1. Jacob Myers Deloitte & Touche, LLP
Accounting for Variable Interest Entities
Jacob Myers
Deloitte & Touche, LLP

2. Agenda Introduction Background - FIN 46(R), FAS 140, FAS 167
Comparisons to newly issued FAS 167 guidance
Research tools
Case study
Audit issues
Questions & Comments

3. Introduction Jacob Myers Deloitte Senior Manager – Assurance Services
Service clients in various industries
Financial Services, Software, Agriculture
St. Louis University
Majors - Accounting and Finance
Other organizations
St. Louis Variety Club – Finance Committee
St. Louis University Business School Alumni Board

4. Why Consolidation Guidance
Add transparency and consistency to the financial statements
Many firms were avoiding reporting debt and losses from special purpose entity (SPE) deals
Enron
Recent credit crisis
Impact of consolidation in marketplace
Financial ratios
Loan covenants
Regulatory capital
Cost to implement guidance, processes

5. FIN 46(R) Variable Interest Entities – VIEs Form & Purpose of VIEs
Special Purpose Entities – SPEs, off balance sheet
Form & Purpose of VIEs
Trust, Partnership, joint ventures, or Corporation
Facilitate transactions – Transfer of Assets, leasing, hedging, R&D
Low-cost financing structure
Characteristics of VIEs
Activities are limited
Equity investor role minor – less than 10%
Sponsoring firm’s involvement
Guarantees
Contribution of Capital
Risks and rewards

6. FIN46(R) Consolidation of VIEs Prior GAAP - ARB 51
Consolidated based on voting rights
Identifying if a VIE exists
Equity at risk not sufficient to permit the potential VIE to finance its activities
Equity investors lack one of the following:
Direct or indirect ability to make decisions about entity through voting or similar rights
An obligation to absorb the expected losses of the entity
Rights to receive the expected residual returns of the entity

7. FIN46(R) Identification of the Primary Beneficiary of the VIE
Requires the primary beneficiary to consolidate
Characteristics include (mirror equity investors in a VIE):
The direct or indirect ability to make decisions about the VIEs activities
The obligation to absorb the entity’s expected losses
The right to receive the entity’s expected residual returns
Assessment of control
Entity that bears the majority of the risk

8. FIN46(R) Disclosure Requirements For Primary Beneficiaries
VIE’s nature, purpose, size and activities
Carrying amount and classification of consolidated assets
Lack of Recourse (if any)
Significant Variable Interest (Not Primary Beneficiary)
Nature of involvement with VIE
Nature, purpose and size of VIE
Exposure to losses

9. FAS 140 Transfers of financial assets
Mortgage loans, accounts receivable, credit card receivables
Qualifying Special-Purpose Entities - QSPE’s
Indicated that financial assets transferred to a QSPE are typically derecognized by the transferor
Legal isolation concept
Permits derecognition of a portion or a component of a financial asset
Relates to FIN 46(R) because QSPE’s are exempt from consolidation requirements

10. Potential Primary Beneficiary
Potential VIEs
Guarantees Debt
ABC Data Center, LLC
Max Return 6%
95% Debt owed by JP Morgan
Leases Data Center
5% Equity Microsoft
Unrelated Shareholders & Debt holders
Facebook
Shares of Intel
70% Equity
Investment of 1% Outstanding
30% Debt
XYZ Office Leasing
95% of Debt owed by Goldman Sachs
Leases Office Space
5% Equity Non Voting Metlife

11. FAS 167 Recently issued guidance for consolidations Why FAS 167
Needed to expand disclosure requirements of FIN 46R and address elimination of QSPEs
Broader Scope:
Includes Entities covered under FIN46R and QSPE’s
FAS 166 eliminated the concept of a QSPE
Amends derecognition guidance in FAS 140
Expands the Consolidation and Disclosure Requirements associated with VIE’s

12. Comparison FIN 46(R) FAS 167 QSPE’s are generally exempt
Primary Beneficiary- Quantitative Reasoning:
Based on Risks and Rewards
3. Shared Power:
Focus is on absorbing expected losses or receiving expected returns
1. Transferors, sponsors, and investors in QSPE’s need to consider consolidation and disclosure
2. Primary Beneficiary- Qualitative Reasoning:
Power and economics model
Power to direct activities
Obligation to absorb losses
3. Shared Power:
Do decisions require the consent of both parties

13. Comparison
FIN 46(R)
FAS 167
4. Reconsideration of Primary Beneficiary:
Changes in contractual agreement
Addition or disposal of interest
5. Reconsideration of VIE:
Interest holders reconsider whether entity is a VIE if certain events occur
4. Reconsideration of Primary Beneficiary
Continuous reconsideration
5. Reconsideration of VIE:
An additional event requires reconsideration

14. Comparison FIN 46(R) FAS 167 6. Presentation Requirements:
Not required to present consolidated VIE separately on Balance Sheet
6. Presentation Requirements:
Must present separately on the face of Balance Sheet the:
Assets used to settle obligations
Liabilities for which creditors do not have recourse against primary beneficiary

15. FAS 167 Disclosure Requirements
Financial preparers must disclose method for determining whether they are the primary beneficiary of a VIE
Disclose significant judgments and assumptions made
Must disclose the details of any financial or other support provided to a VIE
Disclose reasons for providing the support
Disclose all terms of arrangements and agreements with VIE
If Shared Power between multiple parties
Disclose Significant Factors and Judgments made in determination

16. Research Tools Orginal FASB pronouncements
Third party service providers
Lawyers, accountants, etc.
Online research tools
Other company disclosures
Other publications
AICPA, SEC, public accounting firms, state societies

17. Case Study
XYZ Oil is an established oil drilling company that wants to expand its operations to offshore drilling platforms in the Gulf of Mexico. XYZ determines that it can obtain the $350 million needed to lease the platform by issuing debt at an annual interest rate of 5%. Instead of leasing the platform itself, XYZ decides to establish a separate legal entity, Saltwater Drilling Co., to lease the drilling platform. In doing so it can obtain the $350 million needed at an annual rate of 4%. An outside investor contributes $30 million for 100% of the nonvoting shares in Saltwater Drilling Co. The remaining $320 million is raised through a debt offering, of which XYZ is the guarantor. XYZ must also pay the investor for any losses incurred if the asset is sold at the end of the lease term.

18. Questions
Would Saltwater Drilling Co. qualify as a VIE under FIN 46? Under FAS 167?
Could Saltwater Drilling have obtained financing without XYZ guaranteeing the debt?
Does the equity investor have the ability to make decisions about the entities’ activities?
Does the equity investor bear the risk of loss?
Does the equity investor receive the expected residual returns?
Would XYZ qualify as a primary beneficiary?
Does XYZ have the power to direct the activities of Saltwater?
Does it bear the risk of loss or have the right to receive benefits?
Would it qualify as a primary beneficiary under FIN 46? FAS 167?

19. Questions
What documents would you need to examine to determine that Saltwater is a VIE with XYZ as its primary beneficiary?
Should Saltwater be consolidated into XYZ?
How should this be presented on the Financial Statements?

20. Answers
Would Saltwater Drilling Co. qualify as a VIE under FIN 46(R)? Under FAS 167?
The answer is probably ‘Yes’ under both. The equity investor has an insignificant (less than 10% ownership) and the entity probably couldn’t finance the operations without XYZ’s support.
The investor also bears little risk as they are guaranteed their money back if the asset is sold at a loss at the end of the lease.
Would XYZ Qualify as a Primary Beneficiary?
Probably ‘Yes’ under both FIN 46(R) and FAS 167
The investor doesn’t appear to bear much risk and since they own non-voting stock their influence may not be significant.
XYZ appears to bear the risk of loss since they are guaranteeing the debt.
Examination of the agreements would be needed to see who has the power to direct activities and the obligation to absorb losses and receive benefits.

21. Answers So, should Saltwater Drilling Co. be consolidated into XYZ?
If it is determined that Saltwater Drilling Co. is both a VIE and XYZ Oil is its primary beneficiary then it should be consolidated into the Financial Statements
Under FAS 167, certain assets and liabilities would be required to be presented separately on the face of the financial statements and additional disclosures would be required

22. Audit Issues Audit evidence
Company’s accounting memo
Entity documents
By laws
Security holder agreements
Legal Opinions
Consideration of an effective control environment
Timing of closing process for the SPE
Use of specialist/expert
International coordination
Language barriers and translation issues
Legal environment

23. Questions or Comments? jacmyers@deloitte.com