E3.8 Identifying and Analyzing Variable Interest Entities
a. The equity interests are traditional variable interests. However, because minority shareholder C guarantees 92% of A’s debt, which is most of A’s capital, and will absorb 92% of A’s expected losses by protecting the subordinated debtholders, A is a VIE. C has decision-making power through its majority representation on the board. C has the obligation to absorb A’s significant losses and benefits through its equity interest and guarantee of A’s bank loans, and will likely be designated as A’s primary beneficiary. One could also note that because A’s equity is less than 10% of its total assets (.08 = 1 - .92) a presumption exists that A is a VIE.
b. Without any other information, B is not a VIE. D is the sole owner of B through its 100% equity ownership, and should consolidate B under ASC Topic 810. Although contractual and other arrangements could suggest that B is a VIE, the problem is silent on these matters.
c. The 15% equity could be enough to avoid identifying A as a VIE, if that amount of equity is deemed adequate to absorb A’s expected losses. In that case, E is the controlling investor and C does not consolidate A.
If the 15% equity is not adequate, A is a VIE. C has the decision making power, and by agreeing to compensate E for any of A’s losses, C absorbs significant losses. Therefore C is likely A’s primary beneficiary and should consolidate A.
If A reports income that exceeds 10% of its average equity, the excess is distributed to C. A’s shareholders could view this as a kind of insurance payment for being protected from losses, and would report it as an expense. Suppose A earns $18 on average equity of $100. Of this, $8 (= $18 – 10% x $100) is C=s share, accounted for as follows:
Dr. Expense 8
Cr. Payable to C 8
A therefore reports final net income of $10 (= $18 - $8).
d. B’s stockholders’ equity is only 10% of its total assets, and is insulated from losses by the guarantees provided by C and D. Moreover, D’s unsecured loan to B provides additional subordinated financial support. These factors indicate that B is a VIE. D has decision making power through its control of B’s board. Losses in guaranteed residual values on D’s specialized property, and its unsecured loan to B, require D to absorb a potentially significant amount of B’s losses. Therefore it is likely that D is B’s primary beneficiary and must consolidate B.
E3.11 Acquisition and Eliminating Entries: Statutory Merger and Stock Investment a. Coca-Cola took control of CCE’s North American business in October, 2010. The investment is recorded at fair value at the time control changes hands. Coca-Cola “paid” cash, equity-based compensation, and the 33 percent equity interest for all of CCE’s North American business. Previously, Coca-Cola used the
