How and why were SPEs changed by FASB Interpretation No. 46 and Interpretation 46R?

Question

What will be an ideal response?

Answer 1

ANSWER:
As a result of the abuse of SPEs by firms such as Enron, which had as many as 3500 SPEs, FASB addressed their use in Interpretation 46. FASB changed the name to variable interest entity (VIEs) and broadened the requirements for consolidation. The minimum equity interest by an outside investor to avoid consolidation was raised to 10%. However, consolidation can still be avoided if the equity investment in the VIE is sufficient to cover estimated losses.

An enterprise must consolidate a VIE if it would “receive a majority of the VIE’s losses if they occur, receive a majority of the entity’s expected residual returns if they occur, or both.” A direct or an indirect ability to make major decisions for the variable interest entity is a good determinant for whether an enterprise is expected to absorb losses or receive residual gains.

As a result of Interpretation 46R, consolidation must occur if equity investors:
1. do not participate in decision making by means of voting their stock;
2. do not share in returns generated by the entity;
3. do not absorb any of the VIE’s losses;
4. do not share in the expected residual returns of the VIE.