ASC 810-10-25-55 through
ASC 810-10-25-58 clarify under what circumstances a reporting entity should be considered to hold a variable interest in specified assets of an entity–rather than in the entity itself.
ASC 810-10-25-55
A variable interest in specified assets of a VIE (such as a guarantee or subordinated residual interest) shall be deemed to be a variable interest in the VIE only if the fair value of the specified assets is more than half of the total fair value of the VIE’s assets or if the holder has another variable interest in the VIE as a whole (except interests that are insignificant or have little or no variability). This exception is necessary to prevent a reporting entity that would otherwise be the primary beneficiary of a VIE from circumventing the requirement for consolidation simply by arranging for other parties with interests in certain assets to hold small or inconsequential interests in the VIE as a whole. The expected losses and expected residual returns applicable to variable interests in specified assets of a VIE shall be deemed to be expected losses and expected residual returns of the VIE only if that variable interest is deemed to be a variable interest in the VIE.
If a reporting entity has a variable interest in an asset, both of the following conditions must exist for a reporting entity to conclude that its variable interest is not in the entity as a whole:
- The variable interest relates to specified assets that comprise less than a majority of the total value of the entity’s assets (on a fair-value basis)
- The reporting entity does not have another variable interest in the entity as a whole (except interests that are insignificant or have little or no variability)
We believe that this guidance applies only to variable interests in specified assets, and not specified liabilities. In contrast, a guarantee on the repayment of debt that is dependent on the general credit of the entity, regardless of how much debt the guarantee relates to, is a variable interest in the entity.
Example CG 3-11 illustrates the application of the variable interest in specified assets concept.
EXAMPLE CG 3-11
Assessing variable interests in specified assets
Assume that an entity owns two assets: a building worth $5.2 million and equipment worth $4.8 million. The building is leased to Reporting Entity A under a long-term lease, and Reporting Entity A provides a residual value guarantee that the building will be worth at least $4 million at the end of the lease’s term. The equipment is leased to Reporting Entity B under a long-term lease, and Reporting Entity B provides a residual value guarantee that the equipment will be worth at least $3 million at the end of the lease’s term. Neither Reporting Entity A nor Reporting Entity B has other interests in the entity as a whole.
Does either Reporting Entity A or Reporting Entity B have a variable interest in the entity?
Analysis
Evaluation of residual value guarantee provided by reporting Entity A: The residual value guarantee provided by Reporting Entity A is a variable interest in the entity since the guarantee absorbs changes in the fair value of an asset that represents more than 50% of the total fair value of the entity’s assets (the fair value of the building is 57% of the total fair value of assets).
Evaluation of residual value guarantee provided by reporting Entity B: The residual value guarantee provided by Reporting Entity B is not a variable interest in the entity since it protects the value of an asset that represents less than 50% of the total fair value of the entity’s assets (the fair value of the asset is only 43% of the total assets). Since the residual value guarantee is not a variable interest, it is viewed as a creator rather than an absorber of variability. This is due to the fact that the residual value creates a floor for the fair value of the protected asset.
The determination of whether a variable interest is held in an entity or in a specified asset of the entity is based solely on the fair value of the asset relative to the fair value of the entity’s total assets, and not the level of protection provided to the asset or rights to upside on the asset. The reporting entity’s actual obligation related to the specified assets does not influence the evaluation. For example, a guarantee related to assets that represent 90% of the entity’s assets (on a fair value basis) may be limited to 10% of the total loss in value of those assets. Although limited, that guarantee would constitute a variable interest in the entire entity.