A) on
October 1, 2010. Parent initially consolidated Entity A by recognizing the fair value of
the assets, liabilities and noncontrolling interests as of the date it became the primary
beneficiary in accordance with ASC 810-10-30-2 through 30-6. The noncontrolling
interest was legal form equity in the form of common stock and represented Entity
As residual interest (i.e., it was not preferred stock or a liability).
On March 2, 2011, Parent acquires all of the outstanding common shares of Entity A
held by the noncontrolling shareholders and becomes the 100 percent owner of the
common stock of Entity A.
PwC Interpretive Response: The acquisition of the noncontrolling interest
should be accounted for pursuant to existing GAAP, which in this case should be
reflected as an equity transaction as a result of the acquisition of the outstanding
noncontrolling interest in accordance with ASC 810-10-45-23 as there was no
change in control.
Question 6-8: When a variable interest entity is de-consolidated by a primary

beneficiary (either because the VIE is no longer a VIE or the primary beneficiary is
no longer the primary beneficiary of the VIE), can the primary beneficiary report the
variable interest entity as discontinued operations under ASC 360, Property, Plant,
and Equipment (ASC 360)?
PwC Interpretive Response: A primary beneficiary should report the
de-consolidation of a variable interest entity as discontinued operations if the
variable interest entity satisfies the requirements in ASC 205-20-45-1 through 45-2.
Question 6-9: If a primary beneficiary of a VIE constructs an asset which qualifies
for interest capitalization under ASC 835, Interest (ASC 835) specifically ASC 83520-15-5, and the VIE has external debt on which it pays interest expense, can the
consolidated group utilize the VIEs interest expense to perform its capitalization of
interest under ASC 835-20-30-6?
PwC Interpretive Response: Yes. ASC 835-20-30-6 applies to entities
consolidated under both the voting interest model and the variable interest model.
ASC 835-20-30-6 also applies in cases where a primary beneficiary has a 0
percent equity ownership interest in its consolidated VIE.
ASC 835-20-25-3 requires the capitalization of interest in instances where an asset
requires a period of time to bring it to the condition and location necessary for
its intended use. ASC 835-20-30-6 states that the total amount of interest cost
capitalized in an accounting period shall not exceed the total amount of interest
cost incurred by the entity in that period. In consolidated financial statements, that
limitation shall be applied by reference to the total amount of interest cost incurred
by the parent entity and consolidated subsidiaries on a consolidated basis.
Under ASC 835, there is no requirement that the interest cost incurred by one
entity in a consolidated group has to be related to the other entity in the group that
is capitalizing the interest cost (such as a source and use of funds relationship). In
essence, there is no cash flow linkage requirement between the two entities, other
than both entities being a part of the same consolidated group.
Chapter 7:
Presentation and Disclosure Requirements
Presentation and Disclosure Requirements / 7 - 1
Executive Takeaway
The VIE model expands the scope of required disclosures to all reporting entities.
Although the FASB deferred the VIE model as amended by ASU 2009-17 for
certain investment entities as described in VE 2.3, all public and nonpublic
companies need to provide the disclosures required by the VIE model for all
variable interests in VIEs, including VIEs that qualify for the deferral.
A reporting entity that holds a variable interest in a VIE may be required to provide
certain disclosures even if it is not the primary beneficiary of the VIE.
A reporting entity may provide disclosures in more than one footnote in the
financial statements in which case cross-referencing between the applicable notes
is required.
The SEC Staff has indicated that in cases other than the initial adoption, the
consolidation or deconsolidation of a VIE generally would trigger the need to
consider the Form 8-K reporting requirements.
VE 7.1.3 contains a summarized table of disclosure requirements.
7 - 2 / Presentation and Disclosure Requirements
Chapter 7: Presentation and Disclosure Requirements

7.1 Disclosure
The VIE model requires that both the primary beneficiary of a variable interest entity
(VIE) and a reporting entity with a variable interest in a VIE (even if the reporting
entity is not the primary beneficiary), disclose key information on the reporting
entitys involvement with a variable interest entity. This is in addition to the disclosure
requirements that may be required by other accounting topics (e.g., purchase price
allocation for a newly acquired entity). Accordingly, it is important that companies
develop, monitor and maintain systems, processes and internal controls to ensure
compliance with these requirements in a timely and complete manner. VE 7.1.3
contains a summary chart of the disclosures required for reporting entities.
7.1.1 Disclosure Objectives

The VIE model expands the scope of the required disclosures to address nonpublic reporting entities. It also introduces some new disclosures in addition to what
was already required for public reporting entities. The VIE model also provides the
following four disclosure objectives:
Excerpt from ASC 810-10-50-2AA:
The principal objectives of this Subsections required disclosures are
to provide financial statements users with an understanding 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. Consolidate a variable interest entity (VIE)
2. Disclose information about its involvement in a VIE,
b. The nature of restrictions on a consolidated VIEs assets and on
the settlement of its liabilities reported by a reporting entity in its
statement of financial position, including the carrying amounts of
such assets and liabilities,
c. The nature of and changes in, the risks associated with a
reporting entitys involvement with the VIE,
d. How a reporting entitys involvement with a VIE affects the
reporting entitys financial position, financial performance, and
cash flows.
Excerpt from ASC 810-10-50-2AB:
A reporting entity shall consider these overall objectives in providing the
disclosures required by this Subsection. To achieve these objectives,
a reporting entity may need to supplement disclosures otherwise
required by this Subsection, depending on the facts and circumstances
surrounding the VIE and a reporting entitys interest in that VIE.
The FASBs inclusion of disclosure objectives emphasize the need for companies
not to assume that the specific disclosure requirements represent the minimum
requirements, but rather to ensure judgment is applied in determining what is
necessary to provide financial statement users with decision-useful information.

7.1.2 The Aggregation Principle


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. VIEs that are not consolidated because the reporting entity is
not the primary beneficiary but has a variable interest
b. 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.
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.
Aggregation of similar entities for the purpose of these disclosures is allowed if

separate reporting would not provide more useful information to financial statement
users. However, at a minimum, the disclosures should be made in such a way
that financial statement users are able to distinguish between VIEs that are not
consolidated because the reporting entity is not the primary beneficiary of the entity
(but holds only a significant variable interest), and those VIEs that are consolidated.
The disclosure should also include the methodology applied to aggregate the
disclosures. The VIE model provides guidance regarding what qualitative and
quantitative information should be considered in determining whether to aggregate
disclosures.
Different users prefer different levels of information. Although certain users may
naturally prefer the most disaggregated level of information available, others may
find that same level of information unwieldy and excessive. In deciding whether to
disclose disaggregated or aggregated information, companies should use judgment
to determine the information that will be most useful to financial statement users and
accomplish the objectives of the disclosure principles.

7.1.3 Specific Required Disclosures About VIEs

All reporting entities are scoped to the disclosure requirements under the VIE model.
Under this guidance, both public and non-public reporting entities must prepare
the required and relevant disclosures. It calls for certain specific disclosures to be
made by (1) a primary beneficiary of a VIE, and (2) an enterprise that holds a variable
interest in a VIE (but is not the primary beneficiary).
The following tables summarize the required disclosures. For the complete disclosure
requirements, refer to ASC 810-10-50.
Entity Status
Primary beneficiary
(consolidator)
Required Disclosure
Methodology for determining the primary beneficiary, including
significant judgments and assumptions
If the conclusion to consolidate a VIE has changed in a period, the
primary factors that caused the change and effect on the financial
statements
Whether the reporting entity has provided financial or other
support (explicitly or implicitly) to the VIE that it was not previously
contractually obligated to provide or whether the reporting entity
intends to provide support, including the type and amount of support
and the primary reasons for providing the support
Qualitative and quantitative information about the involvement with
the VIE (considering explicit and implicit variable interests)
Carrying amounts and classification of the consolidated VIEs assets
and liabilities, including qualitative information about the relationship
between those assets and associated liabilities (e.g., nature of
restrictions on those assets)
Lack of recourse if creditors or beneficial interest holders of a
consolidated VIE have no recourse to general credit of the primary
beneficiary
Terms of arrangements that could require primary beneficiary to
provide financial support to the VIE
Amount of gain or loss on initial consolidation of the VIE if the
primary beneficiary of a VIE is not a business. The primary
beneficiary of a VIE that is a business should provide the disclosures
required by ASC 805, Business Combinations (ASC 805)
(continued)
Entity Status
Reporting entities
with variable
interests in a
variable interest
entity but is not the
primary beneficiary
Required Disclosure
Methodology for determining the primary beneficiary including
significant judgments and assumptions
If conclusion to consolidate a VIE has changed in a period, the
primary factors that caused the change and effect on the financial
statements
Whether the entity has provided financial or other support (explicitly
or implicitly) to the VIE that it was not previously contractually
obligated to provide or whether the reporting entity intends
to provide support, including the type and amount of support
qualitative and quantitative information about the involvement with
the VIE (considering explicit and implicit variable interests)
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
Carrying amount and classification of the assets and liabilities in
the entitys balance sheet that relate to the entitys variable interest
in the VIE
The reporting entitys maximum exposure to loss as a result of its
involvement with the entity, including how the maximum exposure
is determined and the significant sources of the reporting entitys
exposure to the VIE. If the maximum exposure to loss cannot be
quantified, that fact must be disclosed
A tabular comparison of the carrying amounts of the assets and
liabilities with the maximum exposure to loss and qualitative
and quantitative information on the reasons for the differences
(considering explicit and implicit variable interests)
Information about liquidity arrangements, guarantees or other third
party commitments that may affect the fair value or risk of the
reporting entitys variable interest in the VIE
If power is determined to be shared, the significant factors
considered and judgments made
The maximum loss represents the maximum exposure that would be absorbed by the
reporting entity in the event that all of the assets of the VIE are deemed worthless.
The amount disclosed would include any additional costs that the reporting entity
would incur. Two common examples might be:
A holder of an equity method investment would be exposed to the carrying value
of the equity method investment, assuming no future capital funding requirements.
A guarantor of debt would be exposed to the full principal (and interest, if
guaranteed) amount of the debt that is guaranteed.
Companies should carefully assess whether their disclosures provide sufficient
qualitative and quantitative data regarding the methodology, inputs, assumptions,
values, involvement, and restrictions associated with their involvement with a variable
interest entity.
The VIE model also requires the disclosures about a reporting entitys involvement
with a VIE depending on a reporting entitys assessment of the transaction or its
involvement. For example, a reporting entity that provides a guarantee to a VIE and
a reporting entity that provides a guarantee to a voting-interest entity will not be
subject to the same disclosure requirements.
A reporting entity may provide disclosures in more than one footnote in the financial
statements as long as the disclosure objectives are met. If the disclosures are
provided in more than one footnote in the financial statements, cross-referencing
between the applicable notes is required.
An exception to specific disclosures required to be made is available under the
following circumstance:
Excerpt from ASC 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 are not required.

7.2 Presentation
A reporting entity shall present each of the following separately on the
face of the statement of financial position:
a. Assets of a consolidated variable interest entity (VIE) that can be
used only to settle obligations of the consolidated VIE
b. Liabilities of a consolidated VIE for which creditors (or beneficial
interest holders) do not have recourse to the general credit of the
primary beneficiary.
The information described above is required to be presented on a gross basis, i.e.,
a VIEs liabilities would not be netted against its assets and the VIEs assets or its
liabilities combined into a single line item respectively unless permitted by other
GAAP.
By way of background, in its initial deliberations, the FASB considered a linked
presentation model in which certain assets would be classified separately on a
reporting entitys balance sheet. Any liabilities that are funded solely from the cash
flows from those assets would be reflected as a deduction from the related asset
with a subtotal for a net amount. However, the FASB rejected this approach because
extending the scope of linked presentation to a much broader population of assets
and liabilities, including those that are nonfinancial, would be a significant change
that would be more appropriate to develop as part of the joint project with the IASB
on derecognition and financial statement presentation. Moreover, significant issues
about linked presentation would need to be addressed that could not be completed
in the short term.
The FASB also considered, but rejected, a single-line-item display of assets and
liabilities that meet the separate presentation criteria.
In order to avoid potential inconsistency and comparability issues in a reporting
entitys consolidated financial statements, the FASB decided to require separate
presentation of elements of consolidated variable interest entities as described in
the excerpt above. While some could interpret this requirement to mean that each
consolidated VIEs assets and liabilities that qualify for disclosure must be separately
presented, we understand this requirement to mean that the same or similar assets
of all consolidated VIEs that meet this separate presentation criterion could be
presented in the aggregate on the relevant balance sheet line item. The same applies
to liabilities of consolidated VIEs that meet this separate presentation criterion,
however, qualifying assets and liabilities should not be netted.
Because the criteria for assets and liabilities differ, it is possible that only the assets
or only the liabilities of a particular VIE would need to be separately presented, but
not both. For example, the primary beneficiary of a securitization structure or a real
estate entity may need to separately present the assets of the VIE because they can
be used only to settle the beneficial interests or obligations respectively. However, if
the liabilities of the VIE were guaranteed by the primary beneficiary, they would not
need to be separately presented because the beneficial interest holders or lenders
have recourse to the primary beneficiary. In this case, companies may elect to
separately present the liabilities, but would not be required to do so.

7.3 Information-out Scope Exception

Additional disclosures are required for a reporting entity that elects the informationout scope exception described in VE 2.2.1.
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 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
b. The nature, purpose, size (if available), and activities of the legal
entities and the nature of the reporting entitys involvement with
the legal entities
c. The reporting entitys maximum exposure to loss because of its
involvement with the legal entities
d. 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.
7.4 Item 2.01 Form 8-K and Rule 3-05 Reporting Requirements
At the 2003 AICPA National Conference on Current SEC Developments, several
topics were discussed in relation to the interaction between the VIE model and the
Form 8-K requirements. The SEC Staff addressed potential reporting requirements
under Item 2.01 of Form 8-K and under Regulation S-X Rule 3-05 that could be
triggered by the VIE model. Registrants are generally required to file an Item 2.01 of
Form 8-K if they (or a majority-owned subsidiary) acquire or dispose of a significant
amount of assets in circumstances other than in the ordinary course of business
(refer to VE 8.1.7 for a discussion of the disclosure requirements at transition). For
purposes of reporting under Item 2.01 of Form 8-K, an acquisition includes every
purchase, acquisition by lease, exchange, merger, consolidation, succession or other
acquisition.
At the 2003 Conference, the SEC Staff indicated that it was still contemplating how
these reporting requirements relate to VIEs. A final model was never published.
Nevertheless, at the 2003 Conference, the SEC Staff indicated that in cases other
than the initial adoption of the VIE model, the consolidation or deconsolidation
of a VIE generally would trigger the need to consider the Form 8-K reporting
requirements. The SEC Staff listed several factors that should be considered to
determine if it would be necessary to file a Form 8-K:
The form of the reporting entitys variable interest in the entity (for example, an
asset, obligation, or executory contract).
Whether the event occurred in the ordinary course of business.
The significance thresholds within Form 8-K.
Whether the VIE is a business (as defined under Rule 11-01(d) of Regulation S-X).
With respect to acquisitions, if the VIE is a business and is significant, audited
financial statements and pro forma financial statements will be required under Item
9.01 of Form 8-K and under Rule 3-05. If the disposition of a VIE, that is a business
is significant, pro forma financial statements reflecting the disposition would be
required. The Center of Audit Quality (CAQ) SEC Regulations Committee discussed
this topic with the SEC staff. In that discussion, the SEC staff indicated that in cases
other than the initial adoption of the variable interest entity consolidation accounting
standard, the consolidation or deconsolidation of a VIE would trigger the need to
consider Item 2.01 Form 8-K reporting requirements. The reporting thresholds and
requirements vary based on whether the variable interest entity is a business (as
defined under S-X 11-01(d)) and the significance thresholds under S-X 1-02(w). If the
VIE is a business and significant above the 20 percent level, the SEC staff believes
that the Item 2.01 Form 8-K must include S-X Rule 3-05 financial statements under
Item 9.01 of Form 8-K, as well as pro forma financial information under S-X Article
11. If the VIE is not a business, the consolidation should be regarded as an asset
acquisition and reported under Item 2.01 of Form 8-K if it exceeds the applicable
10 percent significance test and the need for pro forma information under Item 9.01
should also be considered.
A registrant must also consider whether it has a Form 8-K reporting obligation if a
reconsideration event results in deconsolidation of a VIE.
Finally, the SEC staff has not indicated how the timing of these reporting
requirements relates to the consolidation of a variable interest entity. The SEC staff
has yet to clarify the filing and timing requirements of the Form 8-K, whether it must
be filed within four business days of the reconsideration event, and the implications
to a registrants eligibility to use Form S-3.


Question 7-1: How should the assets and liabilities of a consolidated VIE that meet
the separate presentation criteria in ASC 810-10-45-25 be presented in reporting
entitys consolidated financial statements?
PwC Interpretive Response: The VIE model does not provide guidance on
how assets and liabilities that meet the separate presentation criteria should be
presented in the primary beneficiarys balance sheet. We believe that a reporting
entity has presentation alternatives provided the assets and liabilities that meet
the separate presentation criteria are separately presented on the face of the
balance sheet. For example, a reporting entity that is the primary beneficiary of a
VIE could present each asset element that meets the separate presentation criteria
as one line item and parenthetically disclose the amount of the asset in a VIE.
Alternatively, the reporting entity could present an asset element in two separate
line items, one line item for the asset in a VIE that meet the separate presentation
criteria and another line item for the reporting entitys corresponding asset. There
may be other acceptable alternatives.
Chapter 8:
Transition upon Adoption and Effective Date
Transition upon Adoption and Effective Date / 8 - 1
Executive Takeaway
The revised VIE model (as amended by ASU 2009-17) is effective as of the
beginning of a reporting entitys first fiscal year beginning after November
15, 2009, and for interim periods within that first period. Earlier adoption was
prohibited.
There was no grandfatheringthe VIE model as amended by ASU 2009-17 must
be applied to all entities including those that previously met the requirements to be
Qualified Special Purpose Entities (QSPEs). See VE 2.3 for the deferral of the VIE
model (as amended by ASU 2009-17) for certain investment entities.
In transition, the initial measurement of the assets, liabilities and non-controlling
interests of a newly consolidated VIE is based on the amounts that would have
been carried in the consolidated financial statements when the reporting entity first
became the primary beneficiary as if the VIE model as amended by ASU 2009-17
had been effective all along. If it is not practicable to determine these amounts,
then such amounts can be based on fair value at adoption date (or the unpaid
principal balances for securitizations or other forms of asset-backed financings).
A reporting entity which availed itself of the information-out scope exception but
must now consolidate because the scope exception is no longer available (i.e., the
information is now available) may follow the VIE model as amended by ASU 200917 transition guidance and not restate.
To the extent that an entity qualified for the deferral in ASU 2010-10 but no longer
qualifies, the guidance in this chapter would apply.
8 - 2 / Transition upon Adoption and Effective Date
Chapter 8: Transition upon Adoption and Effective Date

8.1 Transition upon Adoption of the VIE Model as Amended by ASU 2009-17
This chapter discusses key points that should be considered upon the adoption of
the VIE model including:
Initial ApplicationTransition Guidance
Fair Value and Unpaid Principal Balance Practicability Exception
Deconsolidation
Fair Value Option
Information-out Scope Exception
Treatment of Pre-existing Hedge Relationships upon Transition
Transitional Disclosure Requirements
SEC Considerations
See VE 2.3 for the deferral of VIE Model as amended by ASU 2009-17 for certain
investment entities.
8.1.1 Initial ApplicationTransition Guidance

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 amount is practicable, the
consolidating entity shall initially measure 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.
2. 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
(continued)
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.
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 entity 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.
f: 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 Subsection, would have required
consideration.
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 Subsection is
first applied.
(continued)
h: 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 assetbacked 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.
On adoption, the VIE model as amended by ASU 2009-17 provides several
alternatives:
Retrospectively apply the guidance through a cumulative-effect adjustment to
retained earnings as of the beginning of the first year presented. A reporting entity
that has previously not applied the VIE model because of the inability to obtain
the information necessary to (1) determine whether the entity is a variable interest
entity, (2) determine whether the reporting entity 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 but
subsequently obtains the information necessary to apply the amended guidance
to that entity should apply the provisions of the amended VIE model as of the date
the information is acquired.
Apply the guidance as of the date of adoption through a cumulative-effect
adjustment to the opening balance of retained earnings in the year of adoption.
If a reporting entity decides to retrospectively apply the guidance, it is important
to note that the amended guidance would need to be applied retrospectively to all
instances in which a reporting entity has a variable interest in an entity and not just
to those variable interests in existence at the adoption date. For example, Company
A reports on a calendar year-end basis with three years of financial information
presented in its financial statements and will adopt the amended guidance on
January 1, 2010, on a retrospective basis. During 2008, Company A acquired a
variable interest in a variable interest entity, which would have caused Company
A to be its primary beneficiary. However, during 2009 Company A disposed of its
variable interest and would no longer be considered the primary beneficiary of the
entity. Despite Company A not holding a variable interest in the entity at the January
1, 2010, adoption date, Company A must include the effects of consolidation in
2008 and deconsolidation in 2009 when applying the amended guidance on a
retrospective basis.
For VIEs that require consolidation due to the application of the VIE model as
amended by ASC 2009-17, reporting entities are required (unless eligible for the
practicability exception discussed in VE 8.1.2) to recognize and measure the

consolidated elements at their carrying values as if they had been consolidated
when the reporting entity first became the primary beneficiary under the VIE model
as amended by ASU 2009-17. The term carrying amount does not refer to the
current book value or historical cost basis of the assets, liabilities and noncontrolling
interests of the VIE. In this context, carrying amount refers to the fair value of the
assets, liabilities and noncontrolling interests at the date the reporting entity first
would have been the primary beneficiary (had the amended VIE model been effective
at that time), carried forward to the adoption date. In other words, carrying value is
the fair value as adjusted by any accounting entries that would have been recorded
between the date the reporting entity first became the primary beneficiary and the
date of adoption.
The initial transition of the VIE model as amended by ASU 2009-17 can be very
cumbersome since all transactions that have occurred between the date the
reporting entity first became the primary beneficiary and the adoption date would
need to be recognized. This would include analysis of any impairment of assets,
intangibles or goodwill and could change goodwill impairment testing for reporting
units when the reporting entity consolidated the entity as its primary beneficiary.
Establishing the appropriate date to determine whether or not an entity is a VIE and
which reporting entity, if any, is the VIEs primary beneficiary can also be challenging
since the reporting entity is required to work backwards from the adoption date
and consider all prior VIE reconsideration events and other changes to the primary
beneficiary determination during the period.
Example 8-1: Company XYZ is required to adopt the VIE Model as amended
by ASU 2009-17 on January 1, 2010. Company XYZ has elected to not
apply the guidance on a retrospective basis and therefore will recognize
a cumulative effect adjustment to retained earnings on January 1, 2010.
Company XYZ acquired a 40 percent equity interest in Entity V on June
1, 2008. On April 15, 2009, Entity V went through a major restructuring
of its business and it has been determined that such event qualified as a
VIE reconsideration event. On August 1, 2009, Company XYZ acquired an
additional 10 percent equity interest in Entity V from another investor in Entity
V bringing Company XYZs ownership interest in Entity V to 50 percent.
Company XYZ has been accounting for its interest in Entity V under the equity
method of accounting.
In determining whether Company XYZ is required to consolidate Entity V at
the adoption date, Company XYZ would need to first consider whether or not
Entity V is a VIE at the last VIE reconsideration event on April 15, 2009.
If the entity is not a VIE on April 15, 2009, then Company XYZ would not be
required to consolidate under the VIE model as amended by ASU 2009-17
and there would be no cumulative effect adjustment because Company XYZ
elected to not apply the amended VIE model on retrospective basis.
If Entity V is first determined to be a VIE at April 15, 2009, and there was no
VIE reconsideration event after April 15, 2009, then Company XYZ would
assess whether it is the primary beneficiary on January 1, 2010 (its adoption
date) and when it first became the primary beneficiary. If it is determined
that Company XYZ became the primary beneficiary on August 1, 2009, (and
was not the primary beneficiary from April 15, 2009 through August 1, 2009)
as a result of additional power granted it through its 10 percent additional
equity acquisition, then in determining the cumulative effect adjustment,
Company XYZ would consolidate Entity V on August 1, 2009, and roll forward
its accounting elements as if Entity V had been consolidated since August
1, 2009. Note that if Company XYZ had VIE reconsideration events prior to
April 15, 2009, Company XYZ would need to go back to all such prior VIE
reconsideration event dates to determine the periods when Company XYZ
was the primary beneficiary when Entity V was a VIE under the VIE model as
amended by ASU 2009-17.

8.1.2 Fair Value and Unpaid Principal Balance Practicability Exception

The VIE model as amended by ASU 2009-17 allows a reporting entity to initially
measure the consolidated elements at fair value as of the date the amended VIE
model first applies if ascertaining the carrying value is not practicable on the
adoption date. In addition, the VIE model (as amended by ASU 2009-17) also allows
the unpaid principal balance to be used as a practicability exception if the activities
of the entity are primarily related to securitization or other forms of asset-backed
financing and the assets of the entity can be used only to settle the obligations of
the entity. This measurement alternative does not eliminate the need for the primary
beneficiary to recognize any accrued interest, allowance for credit losses, or otherthan-temporary impairment.
The Board intends for these additional transition measurement alternatives to be
utilized only in scenarios in which a reporting entity would need to incur an excessive
amount of cost and effort to determine the carrying amounts as described above.
The Board believes that the unpaid principal balance measurement alternative is
acceptable since a fair value measurement upon consolidation with no ongoing fair
value measurement requirement would not reflect the primary beneficiarys exposure
to the activities of the consolidated variable interest entity and that the unpaid
principal balance in these circumstances still provides useful information to financial
statement users. However, fair value must be used if a consolidated element does
not have an unpaid principal balance or if fair value is required under other applicable
GAAP.
8.1.3 Deconsolidation
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 Subsection 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.
Certain VIEs may need to be deconsolidated due to the application of the VIE model
as amended by ASU 2009-17. If a reporting entity is required to deconsolidate a VIE,
the deconsolidating reporting entity shall initially measure any retained interest in the
deconsolidated subsidiary at its carrying amount as of the date the VIE model as
amended by ASU 2009-17 first applies (either the date of adoption or the beginning
of the first period presented, depending on which transition method is selected).
Any differences between the net amount removed from the balance sheet with
respect to the deconsolidated entity and the amount of any retained interest in the
newly deconsolidated entity will be recognized as a cumulative effect adjustment
to the opening balance of retained earnings. The amount of any cumulative effect
adjustment related to deconsolidation should be disclosed separately from any
cumulative effect adjustment related to consolidation of entities.
Note that the date of the deconsolidation will make a difference in the transition
accounting. If a reporting entity concludes that it was not the primary beneficiary
under the VIE model as amended by ASU 2009-17 since inception, then it is as
if the reporting entity would not have ever consolidated the VIE. Therefore, when
considering the accounting at inception, there is no deconsolidation transaction
rather it should be accounted for as an investment. However, if under the VIE
model as amended by ASU 2009-17, the reporting entity is the primary beneficiary
at inception and then ceases to be the primary beneficiary at a later date, than a
deconsolidation transaction has occurred. In this case, the VIE will be consolidated
for a period of time under the VIE model as amended by ASU 2009-17 and then be
deconsolidated at a later date based on the deconsolidation guidance in effect at the
time of the deconsolidation.
Example 8-2: At inception on January 15, 2008, Company A and B invested
$100 million each for a 50 percent common stock ownership interest in a
new entity VIE. Company A was the primary beneficiary under the prior
VIE model because it guaranteed the VIEs external bank debt and therefore
consolidated the VIE. Company A adopted the VIE model as amended by
ASU 2009-17 effective January 1, 2010.
As a result of adoption of the VIE model as amended by ASU 2009-17,
Company A concludes that, at both at inception of the VIE and on an ongoing
basis, Company B has the power to direct activities that significantly impact the
economic performance of the VIE. Therefore, under the amended VIE model,
Company B and not Company A is the primary beneficiary both at inception
and through the period up until adoption of the VIE model as amended by
ASU 2009-17. In applying ASC 323, Company A will record a $105 million
equity method investment at January 15, 2008, representing both the cash it
contributed ($100 million) and the fair value of its guarantee of VIEs debt ($5
million). This equity method investment will then be rolled forward to December
31, 2009, considering its proportionate share of equity earnings, any change
in interest transactions, as well as amortization or accretion of any basis
differences. Additionally, the guarantee liability would also be rolled forward.
The equity method investment rolled forward balance coupled with the liability
recognized for the guarantee of debt will then be compared to the net assets
of the VIE to be deconsolidated at adoption date to determine the cumulative
effect upon adoption of the VIE model as amended by ASU 2009-17.
Example 8-3: At inception on January 15, 2008, Company A and B invested
$100 million each for a 50 percent common stock ownership interest in a
VIE. Company A has the power to appoint and remove a majority of the
VIEs board of directors. On January 15, 2009, Company B entered into a
manufacturing arrangement with the VIE which gave Company B additional

board seats and as a result, Company B obtained control of the board of
directors (therefore, Company B obtained the power over activities that most
significantly impact the economic performance of the VIE). Company A was
the primary beneficiary under the prior VIE model because it absorbed a
majority of the VIEs expected losses (through its 50 percent equity investment
and it guarantee of the VIEs external bank debt) and therefore consolidated
the VIE. Company A adopted the VIE model as amended by ASU 2009-17
effective January 1, 2010.
Upon adoption of the VIE model as amended by ASU 2009-17, Company A
concludes that it is still the primary beneficiary at inception because it has
the power to appoint and remove a majority of the VIEs board of directors
and therefore has the power to direct the activities that significantly impact
the economic performance of the VIE. However, on January 15, 2009, when
Company B enters into a manufacturing arrangement with the VIE, the power
shifts from Company A to Company B. Therefore, under the VIE model as
amended by ASU 2009-17, Company A will consolidate the VIE from January
15, 2008, onwards and will deconsolidate the VIE on January 15, 2009.
Upon deconsolidation, Company As retained interest or equity method
investment (and its guarantee of the external debt) will be recorded at fair
value based upon ASC 810, the guidance in effect in 2009. The equity method
investment will then be rolled forward to December 31, 2009, considering its
proportionate share of equity earnings, any change in interest transactions, as
well as amortization or accretion of any basis differences. The equity method
investment rolled forward balance will then be compared to the net assets to
be deconsolidated at adoption date to determine the impact upon adoption of
the VIE model as amended by ASU 2009-17.

8.1.4 Fair Value Option

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. Managements reasons for electing the fair value option for a
particular VIE or group of VIEs.
2. The reasons for different elections if the fair value option is
elected for some VIEs and not others.
3. 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.
While the VIE model as amended by ASU 2009-17 does not generally provide
accounting guidance for subsequent measurement of consolidated elements, a
reporting entity that is required to consolidate an entity as a result of the initial
application of the VIE model as amended by ASU 2009-17 may elect the fair value
option under the Fair Value Option Subsections of ASC 825. However, at the
transition date a reporting entity must elect the fair value option on an entity by entity
basis and apply the fair value option to all elements of the entity eligible under the
Fair Value Option Subsections of ASC 825. This is different from the provisions of the
Fair Value Option Subsections of ASC 825 that allow for an instrument-by-instrument
election. Note that this discussion applies only to the initial adoption of the VIE model
as amended by ASU 2009-17 and not to its subsequent application. A reporting
entity that elects the fair value option will need to provide the disclosures under the
Fair Value Option Subsections of ASC 825 and also describe its rationale for electing
the fair value option for certain entities.

8.1.5 Information-out Scope Exception

A reporting entity that has not applied the Variable Interest Entities
Subsections to a legal entity because of the condition described
in paragraph 810-10-15-17(c) and that subsequently obtains the
information necessary to apply the Variable Interest Entities Subsections
to that entity shall apply the provisions of the Variable Interest Entities
Subsections as of the date the information is acquired in accordance
with the following paragraph.
The Board expects a reporting entity to continue to make exhaustive efforts to obtain
the necessary information to apply the provisions of the VIE model. See VE 2.2.6 for
more details regarding the information out scope exception.
8.1.6 Treatment of Pre-existing Hedge Relationships upon Transition

Pre-Codification DIG Issue E22 addresses how a pre-existing hedge relationship
should be treated upon the consolidation (or the deconsolidation) of another entity
upon the adoption of the VIE model as amended by ASU 2009-17. At issue is the
treatment or de-designation of a pre-existing hedge relationship that is designated
as a hedge under Accounting Standards Codification 815, Derivatives and Hedging
(ASC 815) upon the application of the VIE model as amended by ASU 2009-17.
Although DIG Issue E22 related to the initial application of the prior VIE model (FIN 46
or FIN 46(R)) and is not included in the FASB Codification, we believe the concepts in
DIG Issue E22 are relevant to the initial application of the amended VIE model.
Excerpt from DIG Issue E22 (pre-Codification):

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).
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.
In addition, if the initial application of the VIE model as amended by AU 200917 causes the discontinuance of a pre-existing hedging relationship for which
effectiveness was being assessed under the shortcut method in ASC 815-20-25-10
through 25-11 and the reporting entity designates a new hedging relationship, the
new hedging relationship can qualify for the shortcut method if the criteria described
in pre-Codification DIG Issue E22 are met.
The guidance in pre-Codification DIG Issue E22 does not affect the designation of
new hedging relationships on or after the date of initial application of the VIE model
as amended by ASU 2009-17. Such new hedging relationships need to comply with
all applicable requirements of ASC 815 except with respect to the special use of the
shortcut method, as previously discussed.
8.1.7 Transitional Disclosure Requirements

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 are also required by the
pending content in the Variable Interest Entities Subsections shall be
presented. For non-public entities, in periods after initial adoption,
comparative disclosures for those disclosures that were not previously
required by are required only for periods after the effective date.
Comparative information for disclosures previously required that are
also required by the pending content in the Variable Interest Entities
Subsections shall be presented.
All reporting entities are required to provide the disclosures for interim and annual
reporting periods ending after the date of adoption. Comparative information is
encouraged (but not required) for periods in which these disclosures were not already
required.
A reporting entity will have to describe the transition method applied and disclose the
amount and classification of the consolidated assets or liabilities in its balance sheet
impacted by adopting the VIE model as amended by ASU 2009-17.
8.1.8 SEC Considerations

The SEC staff shared with the Center for Audit Quality SEC Regulations Committee
its views on the following practice issues with respect to the VIE model as amended
by ASU 2009-17:
Filing Registration Statements After Adoption of the VIE Model as amended by
ASU2009-17
The SEC staff has indicated that if a reporting entity has elected to adopt the
VIE model 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 to reflect a material
retrospective application of the VIE model. Conversely, if a registrant elects to adopt
the VIE model only on a prospective basis, or if the retrospective application of the
VIE model is not material, the registration statement may incorporate by reference
the registrants most recent Form 10-K, which would include its historical annual
financial statements of periods prior to the adoption of the VIE model (assuming that
the prior financial statements do not require revision for other purposes).
Applying the Transition Provisions of the VIE Model as amended by ASU 2009-17
The SEC staff indicated that it expects there to be consistency between the
application of the VIE model in the financial statements and in the table of selected
financial data. For example, a calendar year-end reporting entity adopts the VIE
model on January 1, 2010, and elects to retrospectively apply the VIE model to fiscal
years 2009 and 2008. The reporting entity records a cumulative effect adjustment
to retained earnings as of January 1, 2008. In this example, if the registrant
retrospectively applies the VIE model only to fiscal year 2009, it should apply the
VIE model beginning in 2009 in the table of selected financial data. If the registrant
elects to retrospectively apply the VIE model to fiscal years 2009 and 2008, the SEC
staff indicated that the registrant may decide whether it will also apply the VIE model
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 the VIE model and, if necessary, the fact that certain periods are not
comparable to the periods for which the audited financial statements are provided.
Pro Forma Requirements
The SEC staff indicated that the initial adoption of the VIE model as amended
by ASU 2009-17 would not trigger either an Article 11 or an Item 2.01 Form 8-K
reporting requirement.
Rule 3-05, Rule 3-14 and Form 8-K Considerations
The SEC staff stated that consolidation upon the initial adoption of the VIE model as
amended by ASU 2009-17 would not trigger a Rule 3-05, Item 9.01(a) or Rule 3-14
reporting requirement.

8.2 Effective Date

The VIE model as amended by ASU 2009-17 is effective as of the beginning of a
reporting entitys first fiscal year beginning after November 15, 2009, and for the
interim periods within that first period, with earlier adoption prohibited. It must be
applied to all entities previously subject to the VIE model including those entities
that previously met the requirements to be QSPEs that exist on the date of adoption.
See VE 2.3 for the deferral of the VIE model as amended by ASU 2009-17 for certain
investment entities.

Question 8-1: Can a reporting entity choose a different transition for each VIE that it
is required to consolidate under the VIE model as amended by ASU 2009-17?
PwC Interpretive Response: On adoption, the VIE model as amended by ASU
2009-17, may be applied (1) retrospectively with a cumulative effect adjustment to
retained earnings as of the beginning of the first year presented or (2) applied as
of the date of adoption with a cumulative effect adjustment to retained earnings
recognized on that date. This election applies to all instances in which a reporting
entity had a variable interest in an entity. Said differently, a reporting entity cannot
choose to apply the guidance retrospectively for some entities and not for others.
However, as discussed earlier, the measurement method to be used at transition
is subject to fair value and unpaid principal balance practicality exceptions. We
believe a reporting entity can have a different measurement method for each VIE
that it is required to consolidate under the VIE model as amended by ASU 200917. Consequently, a reporting entity may have certain VIE assets and liabilities
initially consolidated at (i) carrying amounts, (ii) fair value, or (iii) unpaid principal
balance. However, if a reporting entity utilizes the fair value or unpaid principal
balance practicability exception for any entity, then the reporting entity cannot
apply the VIE model as amended by ASU 2009-17 on a retrospective basis.
A reporting entity is required to describe the transition method(s) applied and
disclose the amount and classification of the consolidated assets or liabilities in its
balance sheet impacted by the transition method(s) applied.
Question 8-2: If a reporting entity held a variable interest in a VIE that was not
consolidated and such variable interest was sold prior to the adoption of the
VIE model as amended by ASU 2009-17, does that VIE need to be revaluated at
adoption of the VIE model as amended by ASU 2009-17?
PwC Interpretive Response: It depends on the transition method elected by
the reporting entity. If the VIE model as amended by ASU 2009-17 is applied as
of the date of adoption with a cumulative effect adjustment to retained earnings
recognized on that date (January 1, 2010, for a calendar year-end company), then
the reporting entity does not need to re-evaluate the entity under the VIE model as
amended by ASU 2009-17 at the adoption date.
If the VIE model as amended by ASU 2009-17 is retrospectively applied with
a cumulative effect adjustment to retained earnings as of the beginning of the
earliest year presented, then the reporting entity will need to re-evaluate the
entity under the VIE model as amended by ASU 2009-17. If the entity is a VIE and
the reporting entity is the primary beneficiary for any of the periods presented,
then the reporting entity will have to reflect the consolidation of the VIE for those
periods up until its sale.
Question 8-3: If a reporting entity elects the unpaid principal balance transition
method, would it be required to continue to record the consolidation of securitized
structures on a go-forward basis using unpaid principal balance?
PwC Interpretive Response: No, the unpaid principal balance practicability
exception applies only to day one accounting on the date of adoption of the VIE
model as amended by ASU 2009-17. An allowance for credit losses, accrued
interest, or other-than-temporary impairment may also need to be recorded on
the date of adoption. In periods after the adoption date, such assets and liabilities
should be accounted for in accordance with other GAAP, as appropriate. The
same holds true where the fair value practicability exception is applied, though
in contrast to the unpaid principal balance option, electing the fair value option
would require those assets and liabilities to continue to be measured at fair value
in subsequent periods with changes in fair value recognized in earnings.
Appendix A:
FASB Examples of Applying the By Design Model
FASB Examples of Applying the By Design Model / A - 1
Appendix A: FASB Examples of Applying the By Design Model

Reprint of a portion of ASC 810, Consolidation, specifically ASC 810-10-55-55
through 55-86.
ASC 810-10-55-55 through 55-86 includes eight examples to facilitate the
understanding of the by design model in determining an entitys variability as well
as identifying an entitys variable interests. We have included a full reprint of ASC
810-10-55-55 through 55-86 below.
Example 3: Determining the Variability to Be Considered
55-55: The following Cases illustrate the application of the guidance in
paragraphs 810-10-25-21 through 25-36 for determining the variability
to be considered in the following situations:
a. Financial VIE primarily financed by fixed-rate debt, holding
investments in longer-term fixed-rate debt (Case A)
b. Financial VIE primarily financed by fixed-rate debt, holding
investments in longer-term fixed- and variable-rate debt (with a
fixed-rate swap) (Case B)
c. Financial VIE primarily financed by fixed-rate debt, holding
investments in foreign-currency-denominated debt (with a
currency swap) (Case C)
d. Financial VIE primarily financed by floating-rate debt, holding
investments in fixed-rate securities (Case D)
e. Financial VIE financed by credit-linked notes holding highly rated
floating-rate investments and a credit default swap (Case E)
f. Retail-operating VIE (Case F)
g. Lessor VIE (direct financing lease) with single lessee (operating
lease) (Case G)
h. VIE holding both a fixed-price forward contract to buy and a fixedprice forward contract to sell electricity (Case H).
55-56: Cases A-H share all of the following assumptions:
a. All the entities are presumed to be VIEs.
b. All variable interests are variable interests in the VIE (as a whole)
rather than variable interests in specified assets of the VIE, based
on the guidance in paragraphs 810-10-25-55 through 25-59.
c. A primary beneficiary has not been identified; however, the
determination of the primary beneficiary should be made in
accordance with the guidance in paragraphs 810-10-25-38A
through 25-38G.
(continued)
A - 2 / FASB Examples of Applying the By Design Model
55-57: In each Case, a two-step evaluation is performed as follows:

a. Step 1: Analyze the nature of the risks in the VIE.
b. Step 2: Determine the purpose(s) for which the VIE was created
and determine the variability the VIE is designed to create and
pass along to its interest holders.
55-58: In the diagrams in each Case, creators are on the left and
the variable interests are on the right; the instruments that could be
considered either creators or absorbers of variability are in the bottom
center.
Case A: Financial VIE Primarily Financed by Fixed-Rate Debt, Holding
Investments in Longer-Term Fixed-Rate Debt
55-59: A VIE is created and financed with $96 of 3-year fixed-rate
debt and $4 of equity from investors. The VIE uses the proceeds to
purchase $100 of B- and BB-rated fixed-rate securities with contractual
maturities ranging from 6 to 8 years. At the end of three years, all the
investments will be sold with proceeds used, first, to pay the fixedrate debt holders and, second, to pay the equity holders to the extent
proceeds remain. The transaction was marketed to potential debt
investors as an investment in a portfolio of below-investment-grade,
fixed-rate investments with a longer weighted-average maturity than the
liabilities and credit support from the equity tranche. The equity tranche
was negotiated to absorb the first dollar risk of loss related to credit risk
and interest rate risk and to receive any residual reward from a favorable
change in interest rates or credit risk that affects the proceeds received
on the sale of the investments in the portfolio. The following diagram
illustrates this situation.
CREATORS OF VARIABILITY
VARIABLE INTERESTS
6-8 Year
Investments
3-Year
Debt
$100
$96
Fixed Rate
VIE
Fixed Rate
$4
Residual Return
Equity
Investors
55-60: The VIE is exposed to the following risks:

a. Credit risk associated with a possible default by the issuers of the
investments in the portfolio with respect to principal and interest
payments
(continued)
b. Interest rate risk associated with interim changes in the fair value
of the fixed-rate periodic interest payments received on the fixedrate investment portfolio
c. Interest rate risk associated with changes in cash received upon
the sale of fixed-rate investments prior to maturity.
55-61: The following factors should be considered in the determination
of the purpose(s) for which the VIE was created and in the determination
of the variability the VIE is designed to create and pass along to its
interest holders:
a. The VIE was marketed to debt investors as a VIE that will be
exposed to credit risk and changes in the fair value of the
investments over the three-year life of the VIE due to changes
in intermediate-term interest rates, with the equity tranche
negotiated to absorb the first dollar risk of loss. It has been
determined that substantive subordination is present with respect
to these risks.
b. VIE was not designed to create and pass along to its interest
holders interest rate risk associated with interim changes in fair
value of the periodic fixed-rate interest payments received on
the investments, based on the nature and terms of the debt and
equity interests issued by the VIE.
Based on this analysis, it can be determined that the VIE was designed
to create and pass along risks in (a) and (c) in the preceding paragraph to
the debt and equity investors, who are the VIEs variable interest holders.
Case B: Financial VIE Primarily Financed by Fixed-Rate Debt, Holding
Investments in Longer-Term Fixed- and Variable-Rate Debt (with a
Fixed-Rate Swap)
55-62: A VIE is created and financed with $96 of 3-year fixed-rate debt
and $4 of equity from investors. The VIE uses the proceeds to purchase
$40 of B- and BB-rated fixed-rate securities with contractual maturities
ranging from 6 to 8 years and $60 of B- and BB-rated floating-rate
securities with contractual maturities ranging from 6 to 8 years (average
maturity of 7 years). In addition, the VIE enters into a $60 notional 7-year
pay floating and receive fixed interest rate swap with a bank. The swap
economically converts the $60 of floating-rate investments to fixed-rate
investments of the same average maturity. At the end of three years,
all the investments will be sold, and the swap settled in cash, with
the net proceeds used, first, to pay the fixed-rate debt holders and,
second, to pay the equity holders to the extent proceeds remain. Net
amounts payable to the swap counterparty periodically and at the end
of three years (if required) take priority over payments made to the debt
and equity investors. The transaction was marketed to potential debt
investors as an investment in a portfolio of below-investment-grade
fixed-rate and floating-rate investments (with the floating rate swapped
for fixed) with a longer weighted-average maturity (including the effect of
(continued)
the swap) than the liabilities and credit support from the equity tranche.
The equity tranche was negotiated to absorb the first dollar risk of
loss related to credit risk and interest rate risk, and to receive any
residual benefit from a favorable change in interest rates or credit risk
that affects the proceeds received on the sale of the investments in
the portfolio (including settlement of the swap prior to its contractual
maturity). The following diagram illustrates this situation.
6-8 Year
Investments
VARIABLE INTERESTS
Fixed Rate
3-Year
Debt
$96
$40
Fixed Rate
VIE
$4
$80
6-8 Year
Investments
Residual
Return
Floating
Rate
Entity Receives
Fixed Rate
See Evaluation
Equity
Investors
Entity Pays
Floating Rate
$60 Notational
7-Year Swap

investments in the portfolio with respect to principal or interest
payments
b. Credit risk associated with a possible default by the swap
counterparty with respect to interest payments and the
settlement amount, if any, due to the VIE at the end of three years
c. Interest rate risk associated with changes in the fair value of the
fixed-rate periodic interest payments received on the fixed-rate
investment portfolio and on the fixed leg of the swap
d. Interest rate risk associated with changes in the periodic interest
payments received on the floating-rate investment portfolio
e. Interest rate risk associated with changes in cash received upon
the sale of fixed-rate investments prior to maturity
f. Interest rate risk associated with the amount received or paid
upon settlement of the swap at the end of three years.
(continued)

interest holders:
exposed to credit risk and changes in the fair value of a portfolio
of intermediate-term fixed-rate investments (including floatingrate investments effectively converted to fixed-rate investments
by the swap) over the three-year life of the VIE due to changes
in intermediate term interest rates, with the equity tranche
negotiated to absorb the first dollar risk of loss. It has been
to these risks.
b. The swap counterparty is senior to the debt and equity investors,
and the debt and equity investors understand that they are also
exposed to the credit risk from possible default by the swap
counterparty to the extent the swap is an asset to the VIE.
c. The interest rate swap is strongly indicated as a creator of
variability because its underlying is based on observable market
rates and it is senior in priority to other interest holders. Although
the notional amount of the swap relates to a majority of the assets
of the VIE, changes in the cash flows or fair value of the swap are
not expected to offset all, or essentially all, of the risk or return
(or both) related to those investments because the fair value and
cash flows of the VIEs investments are expected to be affected by
risk factors other than changes in market interest rates (that is,
credit risk).
d. The VIE was not designed to create and pass along to its interest
holders interest rate risk associated with changes in the fair
value of the fixed-rate periodic interest payments received on the
fixed-rate investment portfolio and on the fixed leg of the swap,
based on the nature and terms of the other contracts the VIE has
entered into.
e. The VIE was not designed to create and pass along to its interest
holders interest rate risk associated with changes in the periodic
interest payments received on the floating-rate investment
portfolio, based on the nature and terms of the debt and equity
interests issued by the VIE.
to create and pass along risks (a), (b), (e), and (f) in the preceding
paragraph to the debt and equity investors, which are the VIEs variable
interest holders. The interest rate swap is considered a creator of the
VIEs variability based on the design of the VIE and the guidance in
paragraphs 810-10-25-35 through 25-36.
(continued)
Case C: Financial VIE Primarily Financed by Fixed-Rate Debt, Holding

Investments in Foreign-Currency-Denominated Debt (with a Currency
Swap)
55-65: A VIE is created and financed with $96 of 5-year fixed-rate
purchase $100 of B- and BB-rated fixed-rate securities denominated in
Japanese Yen (JPY) with contractual maturities of 5 years. In addition,
the VIE enters into a $100 notional 5-year pay-fixed JPY and receivefixed U.S. dollars (USD) cross-currency swap with a bank. The swap
economically converts the fixed-rate JPY-denominated investments to
fixed-rate USD investments, effectively offsetting the foreign exchange
risk from both periodic interest payments and the amount due upon
maturity for the JPY-denominated investments. At the end of five years,
all the investments will mature and a final settlement will be paid or
received by the VIE on the swap, with the net proceeds used, first, to
pay the fixed-rate debt holders and, second, to pay the equity holders
to the extent proceeds remain. The transaction was marketed to debt
investors as an investment in a portfolio of below-investment-grade,
JPY fixed-rate investments (with a third-party swap designed to offset
the JPY exchange risk associated with interest and principal repayment
on the investments) and credit support from the equity tranche. The
equity tranche was negotiated to absorb the first dollar risk of loss. The
following diagram illustrates this situation.
5-Year JPYDenominated
Investments
VARIABLE INTERESTS
5-Year
Debt
$100
$96
Fixed Rate
Fixed Rate
VIE
Residual Return
$4
Equity
Investors
USD Principal
JPY Principal
and Fixed
and Fixed
Interest
Interest
$100, 5-Year
Currency
See Evaluation
Swap
(continued)

investments in the portfolio with respect to principal and interest
payments
b. Credit risk associated with a possible default by the crosscurrency swap counterparty with respect to interest payments
and the settlement amount, if any, due to the VIE at the end of five
years
investment portfolio and on the receive leg of the cross-currency
swap
d. Foreign currency exchange risk associated with the periodic
interest payments received on the fixed-rate JPY-denominated
investments and the final receipt of principal at maturity
e. Foreign currency exchange risk associated with the periodic
interest payments or receipts and the amount received or paid
upon final settlement of the cross-currency swap at the end of
five years.
interest holders:
exposed to credit risk from possible default by the issuers of
the JPY-denominated investments (principal and interest) as
well as credit risk from possible default by the cross-currency
swap counterparty, with the equity tranche negotiated to absorb
the first dollar risk of loss related to these risks. It has been
to these risks.
b. The VIE was created to provide an investment vehicle for debt and
equity investors to be exposed to the credit risk of entities whose
securities are denominated in JPY.
c. The swap counterparty is senior to the debt and equity investors,
and the debt and equity investors are also exposed to the credit
risk from possible default by the swap counterparty to the extent
the swap is an asset to the VIE.
d. The currency swap is strongly indicated as a creator of variability
because its underlying is based on observable market rates and it
is senior in priority to other interest holders. Although the notional
amount of the swap relates to a majority of the assets of the
VIE, changes in the cash flows or fair value of the swap are not
expected to offset all, or essentially all, of the risk or return (or
both) related to those investments because the fair value and
(continued)
cash flows of the VIEs investments are expected to be affected

by risk factors other than changes in foreign currency exchange
rates (that is, credit risk).
e. The VIE was not designed to create and pass along to its interest
holders interest rate risk associated with changes in the fair
value of the fixed-rate periodic interest payments received on the
fixed-rate investment portfolio and on the receive leg of the crosscurrency swap, based on the nature and terms of the debt and
equity contracts issued by the VIE.
to create risks (a), (b), (d), and (e) in the preceding paragraph, and pass
along risks in (a) and (b) in the preceding paragraph to the debt and equity
investors, which are the VIEs variable interest holders. The cross-currency
swap is considered a creator of the VIEs variability based on the design of
the VIE and the guidance in paragraphs 810-10-25-35 through 25-36.
Case D: Financial VIE Primarily Financed by Floating-Rate Debt, Holding
Investments in Fixed-Rate Securities
55-68: A VIE is created and financed with $90 of 3-year floating-rate
purchase $100 of AAA-rated fixed-rate securities, which mature in 3
years. The fixed periodic interest payments received on the investments
are used to pay the floating-rate interest to the debt holders with the
remainder used to provide a return to the equity investor. At the end of
three years, all the investments will mature with proceeds used, first, to
pay the floating-rate debt holders and, second, to pay the equity holder
to the extent proceeds remain. The VIE is not actively managed. The
transaction was marketed to potential debt investors as an investment
in a portfolio of high-quality fixed-rate investments with the equity
tranche negotiated to provide support in the event of a credit default on
the investments or in the event the fixed-rate return on the investments
is not sufficient to pay the floating-rate coupon on the debt. The equity
tranche was negotiated to absorb the first dollar risk of loss. The
following diagram illustrates this situation.
VARIABLE INTERESTS
3-Year
Investments
3-Year
Debt
$100
$90
Fixed Rate
VIE
Floating Rate
$10
Residual Return
Equity
Investors
(continued)
55-69. The VIE is exposed to the following risks:

investments in the portfolio with respect to principal or interest
payments
b. Interest rate risk associated with changes in the fair value of the
investment portfolio.
55-70. The following factors should be considered in the determination
interest holders:
a. The VIE was marketed to debt investors as an entity that will be
exposed to changes in the fair value of periodic interest payments
received on the investments due to changes in interest rates
and credit risk associated with the investment portfolio, with the
equity tranche negotiated to absorb the first dollar risk of loss. It
has been determined that substantive subordination is present
with respect to these risks.
b. The equity investor has implicitly issued a $90 notional interest
rate swap to the VIE in which that investor agrees to pay the VIE
a floating rate and receive a fixed rate. However, the maximum
amount payable to the VIE is limited to the equity investment.
The debt holders will absorb the remaining variability caused by
changes in interest rates.
c. The VIE was created to provide an investment vehicle for debt and
equity investors to be exposed to the credit risk and interest rate
risk associated with a mismatch between the assets (fixed-rate)
and liabilities (floating-rate).
d. The VIE was designed to create and pass along to its interest
holders interest rate risk associated with changes in fair value
of the periodic fixed-rate interest payments received on the
investments, based on the nature and terms of debt and equity
interests issued by the VIE.
to create and pass along risks (a) and (b) in the preceding paragraphs
to the debt and equity investors, which are the VIEs variable interest
holders.
Case E: Financial VIE Financed by Credit-Linked Notes Holding Highly
Rated Floating-Rate Investments and a Credit Default Swap
55-71. Bank A holds a $100 investment in bonds issued by ABC Entity
and enters into a credit default swap with a newly established VIE that
has no equity investors and no decision-making ability. The VIE issues
$100 of credit-linked notes to investors. The credit-linked notes pay a
return equal to the London Interbank Offered Rate (LIBOR) + 90 basis
(continued)
points and mature in 5 years. The proceeds from the issuance of the
credit-linked notes are invested in floating-rate AAA-rated investments.
The terms of the credit default swap require Bank A to pay quarterly a
swap premium of 100 basis points to the VIE. If a credit event occurs,
as defined in the agreement, the VIE pays Bank A the notional amount
of $100, and receives from Bank A the bonds issued by ABC Entity. The
VIE then settles its five-year notes by delivering to the note holder the
defaulted ABC Entity bonds or by selling the bonds and delivering cash.
55-72. The coupon on the floating-rate AAA-rated investments, plus
the premium received on the credit default swap, will fund the coupon
payment on the credit-linked notes. The VIE was marketed to potential
investors as a floating-rate investment with an enhanced yield due to
the assumption of credit risk of the referenced entity (in this case, ABC
Entity). The following diagram illustrates this situation.
U.S.
Treasuries
VARIABLE INTERESTS
$100
$100
VIE
LIBOR + 90 bp
Floating Rate
5-Year
Notes
100 bp
Quarterly
Premium
See Evaluation
(Paragraphs 810-10-55-73
through 55-74)
Credit Default
Swap
Reference
Securities
$100 of ABC
Company
Bonds

a. Credit risk associated with ABC Entity
b. Credit risk associated with the AAA-rated investments
c. Credit risk associated with possible default by Bank A with
respect to premium payments made to the VIE
d. Interest rate risk associated with changes in the cash flows from
the interest payments received on the floating rate investments.
(continued)

interest holders:
a. The VIE was marketed to the note holders as a VIE that will be
exposed to credit risk associated with ABC Entity through the
credit default swap, with a small amount of credit risk from Bank
A, because the notes, if there is no credit event that triggers
settlement of the credit default swap, are fully collateralized by
AAA-rated investments.
b. The VIE has sold credit protection on ABC Entity to Bank A and
has purchased credit protection on ABC Entity from the note
holders, who are expected to receive an enhanced return over the
AAA floating rate investment for assuming the credit risk of ABC
Entity and (to a lesser extent) the credit risk of Bank A.
c. The written credit default swap is strongly indicated as a creator
of variability because its underlying is based on observable
market variables and it is senior in priority to other interest
holders.
d. The VIE was not designed to create and pass along to its interest
holders interest rate risk associated with changes in cash flows
from the periodic interest payments received on the floating-rate
investments, based on the nature and terms of the credit-linked
notes issued by the VIE.
Based on the above analysis, it can be determined that the VIE was
designed to create and pass along risks (a), (b), and (c) in the preceding
paragraph to the note holders, who are the VIEs variable interest
holders. The written credit default swap is considered a creator of the
VIEs variability based on the design of the VIE and considering the
guidance in paragraphs 810-10-25-35 through 25-36.
Case F: Retail-Operating VIE
55-75. A VIE is created by a furniture manufacturer and a strategic
investor to sell wood furniture to retail customers in a particular
geographic region of the country that has no viable distribution channel.
The VIE is established with $100 of equity contributed by the furniture
manufacturer and $3 million of 10-year fixed-rate debt financed by the
strategic investor. Interest is paid to the fixed-rate debt holder from
operations before funds are available to the equity holder.
(continued)
The furniture manufacturer has guaranteed the fixed-rate debt to the

strategic investor. The following diagram illustrates this situation.
VARIABLE INTERESTS
10-Year
Debt
(Strategic
Investor)
Fixed Rate
Other
Operating
Assets
$3 million
VIE
Residual Return
$100
Equity
(Furniture
Manufacturer)
Inventory
Debt
Guarantee
(Furniture
Manufacturer
See Evaluation
55-76. The VIE is exposed to the following risks (collectively, operating

risks):
a. Sales volume risk
b. Retail furniture price risk
c. Inventory price risk
d. Other operating cost risk.
interest holders:
a. The VIE was created to enable the furniture manufacturer to
extend its existing business line into a particular geographic
region that lacked a viable distribution channel.
b. The furniture manufacturer is absorbing variability from the
operations of the VIE through its guarantee of the debt.
c. The debt interest was negotiated as a fixed-rate investment in a
retail operating VIE, supported by the furniture manufacturer.
to create and pass along risks (a), (b), (c), and (d) in the preceding
paragraph to the debt and equity investors (the strategic investor and
(continued)
furniture manufacturer, respectively), which are the VIEs variable

interest holders. The furniture manufacturer also holds a variable
interest with respect to its guarantee of the debt of the VIE because
that contract, by design, absorbs a portion of the VIEs variability due to
operating risks.
Case G: Lessor VIE (Direct Financing Lease) with Single Lessee
(Operating Lease)
55-78. A VIE is created and financed with $950 of 5-year fixed-rate
debt and $50 of equity. The VIE uses the proceeds from the issuance
to purchase property to be leased to a lessee with an AA credit rating.
The equity provides protection (up to $50) to the debt related to both
credit risk and interest rate risk because the debt is paid before any
cash flows are available to the equity investors. 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. The lessee is required to provide a firstloss residual value guarantee for the expected future value of the leased
property at the end of five years, and it has a fixed-price purchase option
to acquire the property for the same amount. A third-party residual value
guarantor provides a very small additional residual value guarantee to
the lessor. The governing documents for the VIE do not permit the VIE to
buy additional assets or sell existing assets during the five-year holding
period. The VIE was formed so that the lessee will have rights to occupy
and use the property under an operating lease and retain substantially
all of the risks and rewards from appreciation or depreciation in value of
the leased property. The transaction 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 equity investors is expected
to be slightly greater than the return provided to the debt investors
because the equity is subordinated with respect to the obligation of the
lessee to the VIE. The following diagram illustrates this situation.
VARIABLE INTERESTS
5-Year
Debt
$950
Fixed Rate
Property
5-Year
Lease
Fixed Price
Purchase
Options
$1,000
VIE
Residual Return
$50
Fixed Lease
Payments
Residual
Value
Guarantee
Lessee
Equity
Residual
Value
Guarantee
Third-Party
Guarantor
See Evaluation
See Evaluation
(continued)

a. Price risk with respect to changes in fair value of the underlying
property
b. Credit risk associated with possible default by the lessee of the
property with respect to the lease payments
future lease payments.
interest holders:
a. Although the lease payments are fixed, the VIE was not designed
to be exposed to interim changes in fair value of those lease
payments due to interest rate risk because the VIE is not expected
to sell the property before maturity of the fixed-rate debt.
b. The primary purpose for which the VIE was created was to
provide the lessee with use of the property for five years with
substantially all of the rights and obligations of ownership.
c. The residual value guarantee effectively transfers substantially
all of the risk associated with the underlying property (that is,
declines in value) to the lessee. Therefore, the variability that
is transferred to that interest holder is strongly indicated as
variability that the VIE is designed to create and pass along to its
interest holders.
d. The fixed-price purchase option effectively transfers substantially
all of the rewards from the underlying property (that is, increases
in value) to the lessee.
e. The VIE 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 from possible default by the
lessee with regard to minimum lease payments.
f. The VIE 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 AArated assets.
g. The role of the residual value guarantee and fixed-price purchase
option in the design of the VIE, regardless of their legal form or
accounting classification, dictates whether those interests should
be treated as creating risk for the VIE or absorbing risk from the
VIE. Therefore, price risk with respect to changes in fair value of
the underlying property is a relevant risk for the VIE, even though
the lessor VIE records a direct financing lease receivable, rather
than the property itself, on its balance sheet for accounting
purposes.
(continued)
to create and pass along risk (a) in the preceding paragraph to the
third-party guarantor and the lessee (with respect to the residual
value guarantee and fixed price purchase option) and risk in (b) in the
preceding paragraph to the note and equity holders, all of whom are the
VIEs variable interest holders.
Case H: VIE Holding Both a Fixed-Price Forward Contract to Buy and a
Fixed-Price Forward Contract to Sell Electricity
55-81. A financially distressed electricity producer wishes to monetize
some of its in-the-money forward positions. One such contract is a
physically settled forward contract to sell electricity to Party A at a fixed
price one year in the future. A VIE is created and financed with $100 of
1-year fixed-rate debt from investors for the purpose of monetizing the
value of the forward contract to sell for the electricity producer. The
VIE uses the proceeds from issuance to purchase the physically settled
forward contract to sell (from the VIEs perspective) electricity to Party
A at a fixed price one year in the future. This contract is in-the-money
by $100. After the electricity producer has received its $100, it has no
further involvement with the VIE. The VIE enters into a separate atmarket forward contract to buy (from the VIEs perspective) electricity at
a lower fixed price from Party B on the same future date. Both forward
contracts will be physically settled, and all other critical terms (except
the fixed settlement price) of the two forward contracts are the same.
Both forward contracts have rights senior to those of the investors and
are derivatives whose underlying is a market observable price. The VIE
is not actively managed. The debt was marketed to the investors as a
fixed-rate one-year investment with an enhanced yield due to risk of
possible default by either Party A or Party B with respect to their forward
contracts with the VIE. The following diagram illustrates this situation.
VARIABLE INTERESTS
$100
VIE
1-Year
Debt
Fixed Rate
Fixed Sales
Price
Electricity
Fixed
Purchase
Price
See Evaluation
Party B
See Evaluation
Party A
(continued)

a. Electricity price risk, which affects the fair values of the fixedprice forward purchase contract and the fixed-price forward sales
contract
b. Credit risk associated with possible default by the counterparty to
the forward purchase contract
c. Credit risk associated with possible default by the counterparty to
the forward sales contract.
interest holders:
a. The VIE was designed to hold offsetting positions with respect to
electricity price risk through a forward purchase contract and a
forward sales contract with terms that are the same (except for
fixed settlement price).
b. The debt was marketed to the investors as a fixed-rate oneyear investment with an enhanced yield due to risk of possible
default by either Party A or Party B with respect to their forward
contracts with the VIE.
c. To the extent electricity prices rise and the forward purchase
contract (with Party B) increases in value (from the VIEs
perspective), the debt investors will be exposed to credit risk to
the extent that Party B defaults on its obligation.
d. To the extent electricity prices drop and the forward sales
contract increases in value (from the VIEs perspective), the debt
investors will be exposed to credit risk to the extent that Party A
defaults on its obligation.
e. The forward to buy electricity at a fixed price is strongly indicated
as a creator of variability because its underlying is based on
observable market prices and it is senior in priority to the debt
holders.
f. The forward to sell electricity at a fixed price is strongly indicated
as a creator of variability because its underlying is based on
observable market prices and is senior in priority to the debt
holders.
g. Changes in fair value of each forward contract are expected to
offset all, or essentially all, of the risk and return related to the
other forward contract, so a further analysis of the design of
the VIE is necessary in order to conclude whether each forward
contract is a creator of variability or a variable interest.
(continued)
55-84. A further analysis of the design of the VIE is necessary to

conclude whether each fixed-price forward contract is a creator of
variability or a variable interest because changes in the fair value of
each contract are expected to offset all, or essentially all, of the risk and
return related to the other contract. That analysis should consider the
following factors:
a. The debt interests in this VIE were marketed on behalf of the
electricity producer as fixed-rate debt exposed to the credit risk
of the counterparties to the forward agreements.
b. The counterparties to the forward agreements did not participate
significantly in the design of the VIE.
55-85. In these circumstances, because they meet the characteristics
described in paragraph 810-10-25-35(a) through (b) and based on the
further analysis of the design of the VIE, the two forward contracts
are creators of the VIEs variability. Based on this analysis, it can be
determined that the VIE was designed to create and pass along the risks
in paragraph 810-10-55-82(a) through (c) to the debt investors, which are
the VIEs variable interest holders.
55-86. If, instead of executing the transaction described in this Case, the
electricity producer sold the fixed-price forward sales contract for $100
to an entity that physically owned a power plant and produced electricity,
an analysis of the design of that entity would be required, which would
involve developing a complete understanding of the purpose for which
that entity was created. In this case, the electricity producer also has
no further involvement with the entity after receiving its $100. Provided
the fixed-priced forward contract to sell is senior in priority to other
interest holders, that contract would be strongly indicated as a creator
of variability because its underlying is based on observable market
rates. In addition, changes in the cash flows or fair value of the fixedprice forward contract typically would not be expected to offset all,
or essentially all, of the risk or return (or both) related to the power
plant because the risk or return (or both) of the power plant would be
affected by factors other than changes in electricity prices (for example,
operating costs).
Appendix B:
Detailed Steps to Navigate through the VIE Model under
ASC 810
Detailed Steps to Navigate through the VIE Model under ASC 810 / B - 1
Appendix B: Detailed Steps to Navigate through the VIE Model under

ASC810

STEP 1: Determine if the VIE model applies to the reporting entity.

Step 1A: Is the counterparty a legal Entity? (VE 2.1)
Yes Proceed to Step 1B.
No Apply other appropriate GAAP.
Step 1B: Does the reporting entity have a variable interest in the entity? (VE 2.2)
Yes Proceed to Step 1C.
No Apply other appropriate GAAP.
Step 1C: Is a scope exception available? (VE 3)

Yes Apply other appropriate GAAP.
No Proceed to Step 2.
B - 2 / Detailed Steps to Navigate through the VIE Model under ASC 810
STEP 2: Determine if the entity is a VIE.
Step 2A: Consider the appropriate determination date and

the equity investment at risk. (VE 4.1)
Step 2B: Determine if the equity investment at risk has

any of the five characteristics of a VIE. (VE 4.2)
Characteristic 1: Is the equity investment at risk insufficient to
finance the activities of the entity? (VE 4.2.1)
Characteristic 2: Do the holders of the equity investment at
risk lack power to direct activities that most
significantly impact the entitys performance?
(VE 4.2.2)
Characteristic 3: Was the equity investment at risk of the entity
established with non-substantive voting
rights? (VE 4.2.3)
Characteristic 4: Do parties other than the holders of the
equity investment at risk have the obligation
to absorb expected losses? (VE 4.2.4)
See Step 5:
Determine if a
reconsideration
event has occurred
which could change
the status of a VIE
(VE 4.3) (see details
below); also,
consider disclosure
requirements. (VE 7)
Characteristic 5: Do parties other than the holders of the

equity investment at risk have the right to
receive the residual returns? (VE 4.2.5)
If the answer to all of the above questions is no,
the entity is not a VIE. Apply other appropriate GAAP.
If the answer to any of the questions is yes,
proceed to Step 3 to identify the primary beneficiary.
STEP 3: Determine which reporting entity is the primary beneficiary (i.e., which
reporting entity should consolidate the VIE).
Step 3A: Identify all other reporting entities that hold variable interests in the VIE.
(VE 1 and VE 5.1)
Step 3A1: Identify activities of the VIE that most significantly impact the VIEs
economic performance. (VE 5.1)
Step 3B: Identify all variable interests that are held by related parties and
de facto agents. (VE 1 and VE 5.1)
Step 3C: Determine if the reporting entity fulfills both of the

following criteria required to be a primary beneficiary. (VE 5.1)
Power Criterion: Does the reporting entity on its own (and if not on
its own, its related parties and de facto agents group) have the power
to direct the activities of the VIE that most significantly impact the
VIEs economic performance?
If the answer to the above question is no, the reporting entity
is not the primary beneficiary. Proceed to Step 4C.
If the answer to the above question is yes,
proceed to the question below.
Losses/Benefits Criterion: Does the reporting entity (and if not on

its own, its related parties and de facto agents group) have the
obligation to absorb losses of the entity 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?
If the answer to the above questions is yes, and no member
of the related parties and de facto agents group on its
own should consolidate, proceed to Step 3D.
Reassess the
primary
beneficiary
determination
on an ongoing
basis (VE 5);
also, consider
disclosure
requirements.
(VE 7)
If the answer to the above question is yes, and a member

of the related parties and de facto agents group on its
own should consolidate, proceed to Step 4A.
If the answer to the the question is no, the reporting
enterprise is not the primary beneficiary. Proceed to Step 4C.
Step 3D: Determine which member of the related party

group should consolidate the VIE.
Question: Is the reporting entity most closely associated with the VIE? (VE 5.1.4)
If the answer to the above question is yes, the reporting entity is the primary beneficiary;
proceed to Step 4A.
If the answer to the above question is no, the reporting entity is not the primary
beneficiary; proceed to Step 4C.
STEP 4: Consolidate and/or disclose the VIE.

Step 4A: Determine the initial measurement and accounting for the consolidation
of the entity.
Question: Is the reporting entity initially adopting FAS 167?
If the answer to the above question is yes, apply the transition guidance. (VE 8.1)
If the answer to the above question is no, apply the initial measurement
and consolidation requirements. (VE 6.1)
Step 4B: Perform accounting after the initial measurement. (VE 6.2)
Step 4C: Prepare appropriate disclosures. (VE 7)

Note that the VIE model introduces four key disclosure principles that apply to both the
primary beneficiary of a VIE as well as to any reporting entity involved with a VIE,
even if such reporting entity is not the primary beneficiary.
STEP 5: Determine if a reconsideration event has occurred which could change the
status of a VIE.
Question 1: Have the entitys governing documents or contractual arrangements
changed in a manner that changes either (1) the characteristics or (2) the adequacy
of the entitys equity investment at risk? (VE 4.3)
If the answer to the above question is yes, a reconsideration event has occurred.
If the event is significant, proceed to Step 2 to determine if the VIE status has changed.
If the answer to the above question is no, proceed to Question 2 below.
Question 2: Has (a) any part of the equity investment been returned to the equity
investors and (b) other interests become exposed to expected losses of the entity?
(VE 4.3)
Question 3: Has the entity undertaken additional activities or acquired additional assets,
beyond those that were anticipated at the latter of (a) the inception of the entity or
(b) the latest reconsideration event, that increase the entitys expected losses? (VE 4.3)
Question 4: Has the entity received an additional equity investment that is at risk or
has the entity curtailed or modified its activities in a way that decreases its expected
losses? (VE 4.3)
Question 5: Have there been 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 to direct the activities that most significantly impact the economic performance
of the VIE?
If the answer to the above question is no, a reconsideration event has not occurred.
The entity remains at its current status (i.e., voting interest entity or VIE).
Appendix C:
Technical References and Abbreviations
Technical References and Abbreviations / C - 1
Appendix C: Technical References and Abbreviations

The following table should be used as a reference for the abbreviations utilized
throughout the guide:
Abbreviation
Technical References
ASC 310
Accounting Standards Codification 310, Receivables
ASC 323
Accounting Standards Codification 323, InvestmentsEquity Method and

Joint Ventures
ASC 360
Accounting Standards Codification 360, Property, Plant, and Equipment
ASC 470
Accounting Standards Codification 470, Debt
ASC 480
Accounting Standards Codification 480, Distinguishing Liabilities from Equity
ASC 605
Accounting Standards Codification 605, Revenue Recognition
ASC 715
Accounting Standards Codification 715, CompensationRetirement Benefits
ASC 805
Accounting Standards Codification 805, Business Combinations
ASC 810
Accounting Standards Codification 810, Consolidation
ASC 815
Accounting Standards Codification 815, Derivatives and Hedging
ASC 820
Accounting Standards Codification 820, Fair Value Measurements and

Disclosures
ASC 825
Accounting Standards Codification 825, Financial Instruments
ASC 835
Accounting Standards Codification 835, Interest
ASC 840
Accounting Standards Codification 840, Leases
ASC 845
Accounting Standards Codification 845, Nonmonetary Transactions
ASC 860
Accounting Standards Codification 860, Transfers and Pricing
ASC 915
Accounting Standards Codification 915, Development Stage Enterprises
ASC 946
Accounting Standards Codification 946, Financial ServicesInvestment

Companies
ASC 952
Accounting Standards Codification 952, Franchisors
ASC 958
Accounting Standards Codification 958, Not-for-Profit Entities

Consolidation
ASC 960
Accounting Standards Codification 960, Plan AccountingDefined Benefit

Pension Plans
ASU 2009-17
Accounting Standards Update 2009-17, Consolidation (Topic 810)

Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities
ASU 2010-10
Accounting Standards Update 2010-10, Consolidation (Topic 810)

Amendments for Certain Investment Funds
CON 7
Statement of Financial Accounting Concepts No. 7, Using Cash Flow

Information and Present Value in Accounting Measurements
IFRS 10
Consolidated Financial Statements
EITF Issue No.

85-12 (ASC
810-10-25-15)
EITF Issue No. 85-12, Retention of Specialized Accounting for Investments in

Consolidation
(continued)
C - 2 / Technical References and Abbreviations
Abbreviation
Technical References
EITF Topic
D-74
EITF Topic D-74, Issues Concerning the Scope of the AICPA Guide on
Investment Companies
EITF Topic
D-98 (ASC
480-10)
EITF Topic D-98, Classification and Measurement of Redeemable Securities
FIN 46(R)
FASB Interpretation No. 46, Consolidation of Variable Interest

Entitiesan interpretation of ARB 51
FSP SOP 07-1
FASB Staff Position SOP 07-1, Effective Date of AICPA Statement of

Position07-1
SAB 103
SEC Staff Accounting Bulletin No. 103, Update of Codification of Staff

Accounting Bulletins
SOP 07-1
(ASC 946-10)
Statement of Position 07-1, Clarification of the Scope of the Audit and

Accounting Guide Audits of Investment Companies and Accounting
ParentCompanies and Equity Method Investors for Investments in
Investment Companies
Abbreviation
Other References
AcSEC
Accounting Standards Executive Committee
AICPA
American Institute of Certified Public Accountants
BCG
PwC Global Guide to Accounting for Business Combinations and

Noncontrolling Interests
DIG
Derivatives Implementation Group
EITF
FASB Emerging Issues Task Force
ESOP
Employee Stock Option Plan
FASB
Financial Accounting Standards Board
GP
General Partner
IASB
International Accounting Standards Board
IFRS
International Financial Reporting Standards
LLC
Limited Liability Company
LP
Limited Partner
NAV
Net Asset Value
NFP
Not-for-Profit
PB
Primary Beneficiary
PCAOB
Public Company Accounting Oversight Board
QSPE
Qualifying Special Purpose Entity
SAB
Staff Accounting Bulletin
SEC
Securities and Exchange Commission
SPE
Special Purpose Entity
VE
PwC Guide to Accounting for Variable Interest Entities
VIE
Variable Interest Entity
Technical References and Abbreviations / C - 3
Appendix D:
Summary of Changes from 2012 Edition
Summary of Changes from 2012 Edition / D - 1
Appendix D: Summary of Changes from 2012 Edition

The 2013 edition of the PricewaterhouseCoopers (PwC), Guide to Accounting for
Variable Interest Entities, has been updated as of May 15, 2013 to include additional
authoritative and interpretive guidance not included in the 2012 edition. This
appendix includes a summary of the noteworthy revisions to this guide.
Noteworthy Revisions
Executive Summary
On the HorizonThe FASB/IASB Joint Consolidation Project was updated to
reflect the expected date for the issuance of the final standard on consolidation to
the second half of 2013.
Chapter 2: Scope and Scope Exceptions
Executive Takeaway was updated to reflect the expected date for the issuance of
the final standard on consolidation to the second half of 2013.
Chapter 5: Identifying the Prime Beneficiary of a VIE
Section 5.1.1 was updated with language from the FASB Codification to clarify
how to consider situations where economics are heavily weighted to one party
and the impact that situation has on the power analysis.
Chapter 6: Initial Consolidation and Subsequent Accounting
Section 6.2.2 was updated to include an example on the elimination of
intercompany interest in a voting interest model.
Appendix B: Detailed Steps to Navigate through the VIE Model under ASC 810
Step One was reorganized to provide additional clarity into how to determine if the
VIE model applies to a reporting entity.
D - 2 / Summary of Changes from 2012 Edition
About PwC
PwC United States helps organizations and individuals create the value theyre
looking for. Were a member of the PwC network of firms in 158 countries with more
than 180,000 people. Were committed to delivering quality in assurance, tax and
advisory services. Tell us what matters to you and find out more by visiting us at
www.pwc.com/US.
How PwC Can Help
The VIE Model as amended by ASU 2009-17 represents a consolidation model that
is applicable to a wide array of entities. It is a principles-based standard that bases
consolidation of a variable interest entity on whether a party has both (i) the power
to direct activities that significantly impact the economic performance of the entity
and (ii) the exposure to losses or rights to receive benefits that could be potentially
significant to the entity.
Our consolidation consultants and Assurance professionals frequently advise
companies regarding the interpretation and application of the accounting rules under
the VIE Model as amended by ASU 2009-17 and related matters, including:
Determining whether an interest represents a variable interest;
Determining whether an entity is a variable interest entity;
Identifying the primary beneficiary;
Initial consolidation and subsequent accounting; and
Identifying appropriate disclosure items.
Our professionals bring value to businesses by understanding and resolving
their complex business issues. There will be many such issues related to the
implementation of the VIE Model as amended by ASU 2009-17.
If you have any questions or comments, please contact your PwC partner. In
addition, the following subject matter experts are available to discuss this subject:
David Lukach
Financial Instruments, Structured Products, and Real Estate (FSR) Partner
646.471.3150
[email protected]
Matt Sabatini
Capital Markets and Accounting Advisory Services (CMAAS) Partner
646.471.7450
[email protected]
Pamela Yanakopulos
Capital Markets and Accounting Advisory Services (CMAAS) Partner
312.298.3798
[email protected]

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Guide to Accounting for Variable

Portions of various FASB documents included in this work, copyright by Financial

Dear Clients and Friends:

Definition of Key Terms

Voting Interest Entity................................................................................................1-3

Variable Interest Entity.............................................................................................1-3

Subordinated Financial Support..............................................................................1-6

Expected Losses and Expected Residual Returns................................................1-6

Related Parties and De Facto Agents...................................................................1-10

Kick-Out Rights, Participating Rights and Protective Rights.............................1-15

Substantive Terms, Transactions, and Arrangements.........................................1-16

Scope and Scope Exceptions

Deferral of the 2009 Revisions to the VIE Model for Certain

Questions and Interpretive Responses................................................................2-24

Table of Contents / iii

The Concept of a Variable Interest..........................................................................3-3

The By Design Approach in Determining an Entitys Variability

Examples of Variable Interests..............................................................................3-11

Implied Variable Interests...................................................................................3-25

Variable Interests in Specified Assets..................................................................3-27

Silos: A VIE within a VIE.........................................................................................3-29

Questions and Interpretive Responses................................................................3-30

Determining Whether an Entity is a VIE

First Step: Identifying the Holders of the Equity Investment at Risk...................4-3

Equity Investments Issued in Exchange for Subordinated

Next Steps: Assessing the Five Characteristics of a VIE......................................4-9

Reconsideration Events: VIE Status......................................................................4-34

Questions and Interpretive Responses................................................................4-40

Identifying the Primary Beneficiary of a VIE

Identification of the Primary Beneficiary................................................................5-3

Questions and Interpretative Responses.............................................................5-26

Initial Consolidation and Subsequent Accounting

Initial Measurement and Consolidation..................................................................6-3

Accounting after Initial Measurement.....................................................................6-5

Questions and Interpretive Responses................................................................6-10

Presentation and Disclosure Requirements

Information-out Scope Exception........................................................................7-8

Item 2.01 Form 8-K and Rule 3-05 Reporting Requirements................................7-9

Questions and Interpretive Responses................................................................7-10

Transition upon Adoption and Effective Date

Transition upon Adoption of the VIE Model as Amended by ASU 2009-17.........8-3

Transitional Disclosure Requirements..................................................................8-12

Questions and Interpretive Responses................................................................8-13

FASB Examples of Applying the By Design Model............................................ A-1

Technical References and Abbreviations.............................................................. C-1

Summary of Changes.............................................................................................. D-1

Table of Contents / vii

Characteristic 5The entity was established with non-substantive voting

On the HorizonThe FASB / IASB Joint Consolidation Project

Shortlist of Potential VIEs:

Shortlist of Potential VIEs:

Shortlist of Potential VIEs:

Definition of Key Terms / 1 - 1

1 - 2 / Definition of Key Terms

Chapter 1: Definition of Key Terms

1.1 Voting Interest Entity

1.2 Variable Interest Entity

Definition of Key Terms / 1 - 3

1.3 Primary Beneficiary