Definition
The term variable interest entity refers to a legal business structure that does not provide equity investors with voting rights, or structures involving equity investors that do not have sufficient resources to support the operation of the entity. If a business is the primary beneficiary of the variable interest entity, it must disclose the holdings of that entity as part of its consolidated balance sheet.
Explanation
Publicly-traded companies are required by federal securities laws to disclose certain operating and financial information on an ongoing basis. As part of its Form 10-K filing, companies must disclose its relationship to variable interest entities. The accounting rules that apply to these business structures are clarified by the Financial Accounting and Standards Board's FIN 46.
Also known as a VIE, a variable interest entity is a legal business structure (such as a corporation, partnership, or trust) that:
Does not provide equity investors with voting rights; or
The equity investors do not have sufficient financial resources to meet the ongoing operating needs of the business. This is referred to as a thinly capitalized structure.
Companies oftentimes establish VIEs to hold financial assets. This includes both passive entities as well as those involved in research and development activities. For example, a company may establish a VIE to finance a project without putting the enterprise at risk. Unfortunately, these structures can also be used to keep certain assets off their balance sheets too.
FASB's FIN 46, as well as the Form 10-K requirements under the jurisdiction of the Securities and Exchange Commission, set forth disclosure requirements companies must follow, specifically:
If the company is the primary beneficiary of the entity, then the holdings of that entity must be disclosed on the company's consolidated balance sheet. A company is considered the primary beneficiary of the entity if it has a majority interest in the VIE.
If a company is not the primary beneficiary of the entity, consolidation is not required. However, companies are required to disclose information concerning those entities in which it has significant interest. This disclosure will include contractual commitments, the operating nature of the entity, financial support, as well as the potential losses associated with the VIE.
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