JV, a corporation, was formed in 2013 to design and manufacture electric cars. JV is 60 percent owned by Auto Co (a car manufacturer) and 40 percent owned by Electric Co (a developer of electric car technology). The decision-making authority of JV is equally shared between Auto Co and Electric Co: the board of directors of JV is comprised of two members appointed by Auto Co and two members appointed by Electric Co. JV’s board of directors (1) set the annual budgets; (2) responsible for the hiring, firing, and compensation of management; and (3) approve all material contracts. As part of the agreement, all cars produced by JV will bear Auto Co’s logo and will be sold at Auto Co branded auto dealers.

Auto Co is an established car manufacturer that has been producing cars in the United States for the past century. To meet governmental mandates of lowering emissions and increasing the fuel economy of its fleet, Auto Co has been evaluating various ways to enter the electric vehicle market. Auto Co does not currently have viable technology for the production of electric cars.

Electric Co was established by professors that developed cutting-edge battery technology for electric cars. Although Electric Co has not produced electric cars in a mass market, the battery technology is tested and highly valued.

Auto Co and Electric Co jointly formed JV to produce electric cars for the mass market. JV benefits from Electric Co’s proprietary technology and Auto Co’s manufacturing expertise and access to credit markets and distribution channels.

JV is financed with 30 percent equity and 70 percent debt. When JV was formed, Electric Co did not have access to sufficient cash at inception to fund its equity interest. To purchase its equity interest, Electric Co received a loan from Auto Co. The debt financing was obtained in the form of a credit facility from a third-party bank. For the bank to provide debt to JV, it required that Auto Co guarantee the loan.

Required:

1• Is JV a variable interest entity (VIE)?

2• Which entity, if any, should consolidate JV?

Answer rating: 100% (QA)

1 Variable interests Yes JV is a variable interest entity VIE Contractual ownership or other interes... View the full answer