Case 11-3 Master of the Universe Saturn Inc. (“Saturn”) and Venus Inc. (“Venus”)
ID: 2498786 • Letter: C
Question
Case 11-3 Master of the Universe
Saturn Inc. (“Saturn”) and Venus Inc. (“Venus”), two unrelated parties, 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 (in proportion to their overall contributions).
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:
o Appointment and removal of the CEO.
o Decision to make calls for capital contributions.
o Admission of new joint venture members.
o 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 joint venture scope exception included in ASC 810-10-15-17(d) (as amended by ASU 2009-17, Improvements to Financial Reporting by Enterprises Case 11-3: Master of the Universe Page 2 Copyright 2010 Deloitte Development LLC All Rights Reserved. Involved with Variable Interest Entities and formerly FASB Statement 167, Amendments to FASB Interpretation No. 46(R)), because Saturn has provided more than 50 percent of the equity, subordinated debt, and other forms of subordinated financial support to the entity based upon the fair values of the interest in the entity.
Saturn and Venus are not related parties, as defined in ASC 810-10-25-42 and 25-43 (as amended by ASU 2009-17).
All equity investments represent equity at risk. On the basis of the nature of the entity and the level of equity investment at risk, Jupiter is deemed to be a variable interest entity (VIE) pursuant to ASC 810-10-15-14(a) (as amended by ASU 2009-17).
Required:
What is the primary purpose and design of Jupiter (including the risks that Jupiter was designed to create and pass through to its variable interest holders)?
Determine whether Saturn, Venus, or both are variable interest holders.
Who, if anyone, is the primary beneficiary and why?
Explanation / Answer
With the creation of Jupiter, both Saturn and Venus took into consideration several accounting issues. The issues to be considered when analyzing Jupiter, include Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 810-10, Consolidations, FASB Accounting Standards Update (ASU) 2009-17, Improvements to Financial Reporting by Enterprises Involved with VIEs (ASU 2009-17),
International Financial Reporting Standard (IFRS) 10, Consolidated Financial Statements and IFRS 11, and Joint Arrangements. First, the risk of new market entrance was “passed along” from Venus and Saturn to Jupiter. Next, our team analyzed whether Saturn, Venus, or both are variable interest holders in the newly formed Jupiter. Finally, our team determined who the primary beneficiary of Jupiter was. With the FASB’s ASC readily available online, all accounting issues can be easily addressed. Jupiter Inc. was created to share the risk associated with entering a new market segment, organic clothing manufacturing.
The joint venture unites the individual strengths and market experience of both Saturn and Venus. Saturn enjoys a high market share and Venus holds large- scale manufacturing capabilities with an experienced labor force. The goal of Jupiter is to create economies of scale in the manufacturing and production of organic clothing and reap tax benefits. The risk involved in clothing manufacturing and sales is passed through to the joint venture, Jupiter. Therefore, Jupiter is a an arrangement in which both parties hold joint control and have rights to the net assets of the entity. The entity is in the scope of the VIE consolidation model in FASB ASC 810-10-15-17(d) as amended by ASU 2009-17.
This segment of the codification discusses the “passing along” of risks to variable interest holders and addresses “(a) the activities of the legal entity; (b) the terms of the contracts the legal entity has entered into; (c) the nature of the legal entity's interests issued; (d) how the legal entity's interests were negotiated with or marketed to potential investors; and (e) which parties participated significantly in the design or redesign of the legal entity.” A variable interest entity is a company that meets all three of the following criteria established by the FASB ASC 810-10-05-08. First, this includes “the power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impact the entity’s economic performance.” In this case, both Saturn and Venus have the necessary power to affect the entity’s economic performance. Second, the party must bear “the obligation to absorb.
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