Master of the Universe
Saturn and Venus, form Jupiter, a joint venture. Saturn owns 51 percent of Jupiter and Venus owns 49 percent of Jupiter. The purpose of Jupiter is to own and operate organic clothing design and manufacturing facilities and sell organic clothing to unrelated retailers. When Jupiter was formed, Saturn contributed $561 million to Jupiter and Venus contributed four manufacturing facilities with an assembled workforce, with a total fair value of $539 million to Jupiter. Venus was looking to exit its clothing manufacturing business, as this business no longer was a strategic fit for Venus.
However, Saturn was looking to expand its footprint in the manufacturing of children’s clothing. In exchange for their contributions, Saturn and Venus received a combination of equity and debt securities for Jupiter. The Articles of Incorporation of Jupiter state the following in terms of governance and management of Jupiter: • The Board of Jupiter (the “Board”) comprises eight individuals, four each from Saturn and Venus. • Both Saturn and Venus are able to nominate individuals for the position of CEO of Jupiter (the “CEO”). • The CEO is responsible for the day-to-day operations of Jupiter.
Most Board actions are passed by a simple majority vote; however, the following actions cannot be taken without unanimous approval of the Board: appointment and removal of the CEO, decision to make calls for capital contributions, admission of new joint venture members and mergers and acquisitions. • The power to make strategic decisions regarding the operations of Jupiter has been divided between Saturn and Venus. Saturn controls all decisions regarding the design, manufacturing, pricing, and sales of the clothing. Venus controls all decisions regarding distributing clothing in fulfillment of sales negotiated by Saturn on Jupiter’s behalf.
Profits and losses of Jupiter are split according to ownership percentage; therefore, Saturn receives 51 percent and Venus receives 49 percent of the profits and/or losses of Jupiter. Saturn has performed a consolidation analysis. From Saturn’s perspective, Jupiter does not qualify for the business scope exception. QUESTION NUMBER 1 What is the primary purpose and design of Jupiter (including risks that Jupiter was designed to create and pass through to its variable interest holders)? SOLUTION Jupiter was created as a joint venture from Saturn Inc. and Venus Inc.
One of the purposes for the creation of Jupiter was to give Saturn an opportunity to expand its manufacturing of children’s clothing and to provide Venus with a chance to exit this business line. Although, the main purpose was to own and operate organic clothing design and manufacturing facilities, and sell organic clothing. Risks that Jupiter was designed to create and pass through to its variable interest holders include labor pricing risks, outstanding receivables on sales of inventory, and product pricing risk based on purchases of raw materials and sales to retailers. QUESTION NUMBER 2
Determine whether Saturn, Venus, or both are variable interest holders SOLUTION In order to determine if Saturn Inc. and Venus Inc. are variable interest holder the ASC 810-10-20 was used, it states: “The investments or other interests that will absorb portions of a variable interest entity’s (VIE’s) expected losses or receive portions of the entity’s expected residual returns are called variable interests. Variable interests in a VIE are contractual, ownership, or other pecuniary interests in a VIE that change with changes in the fair value of the VIE’s net assets exclusive of variable interests.
Equity interests with or without voting rights are considered variable interests if the legal entity is a VIE and to the extent that the investment is at risk…” Also, ASC 810-10-55-19 states as a general rule, assets and operations of an entity create its variability, meanwhile its liabilities and equity interest absorb the variability. It also states that the variable interest absorb or receive the expected variability created by those assets, liabilities, or contracts of a VIE that are not variable interests.
Because Saturn Inc. and Venus Inc. have investments in the residual interest and debt securities of Jupiter, both companies are variable interest holders of Jupiter. QUESTION NUMBER 3 Who, if anyone, is the primary beneficiary and why? ALTERNATIVES Alternative 1 – Venus is the primary beneficiary of Jupiter. The distribution of clothing and decisions related to distribution could be the most significant impact on the economic performance of Jupiter.
Venus has the obligation to absorb losses of Jupiter or the right to receive benefits from Jupiter and has the power to direct distributing activities of Jupiter that could affect significantly Jupiter’s economic performance. Alternative 2 – Saturn is the primary beneficiary of Jupiter. Saturn has the power to direct operating activities of Jupiter that could affect significantly Jupiter’s economic performance and has the obligation to absorb losses of Jupiter. Also, Saturn has the right to receive benefits from Jupiter.
Alternative 3 – Saturn and Venus share the power of being primary beneficiary. Both have the obligation to absorb Jupiter’s losses or the right to receive benefits from Jupiter that could affect significantly Jupiter’s economic performance. Also, both Saturn and Venus have the power to make strategic decisions regarding the operation of Jupiter such like the power to nominate four members each on the Board and to nominate individuals to become CEO. SOLUTION Alternative 2 – Saturn is the primary beneficiary of Jupiter.
Both companies have a very important role in Jupiter’s performance and since both parties have the obligation to absorb losses or receive benefits from Jupiter that could potentially be significant to Jupiter. However Saturn’s activities are most significant for Jupiter’s operations. In ASC 810-10-25-38B it states: “a reporting entity must identify which activities most significantly impact the VIE’s economic performance and determine whether it has the power to direct those activities.
Saturn and Venus have joint control over the Board of Jupiter and substantive decisions regarding the operation of Jupiter have been divided between the parties. The ASC 810-10-25-38E clarifies that the nature of the activities that each unrelated party is directing are different, then it must be determined which activities are most significant to the impact of the entity’s economic performance, and the party that “has the power to direct the activities that most significantly impact the VIE’s economic performance” is deemed to have met the characteristic in ASC 810-10-25-38A.
By analyzing both parties power over the activities, Saturn appears to have the most significant activities such like control over decision related to the design, manufacturing, pricing, and sales of clothing produced by Jupiter; Saturn has the power to direct the activities that could impact Jupiter’s economic performance the most. Proving that the second alternative is the correct accounting alternative, making Saturn the primary beneficiary of Jupiter.