Hydro Corporation needs to build a new production facility. Because it already had a relatively high debt ratio, the company decided to establish a joint venture with Rich Corner Bank. This arrangement permitted the joint venture to borrow $30 million for 20 years on a fixed-interest-rate basis at a rate nearly 2 percent less than Hydro would have paid if it had borrowed the money. Rich Corner Bank purchased 100% of the joint venture's equity for $200,000, and Hydro provided a guarantee of the debt of the bondholders and a guarantee to Rich Corner Bank that it would earn a 20% annual return on its investment.
As a senior member of Hydro's accounting staff, you have been asked to investigate the financial reporting standards associated with accounting for variable interest entities and determine whether Hydro's reporting is appropriate. Draft a memo to Hydro's President stating your findings and conclusions and analyzing the impacts on Hydro's financial statements if the current reporting procedures are inappropriate. Include citations to or quotations from the authoritative accounting literature including the ASC to support your findings and conclusions.