Outline

Introduction: Hydro corporation and Rich Corner bank have started a joint venture that has taken debt amount of $30,000,000 and constructed a new production facility. The newly constructed facility is then leased for ten years to Hydro corporation.

• The lease agreement of the joint venture with Hydro corporation shows the requirements for Hydro corporation to consolidate the joint venture with its operations
• The consolidation of joint venture leads to putting together the production facility among the assets of Hydro Corporation and the amount borrowed as a percentage of the long-term liabilities
• Similarly, the variable interest entities define consolidations in business that do not depend on majority voting rights.
• The FASB has issued guidelines concerning variable interest entities and requirements regarding consolidation.
• In financial reporting, FASB provides guidelines that need the firm to declare their financial position that they are variable interest entities.
• FASB also expects the consolidating firms to prepare a separate list on their balance sheet that shows their consolidated asset.

Borrowing by variable interest entities

Memo

To:

Hydro corporation

From:

Re: Corporation of Joint venture

Hydro corporation and Rich Corner bank have started a joint venture that has taken debt amount of $30,000,000 and constructed a new production facility. The newly constructed facility is then leased for ten years to Hydro corporation. Hydro Corporation records the yearly lease payment as operating expenses. It is recorded as a contingent liability in the notes to financial statements as a guarantee of the money borrowed by the joint venture.

The lease agreement of the joint venture with Hydro corporation shows the requirements for Hydro corporation to consolidate the joint venture with its operations. The Rich Corner bank has total ownership of the joint venture's equity, yet it has less than one percent of the contribution to all assets of the joint venture. A typical situation indicates that investment ranging below ten percent in the equities' total assets is perceived as insufficient to allow the venture to finance its activities (Hossain et al., 2020).

In this case, Hydro Corporation assures the borrowed amount of $30,000,000 by the joint venture and has assured annual return on the equity investment of the Rich Corner bank to 20 percent. This leads to absorbing the losses by the Hydro Corporation incurred by the joint venture and setting up Hydro Corporation as the beneficiary of the entity at its primary stage. However, the Financial Accounting Standards Board points out that the entity has to absorb the losses if they have been incurred.

The consolidation of joint venture leads to putting together the production facility among the assets of Hydro Corporation and the amount borrowed as a percentage of the long-term liabilities. Rich Corner bank holds a claim on the net assets of the joint venture that is recorded as non-controlling interests. The consolidated income statement of Hydro Corporation does not include the lease payments as an operating expense. Still, it comprises the depreciation expense on the production facility and the interest expense for the interest payments made on the debt venture's debt.

Similarly, the variable interest entities define consolidations in business that do not depend on majority voting rights. The FASB provides guidelines associated with reporting variable interest entities to minimize complications in their reporting. For example, Hydro Corporation and Rich Corner Bank can be categorized as variable interest entities since their consolidation depends on majority voting rights.

The FASB has issued guidelines concerning variable interest entities and requirements regarding consolidation. According to the standard, variable interest entities do not have adequate equity for financing their operations and resort to other businesses for financing (Rowden, 1992). In variable interest entity contracts, the public company plays as the controlling firm because it has substantial influence and power on the variable interest entity. In this scenario, Rich Bank Corner is the controlling business.

In financial reporting, FASB provides guidelines that need the firm to declare their financial position that they are variable interest entities. The consolidation shall impact their financial position and financial statements. Firms are thus required to declare their yearly financial information that they are variable interest entities and how this affects their financial information. Hydro Corporation must provide a statement to its shareholders showing the contract with Rich Corner Bank and how this affects the shareholders to assist them in decision making. Moreover, FASB expects firms to discuss off-balance sheet transactions and other contractual agreements in their quarterly reports (Graham et al., 2003). Hydro Corporation is supposed to detail any off-balance transaction on its quarterly reports and agreements to the shareholders.

FASB also expects the consolidating firms to prepare a separate list on their balance sheet that shows their consolidated asset. For this scenario, Hydro Corporation and Rich Corner bank are supposed to include a list showing the consolidated assets in their balance sheets.