• Explanation

A variable interest entity A business structure where one entity can have a controlling financial interest in another entity without owning any of its equity. (VIE) exists when an investor has a controlling financial interestA situation in which one entity obtains a majority (ie, greater than 50%) of another entity's voting equity. in another entity, but the amount of control in the VIE is disproportionate to its ownership. A VIE is formed as a separate legal entity for the purpose of holding assets or incurring liabilities and is used to protect the business from creditors and legal action. Enron used VIEs to avoid reporting impairment losses by selling the impaired assets to VIEs at full value.

Typical characteristics of VIEs include the following:

• VIEs are not self-sufficient.
• Investors do not participate in a VIE's gains and losses.
• A VIE's value is affected by another entity's value.

A VIE's primary beneficiary An entity that has first right to receive the benefits or the responsibility to bear the losses of another entity. has the power and authority to direct the VIE's operations and to participate in its gains and losses to a significant extent. The primary beneficiary is required to prepare consolidated financial statements The financial statements of a consolidated group of entities, including a parent and all its subsidiaries, presented as those of a single economic entity. with the VIE, even if it does not meet the 50% threshold for consolidation (Choice B).

When a holder of a VIE purchases additional variable interests, the holder should evaluate whether its interest has increased to the point of having a controlling interest, therefore becoming the VIE's primary beneficiary (Choices C and D).

Things to remember:
A variable interest entity (VIE) exists when an investor has a controlling interest in another entity, but the amount of control in the VIE is disproportionate to its ownership. The entity with a controlling interest in the VIE is the primary beneficiary and is required to prepare consolidated financial statements with the VIE, even if it does meet the 50% ownership threshold for consolidation.

• FAR 22.07 : Business Combinations & Consolidations: Intercompany Transactions