Project Updates

*Project Objective

The objective of this project is to reconsider the guidance in FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, for determining which enterprise with a variable interest in a variable interest entity (VIE), if any, shall consolidate the entity . The project will address the effect of the proposed elimination of the qualifying special-purpose entity (QSPE) concept as decided in another Board project, Transfer of Financial Assets, which seeks to amend certain aspects of the guidance in FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. The FIN 46(R) project also will address concerns raised about FIN 46(R) as a result of recent market events. Key areas that will be addressed include the guidance on reconsidering if an entity is a variable interest entity, reconsidering which enterprise, if any, consolidates the entity (the primary beneficiary) and the process for determining which enterprise, if any, is the primary beneficiary in a variable interest entity.

*Decisions Reached at Last Meeting

See minutes below.

*Summary of Decisions Reached to Date

The Board deliberated the staff’s recommendations to amend certain key provisions of Interpretation 46(R), primarily in response to the potential elimination of the (QSPE) concept in Statement 140, and in Interpretation 46(R), as well as the recent activities in the credit markets.

The Board supported requiring an enterprise (including its related party and de facto agents) to determine whether it is the enterprise that must consolidate a variable interest entity (the primary beneficiary) primarily through a thorough qualitative assessment. If an enterprise is unable to determine if a primary beneficiary exists (or does not exist) through the qualitative assessment, the enterprise would perform the current quantitative analysis described in Interpretation 46(R). (That is, it would determine the primary beneficiary based on which enterprise quantitatively absorbs the majority of the expected losses, receives the majority of the residual returns, or both).

The Board approved the addition of the “passive interest” concept. A passive interest in a variable interest entity has the following characteristics:

1. It has a maximum exposure that is capped (that is, it cannot exceed an amount determinable at the date of the enterprise’s involvement with the entity).

2. The enterprise (including related parties and de facto agents) with the interest has no involvement with the design or redesign of the variable interest entity.

3. The enterprise has no additional involvement with or interests in the variable interest entity.

4. The interest does not give the entity significant control rights (that is, guidance and factors are within the qualitative assessment guidance).

5. The interest is insignificant. (The Board agreed that the guidance for insignificant interests would be established by the staff at a later date).

The Board agreed that an enterprise with a passive interest would not be considered the primary beneficiary in any circumstance when the interest is passive.

The Board agreed to rescind the current guidance regarding reconsidering when an entity is a variable interest entity and which enterprise, if any, with a variable interest in a variable interest entity should consolidate the entity as provided in paragraphs 7 and 15, respectively, of Interpretation 46(R). The Board unanimously agreed that the reconsideration of the status of an entity and the primary beneficiary should be made during each reporting period using the amended guidance requiring that the primary assessment be based on a qualitative analysis.

The Board agreed to rescind the exemption of troubled debt restructurings from the reconsideration guidance in paragraphs 7 and 15 of Interpretation 46(R).

*Next Steps

In supporting the addition of and emphasis on a qualitative assessment, the Board requested that the staff establish an overall objective of the qualitative analysis and suggested developing criteria supporting that objective that can be easily understood and applied by constituents. The Board agreed that the criteria would not be considered all-inclusive and that constituents would have to apply professional judgment.

*Board/Other Public Meeting Dates

The Board meeting minutes are provided for the information and convenience of constituents who want to follow the Board’s deliberations. All of the conclusions reported are tentative and may be changed at future Board meetings. Decisions become final only after a formal written ballot to issue a final Statement, Interpretation, FSP, or Statement 133 Implementation Issue.

*Background Information

Interpretation 46 (R) clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. Paragraph 1 of ARB 51 states that consolidated financial statements are “usually necessary for a fair presentation when one of the companies in the group directly or indirectly has a controlling financial interest in the other companies.” Paragraph 2 states that “the usual condition for a controlling financial interest is ownership of a majority voting interest. . . .” However, application of the majority voting interest requirement in ARB 51 to certain types of entities may not identify the party with a controlling financial interest because the controlling financial interest may be achieved through arrangements that do not involve voting interests.

Once an entity is within the scope of the FIN 46(R) consolidation guidance, it is considered to be a variable interest entity. The Interpretation then requires enterprises holding variable interests (interests that absorb the variability of changes in the fair value of the VIE’s assets) to determine if they are required to consolidate the entity. The consolidator of a VIE is its primary beneficiary. That is, the primary beneficiary is currently the entity that quantitatively absorbs the majority of the variable interest entity’s expected losses, its residual returns, or both. It is possible that in certain scenarios (e.g., if risks are widely dispersed) a variable interest entity may not have a primary beneficiary and, thus, no enterprise consolidates the entity.

FIN 46(R) has come under scrutiny as a result of the substantial ongoing losses incurred by banks, investors, and other entities related to the subprime residential mortgage industry. This has resulted in an overall credit disruption in the markets. Constituents have voiced concerns over the lack of transparency (either through consolidation or disclosure) of the enterprises’ involvement with structures that contained significant risk; for example, they cite an inability to understand the nature of the enterprises’ involvement and maximum exposure, and an inability to assess the current status of their exposure. Major financial institutions have recognized billions of dollars in losses in late 2007 and in 2008 as a result of their involvement with the subprime residential mortgage lending industry.

Additionally, QSPEs permitted activities that are significantly limited, are predefined in the legal documents that created the entity, and only can be changed by a majority vote by its beneficial holders other than the transferor, its affiliates, and its agents. The consolidation of QSPEs will inherently pressure the FIN 46(R) model and may require massive consolidation of financial assets and liabilities.

*Contact Information