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Pacer Ltd transferred equipment to Thelma Ltd in exchange for the receipt of $1M cash and a 25% equity ownership stake in Thelma Ltd. Pacer Ltd’s book basis in the transferred equipment was $6M, and the equipment was recently appraised for $6.5M. The fair value of the investment in Thelma Ltd is $5.5M, and the fair value is reliably determined. The investment gives Pacer Ltd significant influence over Theta, but is not a controlling financial interest in Thelma Ltd. Thelma Ltd is in the business of making and selling tissues and will use the equipment for tissue production. Prior to transferring the equipment, Pacer Ltd used the equipment to produce paper towels and napkins. However, significant overseas competition has caused profit margins and demand for the domestic production paper towels and napkins to fall. Production using the equipment had recently been cut down to only one-eight hour shift per day. Tissues are expected to be a more profitable output, with steady consumer demand. Theta expects to run the equipment for three-eight hour shifts per day. Pacer Ltd hopes the investment in Thelma Ltd will revive its slowing growth prospects.
You are in the controller’s group of Pacer Ltd and need to determine the appropriate accounting for this transaction. Prepare a technical memorandum, citing the appropriate authoritative and non-authoritative literature to address the accounting for this transaction.

First of all, identification of VIE interest model test should be applied for this case. Should the 25% equity ownership of Thelta LTD can be reviewed as VIE? According to the Hoyle,Joe B, Schaefer Thomas, Doupnik, Timothy 12 editon(page 279) this ownership can be evaluated as a VIE equity ownership. Because the ownership is lack of power; it doesn’t have voting rights or similar rights to direct the activities of an entity that most significantly impact the entity’s economic performance. We cannot made any comment about the first rule which is “the total equity at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support provided by any parties, including equity holders”. We cannot make a comment about the assets of Thelta and risked equity. According to the data we can assume that it may or may not be a VIE model. If we assume that it is a VIE model than we should determine that if Pacer is Thelta’s primary beneficiary. We run the test according to information Hoyle, page 279; “if the power to direct the activities of a variable interest entity that most significantly impact the economic performance?” and as the data we can use we could also cannot answer this question. And second and one of the most important part of the test should be examined: “ if the obligation to absorb losses a significant share of the VIE’s losses or receive a significant share of the VIE’s residual returns or both. As the data we have don’t have any clue that Thelta is a primary beneficiary of Pacer. So we may evaluate the case above with equity method.

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