Chapter 5 — Determining Whether a Legal Entity Is a VIE

5.1 Introduction

ASC 810-10

25-37 The initial determination of whether a legal entity is a VIE shall be made on the date at which a reporting entity becomes involved with the legal entity. For purposes of the Variable Interest Entities Subsections, involvement with a legal entity refers to ownership, contractual, or other pecuniary interests that may be determined to be variable interests. That determination shall be based on the circumstances on that date including future changes that are required in existing governing documents and existing contractual arrangements.

To determine which consolidation model a reporting entity should apply to evaluate its variable interest in a legal entity, the reporting entity must determine whether the legal entity is a VIE. This determination must be made upon a reporting entity’s initial involvement with a legal entity and reassessed upon the occurrence of a reconsideration event (see Chapter 9 for a discussion of VIE reconsideration events). If the legal entity is a VIE, a reporting entity with a variable interest (see Chapter 4) in that legal entity applies the VIE provisions of ASC 810-10 to determine whether it must consolidate the legal entity. If a legal entity is not a VIE, it is considered a voting interest entity, and a reporting entity applies the voting interest entity model to determine whether it must consolidate the legal entity (see Appendix D for a discussion of the voting interest entity model).

The consolidation conclusions under the VIE model can be different from those under the voting interest entity model. Because the differences between a VIE and a voting interest entity can be subtle, a reporting entity must have a complete understanding of all contractual arrangements (explicit and implicit) as well as the design and purpose of the legal entity.

Legal entities can differ in structure as well as legal form (e.g., corporations compared with limited partnerships and similar entities), which affects the method used to understand their design and purpose. In simple terms, the distinction is based on the nature and amount of the equity investment and the rights and obligations of the equity investors. If a legal entity has sufficient equity investment at risk to finance its operations, and those equity investors, through their equity investment at risk, make decisions that direct the significant activities of the legal entity, consolidation based on majority voting interest is generally appropriate. However, if equity is not sufficient, or the equity investors do not control the legal entity through their equity investment, the VIE model is used to identify the appropriate party, if any, to consolidate.

To qualify as a VIE, a legal entity needs to possess only one of the following characteristics (which are discussed in detail in the sections below):

The legal entity does not have sufficient equity investment at risk (Section 5.2).
The equity investors at risk, as a group, lack the characteristics of a controlling financial interest (Section 5.3).
The legal entity is structured with disproportionate voting rights, and substantially all of the activities are conducted on behalf of an investor with disproportionately few voting rights (Section 5.4).

5.1.1 Application of VIE Guidance to Multitiered Legal-Entity Structures

Section 3.2.2 describes the application of the VIE framework to multitiered legal-entity structures, noting that such an analysis begins at the bottom and proceeds to the top. Each entity within the structure should then be evaluated on a consolidated basis. The attributes and variable interests of the underlying consolidated entities generally should become those of the parent company upon consolidation. As a result of this framework, in certain structures, if a lower-tiered legal entity is a VIE and consolidated by another legal entity (its parent), the parent may be determined to be a VIE. For example, if the lower-tiered legal entity is a VIE because of insufficiency of equity investment at risk, when those attributes become those of the parent, the parent may also be determined to be a VIE depending on the design of the legal entity and whether the parent has other substantive activities or consolidated subsidiaries (see Examples 3-4 and 3-5 in Section 3.2.2).

5.1.2 Anticipating Changes in the Design of a Legal Entity

In general, the assumptions a reporting entity uses to determine whether a legal entity is a VIE are limited by the legal entity’s design as of the assessment date. In its evaluation, the reporting entity should not consider contractual changes to the legal entity’s design that are anticipated but not required. The governing documents and contractual arrangements establish a legal entity’s design and usually give insight into why the legal entity was formed and the primary activities it is expected to perform.

However, it would be appropriate to consider activities (and the potential funding sources of those activities) that are expected to be undertaken by the legal entity in its ordinary course of business as a result of its design. While a reporting entity must use judgment in determining whether an assumption is within the scope of the legal entity’s design, it would be appropriate to assume that the legal entity will enter into sales and purchase contracts as part of its ordinary course of business because its ability to enter into such contracts affects the variability in the designed operations.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.