It is my understanding that GlobalEd Inc., has set up a wholly foreign-owned enterprise (WFOE) within the Peoples Republic of China (PRC) for the purpose of gaining control of a PRC-domiciled enterprise. Additionally, whether the Enterprise created by related parties of the WFOE, the Nominee Shareholders, is a variable interest entity (VIE), and if it requires consolidation. Analysis of the Equity Pledge Agreement, Call Option, and Management Service Agreement, various contractual agreements, should provide insight into these concerns and if consolidation is necessary. Review of the agreements will either support or negate the qualifications of VIE, as well as, primary beneficiary ...view middle of the document...
The total equity investment at risk is represented by the Nominee Shareholders 100% equity ownership in the Enterprise. However, that equity investment is not sufficient to uphold its activities. This is demonstrated by the management service agreement entered into between the Nominee Shareholders and the WFOE; it alone provides the Enterprise with all their necessary resources. Therefore without the intellectual property, employees, resources, and other services provided by the service agreement the Enterprise would not have the capability of sustaining its activities.
Fees paid to the WFOE under the Management Service Agreement constitute a service contract and are not variable interests if all of the six conditions in ASC 810-55-37 are met; three of which are not (FASB, ASC 810-55-37(a-f)). Fees paid under a service contract are to be inconsequential to the entity’s performance and should, quantitatively, resemble other liabilities of the entity. This is not the case with the Enterprise since fees paid to the WFOE are what they choose, can change at any time, and are not subject to a minimum or maximum. In addition, the fees are extremely imperative to the entity’s performance, on account of them being considerably all of the Enterprise’s net earnings. The service provider is also not to hold interests in the entity that would permit them to consume a substantial portion of the losses or returns; considering that the services fees equate to the majority of the entity’s net income, that condition is not met (FASB, ASC 810-55-37(a-f)). The three conditions that are discussed above are those not met and that which establish a variable interest of the service provider within the Enterprise.
According to the Deloitte Guide to the Consolidation of Variable Interest Entities,
Holders of variable interests other than equity, including but not limited to, providers under service contracts, have sufficient voting or contractual rights to prevent the holders of the equity ‘at-risk’ from having the power to direct the activities that significantly affect the entity’s performance. ("Consolidation of variable," 2010, pp. 92)
This would therefore stipulate that the Nominee Shareholders as the equity investors lack the ability to make decisions about the entity’s activities, fulfilling the second criteria.
Returns that are capped as a result of governing or other...