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Variable interest entity (VIE) is a term used by the
Financial Accounting Standards Board The Financial Accounting Standards Board (FASB) is a private standard-setting body whose primary purpose is to establish and improve Generally Accepted Accounting Principles (GAAP) within the United States in the public's interest. The Securi ...
(FASB) to refer to a
legal entity In law Law is a system A system is a group of Interaction, interacting or interrelated elements that act according to a set of rules to form a unified whole. A system, surrounded and influenced by its environment, is described by ...
with certain characteristics such that a
public company A public company, publicly traded company, publicly held company, publicly listed company, or public limited company is a company whose ownership is organized via shares of share capital, stock which are intended to be freely traded on a stock ...
with a financial interest in the entity is subject to certain financial reporting requirements. VIEs rose to prominence after the
Enron scandal The Enron scandal was an accounting scandal Accounting scandals are business scandals which arise from intentional manipulation of financial statement Financial statements (or financial reports) are formal records of the financial activities ...
. Some Chinese companies, such as
Alibaba Ali Baba (character), Ali Baba is a character from the folk tale ''Ali Baba and the Forty Thieves''. Ali Baba may also refer to: Films * Ali Baba and the Forty Thieves (1902 film), ''Ali Baba and the Forty Thieves'' (1902 film), a French film di ...
, use VIEs to get access to foreign capital that would otherwise not be available due to
Chinese government The Government of the People's Republic of China () is collectively the state authority in the People's Republic of China China (), officially the People's Republic of China (PRC; ), is a country in East Asia East Asia is the e ...
regulations. The use of VIEs by Chinese businesses has received criticism for its lack of transparency.


Background

The FASB's
Accounting Standards Codification In US accounting practices, the Accounting Standards Codification is the current single source of United States Generally Accepted Accounting Principles (GAAP). It is maintained by the Financial Accounting Standards Board (FASB). FASB accounting s ...
(ASC) 810, ''Consolidation'', provides accounting guidance on when a reporting entity (e.g., a public company) should consolidate a legal entity as a
subsidiary A subsidiary, subsidiary company or daughter company is a company (law), company owned or controlled by another company, which is called the parent company or holding company. Two subsidiaries that belong to the same parent company are called sis ...
in the reporting entity's financial statements. If consolidated, the reporting entity will account for the subsidiary's
assets In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such ...
,
liabilities Liability may refer to: Law * Legal liability, in both civil and criminal law ** Public liability, part of the law of tort which focuses on civil wrongs ** Product liability, the area of law in which manufacturers, distributors, suppliers, reta ...
and any non-controlling interests of that legal entity in the reporting entity's consolidated financial statements. In order to determine whether a legal entity should be consolidated, the reporting entity must first assess whether the legal entity is a VIE. An entity that is not a variable interest entity is referred to as a voting interest entity. Under the voting interest entity model, a reporting entity with ownership of a majority of the voting interests of a legal entity will generally consolidate that legal entity. However, the VIE model was established for situations in which control may be demonstrated other than by the possession of voting rights in a legal entity. Accordingly, ASC 810 requires that all consolidation analysis first consider whether a legal entity is a VIE before applying the guidance for voting interest entities. VIEs came to prominence after
Enron Enron Corporation was an American energy In , energy is the that must be to a or to perform on the body, or to it. Energy is a ; the law of states that energy can be in form, but not created or destroyed. The unit of measuremen ...
made "creative" use of special-purpose entities to conceal widening losses from its investors at the beginning of the 2000s. For Chinese companies, VIEs have allowed them to get access to foreign capital that would otherwise not be available due to
Chinese government The Government of the People's Republic of China () is collectively the state authority in the People's Republic of China China (), officially the People's Republic of China (PRC; ), is a country in East Asia East Asia is the e ...
regulations against foreign ownership of certain assets and industries.


Characteristics

A VIE is a legal entity with any of the three criteria outlined in FASB ASC 810-10-15-14, as follows: * The entity does not have enough equity to finance its activities without additional subordinated financial support (e.g., the entity is thinly capitalized) * The equity holders, as a group, lack any one of the common characteristics of a controlling financial interest: ** The power to direct the economic activities of the entity through voting rights ** The obligation to absorb expected losses ** The claim on residual returns (also known as the "
residual claimantThe residual claimant refers to the economic agent who has the sole remaining claim on an organization's net cash flows, i.e. after the deduction of precedent agents' claims, and therefore also bears the residual risk. Residual risk is defined in thi ...
") * The entity is structured with non-substantive voting rights (commonly known as the "anti-abuse test")


VIE shares vs. traditional stock certificates

A share of stock, or a
stock certificate In corporate law Corporate law (also known as business law or enterprise law or sometimes company law) is the body of law Law is a system A system is a group of Interaction, interacting or interrelated elements that act accordin ...

stock certificate
, certifies ownership of a portion of a company. In other words, it provides proof of a legal
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