Teaching variable interest entities under FIN 46: Untangling risks, expected losses, and expected residual returns

FASB Interpretation No. 46 (FIN 46), as revised, addresses consolidation of variable interest entities. FIN 46 has been described as complex, hard to understand, and difficult to apply. This paper presents a conceptual approach that explains the rationale for consolidation of variable interest entities. A brief discussion of “special purpose entities” (SPEs), including a comparison of an SPE with a parent and a majority-owned subsidiary, is presented first, followed by a summary of the primary consolidation requirements of FIN 46. The main part of this paper uses two hypothetical companies to illustrate and explain what the requirements of FIN 46 are designed to accomplish. The conceptual approach presented in this paper should be a useful pedagogical tool for instructors teaching consolidations and for students attempting to understand the complexities of FIN 46.