The primary beneficiary of a variable interest entity

In this lesson you will

Apply the power and the economics criteria in 810-10-25-38A
Evaluate shared power, kick-out rights and decision-maker fees
Apply the related party guidance when no single party is the primary beneficiary
Measure the assets and liabilities of a newly consolidated VIE

The two criteria

Under 810-10-25-38A, a reporting entity is the primary beneficiary of a VIE, and consolidates it, if it has both:

Power: the power to direct the activities of the VIE that most significantly affect the VIE's economic performance.
Economics: the obligation to absorb losses of the VIE, or the right to receive benefits from the VIE, that are potentially significant to the VIE.

Only one party, if any, can be the primary beneficiary. Many parties can meet the economics criterion, but only one can have the power.

Identifying the activities that matter

Start with the purpose and design of the entity: what risks it was created to create and pass along, and who was meant to absorb them. Then list the activities that drive performance, such as leasing a property, managing an asset portfolio, servicing loans, selecting and replacing tenants, or deciding when to sell. Rank them. Decisions made at formation that cannot be changed later, and protective rights, do not convey power.

Shared power and kick-out rights

If power is shared among unrelated parties and the decisions that most significantly affect performance require the consent of each of them, no party has the power, and there is no primary beneficiary (810-10-25-38D). If several unrelated parties each direct different activities, the one directing the most significant activities has the power.

Kick-out rights and participating rights held by a single party, including its related parties, can shift power. If one party can remove the decision maker without cause, that party, not the decision maker, has the power. Rights held by many unrelated parties that must act together do not shift power.

Decision-maker fees

ASU 2015-02 narrowed when a fee paid to a decision maker or service provider is a variable interest. A fee is not a variable interest if it is commensurate with the level of effort required and the arrangement includes only customary, arm's-length terms, provided the decision maker holds no other interest that would absorb more than an insignificant amount of the VIE's variability. A fee that is not a variable interest is also excluded from the economics criterion. ASU 2018-17 then said indirect interests held through related parties under common control are counted proportionally: a 20 percent stake in a related party that owns 40 percent of the VIE counts as an 8 percent direct interest.

Related parties

If no single party meets both criteria, but a reporting entity and its related parties together do, the related party guidance in 810-10-25-42 through 25-44B applies. When the decision maker and its related parties are under common control, the member of the group most closely associated with the VIE is the primary beneficiary. When they are not, a member is the primary beneficiary only if substantially all of the VIE's activities involve or are conducted on behalf of that member. The most closely associated test in 810-10-25-44 weighs any principal and agent relationship, the relationship with the VIE's principal activities, exposure to variability, the significance of the activities to each party, and the design of the entity.

Continuous reassessment

Whether a reporting entity is the primary beneficiary is reassessed on an ongoing basis. Whether a legal entity is a VIE is reconsidered only when specified events occur, such as a change in governing documents, a return of equity, additional equity at risk, or a troubled debt event.

Measuring a newly consolidated VIE

810-10-30 sets initial measurement for the primary beneficiary:

If the VIE and the primary beneficiary are under common control, the primary beneficiary uses the amounts at which the assets and liabilities are carried in the accounts of the reporting entity that controls the VIE (810-10-30-1).
If the VIE is a business, the primary beneficiary applies Topic 805, as the acquisition method lesson describes.
If the VIE is not a business, the primary beneficiary recognizes and measures the assets (except goodwill), liabilities and noncontrolling interests using the Topic 805 guidance, generally at fair value, except that assets and liabilities it transferred to the VIE keep their prior amounts. It recognizes no goodwill, and any difference is a gain or loss (810-10-30-3 and 30-4).

Disclosures

The primary beneficiary discloses the carrying amounts and classification of the VIE's assets and liabilities, any lack of recourse by creditors, and any support provided that it was not contractually required to provide. A variable interest holder that is not the primary beneficiary discloses its maximum exposure to loss and how it was determined.

Worked example

A solar project LLC with two investors and a lender

Sunridge Energy Project LLC owns a $20,000,000 solar facility. It is financed by a $15,000,000 senior bank loan, a $3,000,000 subordinated loan from Corvin Renewables, and $2,000,000 of member equity: Corvin holds 10 percent ($200,000) and a tax equity investor holds 90 percent ($1,800,000).

Is it a VIE? Equity is 2,000,000 / 20,000,000 = 10 percent, but the facility could not be financed without Corvin's subordinated loan, so the equity is insufficient. Also, the tax equity investor, which holds 90 percent of the equity, has no substantive kick-out or participating rights over Corvin as managing member. It is a VIE.

Power: the activities that most significantly affect performance are operations and maintenance, power sales contracting and dispatch. Corvin is the managing member and directs all three. The tax equity investor has protective rights only (approving a sale of the facility or new debt). Corvin has the power.

Economics: Corvin's exposure is its equity plus its subordinated loan: 200,000 + 3,000,000 = $3,200,000, out of total subordinated capital of 2,000,000 + 3,000,000 = $5,000,000, or 64 percent. That exposure is potentially significant to the VIE.

Conclusion: Corvin is the primary beneficiary and consolidates Sunridge. The tax equity investor's $1,800,000 interest appears as a noncontrolling interest in Corvin's statements. The tax equity investor meets the economics criterion but has no power, so it does not consolidate.

Self-check

Answer each question before you open the answer.

Can two parties both be the primary beneficiary of the same VIE?
Show answer
No. Only one party can have the power to direct the activities that most significantly affect performance, so at most one party is the primary beneficiary.
Two unrelated investors must both consent to every significant operating decision. Who consolidates?
Show answer
Neither. Power is shared, so under 810-10-25-38D there is no primary beneficiary. Each investor accounts for its interest under other guidance, such as the equity method.
A fund manager earns a market-rate fee and holds no other interest. Is the fee a variable interest?
Show answer
Not if the fee is commensurate with the services and includes only customary, arm’s-length terms, and the manager holds no other interest that absorbs more than an insignificant amount of variability.
How does a primary beneficiary measure a VIE that is not a business and is not under common control?
Show answer
Using the Topic 805 recognition and measurement guidance, generally fair value, with no goodwill. Any difference is recognized as a gain or loss, under 810-10-30-3 and 30-4.

Sources

Back to the syllabus

Standards are paraphrased from the primary sources listed above; read the source before relying on a requirement. This lesson is training material, not professional advice. Report an error