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3.7 Variable interests in specified assets
Publication date: 31 May 2024
us Consolidation guide
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.
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
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.
3.7.1 How variable interests in specified assets affect expected losses
Whether a variable interest in specified assets is considered an interest in the entity that owns those assets or, instead, an interest in only those assets, can have repercussions on the consolidation analysis for the entity in question.
Expected losses related to variable interests in specified assets are not considered part of the expected losses of the legal entity for purposes of determining the adequacy of the equity at risk in the legal entity or for identifying the primary beneficiary unless the specified assets constitute a majority of the assets of the legal entity. For example, expected losses absorbed by a guarantor of the residual value of underlying asset are not considered expected losses of a VIE if the fair value of the underlying asset is not a majority of the fair value of the VIE’s total assets.
If a variable interest is determined to be a variable interest in specified assets and not a variable interest in the entity as a whole, the expected losses and expected residual returns related to those specified assets that are absorbed by such interests should be excluded from the calculation of the entity’s expected losses and expected residual returns. As a consequence, the entity’s expected losses and expected residual returns are calculated net of the effects of any variable interests in specified assets that are not variable interests in the entity as a whole.
If an interest in specified assets of an entity is a variable interest in the entity as a whole, the losses related to those specified assets intended to be absorbed by the variable interest are included in the determination of the entity’s expected losses for the purposes of determining whether the entity is a VIE (refer to CG 4.3 for information on assessing the sufficiency of an entity’s equity investment). Said differently, the measurement of the entity’s expected losses and expected residual returns are grossed up to the amounts that they would be absent the effects of the variable interest.
For example, if the guarantee in Example CG 3-11 only provided protection up to the first $100,000 of losses on the equipment, expected losses of the entity would exclude the first $100,000 of losses in the value of the equipment, but include the amount in excess of $100,000 (i.e., losses not absorbed by the guarantee).
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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