VIE's - Agenda

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VIE's - Agenda Powered By Docstoc
					     Jacob Myers
Deloitte & Touche, LLP
• Introduction
• Background - FIN 46(R), FAS 140, FAS 167
• Comparisons to newly issued FAS 167
• Research tools
• Case study
• Audit issues
• Questions & Comments
• 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
      Why Consolidation Guidance
• Add transparency and consistency to the financial
  – 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
                            FIN 46(R)
• Variable Interest Entities – 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
• 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
– 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
      – 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
– 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
                       FAS 140
• Transfers of financial assets
   – Mortgage loans, accounts receivable, credit card
• 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
           Potential Primary Beneficiary                                  Potential VIEs

                                           Guarantees Debt

                                                                                            Max Return 6% 95% Debt owed by
                                                                                                         JP Morgan
                                           Leases Data Center
                                                                     ABC Data Center, LLC
                                                                                                         5% Equity

 Unrelated                                             Investment                                        70% Equity
Shareholders               Facebook                       of 1%
  & Debt                                               Outstanding      Shares of Intel
                                                                                                         30% Debt

                                                                                                         95% of Debt owed
                                                                                                         by Goldman Sachs
                                           Leases Office Space
                                                                      XYZ Office Leasing
                                                                                                         5% Equity Non
                                                                                                         Voting Metlife
                        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
FIN 46(R)                             FAS 167
1. QSPE’s are generally exempt        1. Transferors, sponsors, and
                                          investors in QSPE’s need to
                                          consider consolidation and
2. Primary Beneficiary-               2. Primary Beneficiary-
   Quantitative Reasoning:               Qualitative Reasoning:
   –   Based on Risks and Rewards         – Power and economics model
                                          – Power to direct activities
                                          – Obligation to absorb losses
3. Shared Power:                      3. Shared Power:
   –   Focus is on absorbing              – Power to direct activities
       expected losses or receiving       – Do decisions require the
       expected returns                     consent of both parties
FIN 46(R)                            FAS 167
4. Reconsideration of                4. Reconsideration of
   Primary Beneficiary:                 Primary Beneficiary
   –   Changes in contractual           –   Continuous reconsideration
   –   Addition or disposal of

5. Reconsideration of VIE:           5. Reconsideration of VIE:
   –   Interest holders reconsider
                                        – An additional event requires
       whether entity is a VIE if
       certain events occur               reconsideration
FIN 46(R)                          FAS 167
6. Presentation Requirements:      6. Presentation Requirements:
   – Not required to present          – Must present separately on
     consolidated VIE separately        the face of Balance Sheet the:
     on Balance Sheet                     • Assets used to settle
                                          • Liabilities for which creditors
                                            do not have recourse against
                                            primary beneficiary
 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
• If Shared Power between multiple parties
   – Disclose Significant Factors and Judgments made in
               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
                        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.
• 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?
• 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
• 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
   – 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.
• 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
  – 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
                     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
Questions or Comments?

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