February 17 Discussion Question
Christopher Suto 1. What is a VIE?
An entity (investee) in which the investor has obtained less than a majority-owned interest, according to the United States Financial Accounting Standards Board. A VIE refers to an entity (the investee) in which the investor holds a controlling interest that is not based on the majority of voting rights. As long as the investee is not the primary beneficiary then they do have to consolidate the company on their balance sheet. 2. How did we determine whether an entity need to be consolidated before FIN 45?
Before FIN 45, “Many financial institutions were secondarily liable (without adequate disclosures) for many financial instruments held in special purpose entities” (Reinstein, 2012). The old consolidation framework used a common-sense approach, where a company should consolidate operations when they had a controlling ownership interest in another. Controlling abilities were tough to recognize and led to many unconsolidated statements. a. Explain how FIN 46 modified the guidance on VIEs.
Originally FIN 46 focused only on special purpose entities and required a reporting enterprise to consolidate them. Soon FASB changed it where FIN 46 should apply to all entities where a VIE exists. Part of this decision involves more judgment now according to sec.gov. There is no bright line test and all facts and circumstances, qualitative and quantitative, should be considered. b. Explain how SFAS 167 has modified the guidance on VIEs.
Under GAAP, a company must consolidate any entity in which it has a “controlling interest.” This term was long defined as ownership of more than 50% of the entity’s voting interests. SFAS makes two critical changes: It defines when a company (sponsor or creator of a variable interest entity) should base “controlling financial interest” on factors other than voting rights, and it applies a new “risk and rewards” model in these situations. First, they should not be self-supportive. Second, the entities must have variable interests in the VIE (e.g., provide it with financial support). The third and final requirement is that the entity must be the VIE’s primary beneficiary (e.g., one absorbing more than half of expected losses or receiving more than half of expected residual returns). 3. What factors are to be considered in determining VIE status? * The entity has demonstrated that it can finance its activities without additional subordinated financial support; * The entity has at least as much equity invested as other entities that hold only similar assets of similar quality in similar amounts and operate with no additional subordinated financial support; or * The amount of equity invested in the entity exceeds the estimate of the entity’s expected losses, based on reasonable quantitative evidence. 4. Why might some companies try to structure their affairs to avoid VIE status? How did this create problems for Enron and for banks during the market meltdown in 2007-2008?
Companies will restructure their affairs in ownership and their controlling interest below whatever thresholds allow to avoid being VIE statues so they can take advantage of their financial statements looking better. This can significantly improve their balance sheet and income sheet without having to change much. After the meltdown starting in 2007 whichever company holds a majority of the VIE’s expected losses or expected residual returns is considered to be the primary beneficiary and is consequently responsible for consolidating the entity into its balance sheet. This forced big losses for Enron and thousands of banks. 5. How might the requirement to consolidate VIEs affect financial statement users?
The requirement to consolidate VIEs affects financial statement users very positively. Now users can trust the numbers now and understand that the companies are not hiding lots of debt off of their statements. There is now a more realistic financial accuracy to the data for all companies. 6. Do a bit of research to find out how Goldman Sachs used a VIE Is this ethical? Why? Or Why not?
Goldman Sachs was one of the more famous users of SPEs, when it created ABACUS, a synthetic collateralized debt obligation. This was part of the subprime mortgage crises which allowed him to hide risky assets off of this balance sheet. This enabled him to appear to regulators and investors as if he had moved the risk of the mortgages off their books, when in reality, it was these people and the tax payers bailing out the SPEs. It is not ethical because Goldman now that his balance are not even close to a true representation. Whether he is following the rules or not he is purposely trying to look better than he does through basically lying.

Group 3 Presentation Questions Read Pgs. 821-836 1) What where the requirements for a Special Purpose Entity to be created?
Besides what answered earlier there was a 3% outside equity rule. A firm could own up to 97 percent of an SPE without reflecting either its assets or liabilities on the firm’s balance sheet. Also it is important that the SPE not to be owned by the entity on whose behalf the SPE is being set up. 2) Did Enron follow these rules?
Enron in the beginning closely followed the rules where allowed by forcible being under the limiting requirements. Eventually what led to them being caught was when they couldn’t fall under the 3 % limit. They also didn’t follow the rules when Enron owned its own SPE and transferred its stock too itself. 3) What could Enron’s management done differently to prevent the downfall?
They could have avoided the limits of the rules with SPEs in order to stay honest and continue their regular profiting business. Or they could have not done equity swaps with themselves on their own stock which is even more risky than what they were doing. They should have taken the losses when incurred instead of digging themselves deeper each year.

Group 4 Presentation Questions 1) Do you believe the use of VIE's is a reasonable accounting practice and should it continue?
I believe there are legitimate economic reasons to use VIEs. They can reduce the cost of borrowing, shift risk to another party, and transfer tax advantages to those who can use them. However, all transactions must be obvious to all impacted parties, and all parties must understand the risk implications. With appropriate standards in place there should be no problems. 2) In what ways could companies abuse VIEs when dealing with mortgage financing situations?
As like Goldman and other banks, they could take all the risk with their mortgage situations and put them off their balance sheet through using VIEs. Instead of using VIEs when necessary they started relying on them all the time.

References
"A Transactional Genealogy of Scandal: From Michael Milken to Enron to Goldman Sachs" pgs. 821-836.
Reinstein et al. 2012 Changes in the consolidation of variable interest entities. Journal of Corporate Accounting and Finance, May/June 2012.
Changed is Special Purpose Entities. FASB.org
2011. SPEs of Old vs. VIEs and Changes to FIN 46. Trinity.edu.
Nectin. Arnold. 2005. “To Consolidate or Not. Journal of Accountancy.” Pgs. 36-53.