When applying the VIE model, in addition to assessing all explicit, direct interests in an entity, a reporting entity should evaluate whether any “implicit” variable interests exist in the entity. Implicit variable interests sometimes, but not exclusively, manifest themselves in situations where two related parties are involved with an entity, but only one has a direct variable interest in the entity. If deemed to exist, an implicit variable interest is treated no differently than an explicit variable interest when applying the VIE model.
An implicit variable interest is described as an interest that absorbs or receives the variability of an entity indirectly, rather than through direct interests in the entity.

ASC 810-10-25-51

An implicit variable interest is an implied pecuniary interest in a VIE that changes with changes in the fair value of the VIE’s net assets exclusive of variable interests. Implicit variable interests may arise from transactions with related parties, as well as from transactions with unrelated parties.

ASC 810-10-25-52 elaborates on the concept of an implied variable interest.

ASC 810-10-25-52

The identification of explicit variable interests involves determining which contractual, ownership, or other pecuniary interests in a legal entity directly absorb or receive the variability of the legal entity. An implicit variable interest acts the same as an explicit variable interest except it involves the absorbing and (or) receiving of variability indirectly from the legal entity, rather than directly from the legal entity. Therefore, the identification of an implicit variable interest involves determining whether an entity may be indirectly absorbing or receiving the variability of the legal entity. The determination of whether an implicit variable interest exists is a matter of judgment that depends on the relevant facts and circumstances. For example, an implicit variable interest may exist if the reporting entity can be required to protect a variable interest holder in a legal entity from absorbing losses incurred by the legal entity.

In practice, the concept of an implied variable interest is generally used to describe two types of arrangements:
  1. Variable interests “around” an entity
  2. Noncontractual variable interests

Variable interests “around” an entity are often easier to identify as they arise from contractual relationships between parties involved with the entity being evaluated for consolidation. The following list of questions, which is not intended to be all-inclusive, may assist in identifying variable interests around an entity being evaluated for consolidation:
  • Was the arrangement entered into in contemplation of the entity’s formation?
  • Was the arrangement entered into contemporaneous with the entity’s issuance of a variable interest to another party?
  • Why was the arrangement entered into with a variable interest holder instead of with the entity?
  • Did the arrangement reference specified assets of the entity?

Noncontractual variable interests are more difficult to identify given the absence of explicit contractual relationships. Identifying implied variable interests stemming from noncontractual arrangements will depend on facts and circumstances and require the use of judgment. When performing this analysis, a reporting entity may find it useful to consider the impediments and incentives to why one entity would choose to protect another party involved with the entity being evaluated for consolidation from the entity’s expected variability.
The following table describes potential matters to consider when assessing one entity’s impediments and incentives to protect another party involved with an entity being evaluated for consolidation from its expected variability:
Impediments to protect
Incentives to protect
  • Does the reporting entity have the capacity to provide protection to the other party involved with the entity? If so, in what form and to what extent?
  • Is the reporting entity a related party, have other fiduciary responsibilities to the other party, or under common control with the other party?
  • Is the reporting entity subject to any debt covenants or similar contractual restrictions that would prevent it from protecting the other party involved with the entity?
  • How important is the arrangement to the reporting entity’s commercial success? Can the assets held by the entity being evaluated for consolidation be replicated, and/or can the reporting entity readily relocate the entity’s operations?
  • Are there regulatory or statutory provisions that could constrain or prevent the reporting entity from providing protection to the other party involved with the entity, and/or could any such action raise other legal concerns, such as potential conflicts of interests?
  • What are the consequences, if any, for the reporting entity in the event that the other party involved with the entity defaults on any of its obligations?
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