Case 12-1 Unlikely Alliance Memo

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  • Topic: Majority, Board of directors, Generally Accepted Accounting Principles
  • Pages : 4 (1029 words )
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  • Published : October 24, 2012
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TO: Dr. Wilks
FROM: Russell Gardner (Section 1 / Group 4)
DATE: October 10, 2012
SUBJECT: Trueblood Case 2 Individual, Unlikely Alliance

Background

Florabama is an energy venture classified as a variable interest entity (VIE) of its two investors – Meyer Inc. and Saban Company. Meyer and Saban own 60 percent and 40 percent of Florabama respectively and the profit and losses are split according to ownership percentage. According to the terms of the venture arrangement, Saban is permitted, but not required, to purchase up to 20 percent of the power produced by Florabama at cost plus. The cost-plus arrangement between Saban and Florabama represents a variable interest in that Saban absorbs variability in Florabama through the cost-plus pricing terms.

The questions facing us are the following: Because Florabama is a variable interest entity, what are the business activities of Florabama that most significantly impact the entity’s economic performance? And should the cost-plus arrangement between Saban and Florabama be considered in the determination of the consolidating entity? In this memo I will first discuss the issue of consolidation common to all alternatives, and then explain how Meyer Inc. or Saban Company could consolidate Florabama according to US GAAP. Finally, I will recommend which entity is the controlling interest, and in effect, should consolidate Florabama to its financial statements.

Discussion of Alternatives

In either alternative, there is no question that since Florabama is classified as a variable interest entity, it needs to be assessed whether Meyer or Saban is the VIE’s primary beneficiary according to ASC 810-10-25-38A. As defined in ASC 810-10-15, the primary beneficiary is an entity that consolidates the variable interest entity.

In the past, the determination of the controlling financial interest was done by simply establishing which entity owned the majority of the subsidiary in question. Now according to ASC...
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