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Vie Poa Agreement

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Submitted By carrolinegao
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Issue 1
The education Enterprise in the WFOE case should be deemed a VIE. According to U.S.GAAP code 810-10-15-14-b, a legal entity could be considered to be VIE if the conditions in section b exists. In section b, as a group the holders of the equity investment at risk lack any one of the following three characteristics of a controlling financial interest:
1. The direct or indirect ability through voting rights or similar rights to make decisions about a legal entity's activities that have a significant effect on the success of the legal entity. The investors do not have that ability through voting rights or similar rights if no owners hold voting rights or similar rights.
2. The obligation to absorb the expected losses of the legal entity. The investor or investors do not have that obligation if they are directly or indirectly protected from the expected losses or are guaranteed a return by the legal entity itself or by other parties involved with the legal entity.
3. The right to receive the expected residual returns of the legal entity.
The objective of this provision is to identify as VIEs those legal entities in which the total equity investment at risk does not provide the holders of that investment with the characteristics of a controlling financial interest. If interests other than the equity investment at risk provide the holders of that investment with the characteristics of a controlling financial interest or if interests other than the equity investment at risk prevent the equity holders from having the necessary characteristics, the entity is a VIE.
In the WFOE education case, the Enterprise is considered to be VIE because of the compliance with the code and the two assumptions in issue one. As mentioned in the issue one, the Enterprise is not qualified for the scope exceptions and the equity investment by the Nominee Shareholders in the Enterprise represents equity investment at risk, so the holders of the equity investment at risk in this case are the Nominee Shareholders. 1. The Nominee Shareholders establish the board of directors to manage the business of the Enterprise and the management team who implement the daily operation should report directly to the board of directors. The nominee shareholders could also make decisions on the activities that have the most significant impact on the economic performance of the Enterprise. And therefore the investors would have the similar rights to affect the economic activities. Since the first requirement under section b states that the holders should have the ability to make decisions about entity’s activities that have a significant effect on the success of the entity, the rights of the nominee shareholders mentioned in the case meet the requirement. However, the ability also refers to the consideration of kick-out rights and participating rights. The equity pledge agreement protects the WFOE against possible unauthorized transfers of equity or assets by the Nominee Shareholders and maintains the assets of the Enterprise unencumbered. Conversely, according to call option, the WFOE can require the Nominee Shareholders to transfer all or part of their equity ownership interests in the Enterprise at any time. Therefore, the Nominee shareholders do not have the consideration of kick-out rights. 2. The WFOE and Nominee Shareholders enter into the equity pledge agreement whereby the Nominee Shareholders pledge their equity interests in the Enterprise to the WFOE to secure and protect the WFOE from incurring economic losses. The WFOE are guaranteed a return by the equity pledge agreement and the Nominee Shareholders would pay their equity interests to the WFOE if the expected losses occur. So the WFOE does not have the obligation to absorb the expected losses of the enterprise. 3. Under management service agreement, the WFOE has the right to claim the service fees and adjust the service fees at any time. The annual service fee amounts account substantially for all of the net income of the Enterprise extracted from the earnings by WFOE. The Nominee Shareholders do not have the rights to terminate the agreement. In this sense, the Nominee Shareholders cannot receive the expected residual returns of the enterprise and therefore lack the characteristics of the controlling interest.
According to the items above, the Enterprise can’t provide the Nominee shareholders with equity investment at risk the characteristics of controlling interest because the Nominee shareholders cannot receive the expected residual returns, so the Enterprise is a VIE.
Issue 3
The POA agreement does not affect the conclusion reached in Question 2.
According to U.S.GAAP code 810-10-55-35, the POA agreement would not affect the status of a decision maker’s fees in the application unless the rights are substantive. Whether the rights are substantive depends on a consideration of all relevant facts and circumstances. If one of the following characteristics cannot be satisfied, the POA agreement would not have significant impact.
a. The decision maker can be removed by the vote of a simple majority of the voting interests held by parties other than the decision maker and the decision maker’s related parties.
b. The parties holding the kick-out rights have the ability to exercise those rights if they choose to do so; that is, there are no significant barriers to the exercise of the rights.
The WFOE cannot be removed by the vote of majority. Under the POA agreement, the Nominee Shareholders assign the WFOE as their attorney-in-fact to vote on their behalf so that the Nominee Shareholders would act in the best interest of WFOE. Since the WFOE can control the voting results and indirectly affect the decisions of the board of directors, the vote of majority to kick the WFOE out cannot be exercised. The POA agreement doesn’t meet the first requirement.
The POA agreement is not substantive because of the breach of item a, so it has no impact on the conclusion in Question 2.
Conclusion
According to U.S.GAAP code 810-10-15-14, the Enterprise is deemed a VIE because the Nominee Shareholders does not satisfy the requirement of the characteristics of controlling interest. As U.S.GAAP code 810-10-25-38, the WFOE should consolidate the Enterprise. And under U.S.GAAP code 810-10-55-35, the POA agreement has no impact on the consolidation conclusion in issue 2. Under IFRS,

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