What is a Variable Interest Entity?

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Financial terms relating to investment, interest and voting shares can be confusing. If you are considering an investment, you should familiarize yourself with some of the key terms around financial investments and investing practices.

What is a Variable Interest Entity?

The United States Financial Accounting Board uses the term “variable interest entity” to describe an investment product in which the investor holds a controlling interest that is not based on majority voting rights. It also describes a situation where an entity such as a subsidiary company has a cash flow situation that alters depending on the status of its assets and liabilities.

Variable Interest Entity Example

An example of a variable interest entity would be if The Jones Corporation created a smaller company called The Smith Company. The Smith Company needs to build a factory to manufacture its product. It must take out a loan to finance the construction, and because it is a new company, The Jones Corporation guarantees the loan. Once The Smith Company is fully operational, The Jones Corporation buys all the products it produces. The Jones Corporation benefits from the existence of The Smith Company and is The Smith Company's source of capital. Should The Smith Company take a huge hit or be unable to pay back the loan it has borrowed, The Jones Corporation would be accountable. Thus, The Smith Company is a variable interest entity.

What is Reporting Entity?

A reporting entity describes an investment product or investee, wherein users or investors need to have a certain amount of reported information, for example, the information contained in annual financial reporting, to make decisions.

What is a Variable Rate of Interest?

A variable rate of interest is an interest on a loan or some other security that can fluctuate depending on the changes to the benchmark interest rate underlying the loan. This can benefit the borrower if the interest rate goes down since the borrower's responsibilities would be less than expected. However, it is to the borrower's detriment if the benchmark interest increases, because they would then owe more money.

What is Controlling Interest in a Company?

Controlling interest in a company means one of two things. It can mean that a shareholder holds a controlling amount of stock in the company. The minimum for a controlling interest is 50 percent of all available shares plus one share. Holding that number of shares or more gives that shareholder controlling interest.

Controlling interest outside of majority shareholder status means a person or group holds a majority of "voting shares" in the company. As not every share in the company carries voting rights in shareholder meetings, a majority portion of voting rights held by an individual or group would give them a controlling interest in the company regardless of the percentage of shares held.

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About the Author

Ashley Friedman graduated from Sarah Lawrence College in 2003 with a Bachelor of Arts in Creative Writing and Social Sciences. She has experience writing copy for the websites of creative professionals, and regularly contributes to several blogs covering popular culture, travel, food, and social action.