FIN 46

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FIN 46, revised and replaced in its entirety by FIN 46R, is a statement for the purposes of United States Generally Accepted Accounting Principles published by the US Financial Accounting Standards Board (FASB) which requires a reporting enterprise to consolidate a variable interest entity (VIE) if it is the primary beneficiary of the VIE based on variable interests. One of the main reasons FIN46 was issued as an interpretation instead of an accounting standard was to issue the standard in a relatively short period of time in response to the Enron scandal.

FIN 46R is an interpretation of ARB 51 relating to consolidation. Consolidation of assets and liabilities is required whenever one entity has a controlling financial interest in another entity. The traditional ARB 51 approach assumed that equity - usually common stock - would receive the residual economic interest generated by a business, which is why ARB 51 focuses on equity-based majority voting interests. The traditional criterion for a controlling financial interest under ARB 51 is a majority voting interest. In the 1980s and 1990s it became common for many companies to control assets in certain businesses without maintaining a majority voting interest in those businesses. This was more often done with securitizations rather than traditional limited liability corporations, because the securitization's common stock or other voting interests could be paid defined, limited amounts and all other cash flows could be directed to other securityholders. Before FIN 46, this enabled companies to avoid consolidation, which permitted them to keep the liabilities and losses of their controlled special purpose entities off of their financial statements. In such cases, consolidation based on equity did not serve the purpose of effective reporting because it does not reflect the true nature of relationships among entities.

FIN 46R closed this loophole by defining tests to identify a controlling financial interest beyond just equity ownership and voting rights. This is important in cases where the legal equity is insignificant or at least somewhat irrelevant from the viewpoint of risk/rewards. The new rules emphasize the substance of relationships among entities, rather than emphasizing the form of relationships among entities (such as a majority voting interest), which can be more easily manipulated.

Under FIN 46R, the first step is to determine if a company has a variable interest in another entity. In general terms, a variable interest is an interest in an entity that increases and decreases in value (i.e., is variable) according to increases and decreases in the expected cash flows from the entity's assets and liabilities. Once a variable interest is established, the second step is to determine who is the primary beneficiary of the variable interest entity (or "VIE"). The primary beneficiary is the entity, if any, that holds the majority of the risks and rewards associated with the VIE. Once a primary beneficiary is identified, it is deemed to have a controlling financial interest in the VIE and must consolidate the VIE onto its financial statements, whether or not it holds a majority voting interest.

Note that when the FASB first began working on FIN 46, it focused on special purpose entities, like the entities Enron used. The FASB then quickly recognized that the principles of FIN 46 should apply to all entities where a variable interest exists, so the final interpretation is broader than the original objective.

Finally, note that where, as in a securitization, a party selling assets to a VIE and maintaining an ongoing involvement with those assets (for example as a swap counter-party to the VIE with respect to asset cashflows) then Financial Accounting Standard 140 (FAS140), which deals with de-recognition of assets upon transfer to a special purpose entity) will also be relevant.

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