As a student of accounting, it is important to know when to consolidate entities, and it is also important to know the GAAP regulations on consolidation. If the voting interest does not apply (greater than 50% ownership) the risk-and-reward model is used to see if the company stands to gain in the economies of another company. If the answer is yes, then it needs to consolidate. This introduced the notion of a variable-interest-entity (VIE). Answer the following:
- What characteristics does an entity need to have to be classified as a VIE?
- If it meets the characteristics of a VIE, what is the next step to determine if it should consolidate this entity?
- Based on these characteristics, please discuss whether the companies in each one of the situations should consolidate or not:
- ABC company sells its notes to another entity, XYZ. The assets of XYZ are financed by lenders (90%) and investors (10%).
- If ABC does not guarantee the debt of XYZ, should it consolidate XYZ’s financial statements or not?
Grandeur, a utility company, has a contract to purchase all of the power generated by the local companies over its lifetime.
- Based on the characteristics of VIE discussed above, should these entities be classified as VIE?
- Why or why not?
- How will this affect their decision to consolidate?
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