Variable Interest Entities (VIEs) and Special Purpose Entities (SPEs)

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  • A company may elect to create (or sponsor) a VIE or SPE as a separate business entity, in order to isolate assets and liabilities for structured finance purposes.
  • Example: a company may create an SPE for the sole purposes of securitizing the receivables of the primary business unit.
  • Following a wave of accounting scandals in the early 2000s, U.S. accounting rules were changed to require that the financial statements of VIEs be consolidated on the sponsoring company’s financial statements when the sponsor is in position to incur most of the VIE’s losses or retain most of the VIE’s returns.  The sponsor is the primary beneficiary of the VIE.
  • It is common for VIEs/SPEs to hold financial assets, loans, trade receivables, real estate, and/or other property.
  • One potential benefit of creating a VIE is that it can lower the sponsor’s financing costs for a specific business venture.
  • A sponsor’s control over VIE cannot necessary be measured by voting stock.  The interest is variable because the VIE will incur a portion of the losses or retain a portion of the gains.
  • Examples of variable interests include: sponsor guarantee’s on VIE assets, credit enhancements, or lease arrangements.
  • If one of the following conditions is met, then an entity qualifies as a VIE and its financial statements must be consolidated with the sponsor’s financial statements.
  1. If the total equity investment in the entity at risk is not large enough to absorb its potential losses, then the entity is a VIE.  The standard level is 10%, that is, if the equity investment at risk is less than 10% of the entity’s assets, then the entity is a VIE.
  2. If the equity investors in the entity do not possess any one of the following characteristics of a controlling financial interest:
  • Investors cannot control the entity’s affairs through share voting.

  • Investors are not responsible to absorb losses from the entity, if they occur.

  • Expected entity returns are capped for equity investors.

  • If one of the conditions is met, then the entity qualifies as a VIE and must be consolidated onto the sponsoring company’s financial statements.  The consolidating company is called the primary beneficiary of the VIE.

  • The primary beneficiary may own no voting shares in the VIE, but it retains control over the VIE through other means.  The equity investors in the VIE commonly exchange their right to greater returns for a guaranteed rate of return.

  • Under U.S. GAAP, certain SPEs may qualify for exemption of the consolidation requirement if certain conditions are met.  These are called qualifying SPEs (QSPEs).  QSPEs are not permitted under IFRS.

01
CFA Level 2: Financial Reporting Part 2 – Introduction
02
Intercorporate Investments Accounting - Ownership Categories
03
Minority Passive Investments – Accounting Classes
04
Minority Active Investments and the Equity Method for Financial Reporting
05
Joint Venture Investments
06
Controlling Interest Investments: Accounting for Business Combinations
07
Purchase Method of Accounting for Controlling Interest Investments or Acquisitions
08
Pooling of Interests Method to Account for Controlling Interest Investments
09
Purchase Method vs. Pooling of Interest Method
10
Acquisition Method to Account for Controlling Interest Investments
11
GAAP Purchase Method, IFRS Purchase Method, and GAAP Acquisition Method Accounting
12
Variable Interest Entities (VIEs) and Special Purpose Entities (SPEs)
13
Defined Benefits Plans vs. Defined Contribution Plans
14
Measuring the Defined Benefit Obligation
15
Pension Expense (both GAAP & IFRS) for the Income Statement
16
Defined Benefit Plans & the Company Balance Sheet
17
The Role of Actuarial Assumptions in DB Plan Accounting
18
Economic Pension Expense
19
Pensions and the Statement of Cash Flows
20
Accounting for Stock (or Share) Based Compensation
21
Financial Statement Consolidation of Multinational Operations
22
Consolidation: Presentation Currency vs. Functional Currency vs. Local Currency
23
Foreign Currency Translation
24
Temporal Method for Translation of Foreign Statements
25
Current Rate Method for Translation of Foreign Statements
26
Consolidating Financial Statements: Determining the Functional Currency
27
Translation Methods and Financial Statement Effects
28
Accounting for Subsidiaries in Hyperinflationary Economies
29
CFA Level 2: Financial Reporting 2 - Recommendations
30
MBS Weighted Average Life