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, a legal person is any person or 'thing' (less ambiguously, any legal entity) that can do the things a human person is usually able to do in law – such as enter into contracts, sue and be sued, own property, and so on. The reason for ...
with certain characteristics such that a
public company
A public company is a company whose ownership is organized via shares of stock which are intended to be freely traded on a stock exchange or in over-the-counter markets. A public (publicly traded) company can be listed on a stock exchange ( ...
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 involving Enron Corporation, an American energy company based in Houston, Texas. Upon being publicized in October 2001, the company declared bankruptcy and its accounting firm, Arthur Andersen then ...
.
Some Chinese companies, such as
Alibaba, 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 an authoritarian political system in the People's Republic of China under the exclusive political leadership of the Chinese Communist Party (CCP). It consists of legislative, executive, m ...
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 owned or controlled by another company, which is called the parent company or holding company. Two or more subsidiaries that either belong to the same parent company or having a ...
in the reporting entity's financial statements. If consolidated, the reporting entity will account for the subsidiary's
assets
In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can ...
,
liabilities 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, commodities, and services company based in Houston, Texas. It was founded by Kenneth Lay in 1985 as a merger between Lay's Houston Natural Gas and InterNorth, both relatively small regional compani ...
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 an authoritarian political system in the People's Republic of China under the exclusive political leadership of the Chinese Communist Party (CCP). It consists of legislative, executive, m ...
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 claimant The 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 th ...
")
* 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, a stock certificate (also known as certificate of stock or share certificate) is a legal document that certifies the legal interest (a bundle of several legal rights) of ownership of a specific number of shares (or, under Ar ...
, certifies ownership of a portion of a company. In other words, it provides proof of a legal