Comments on the FASB's Proposals on Consolidating Special‐Purpose Entities and Related Standard‐Setting Issues

AAA Financial Accounting Standards Committee INTRODUCTION The June 28, 2002 Financial Accounting Standards Board Exposure Draft (ED), Proposed Interpretation: Consolidation of Certain Special-Purpose Entities--an interpretation of ARB No. 51, addresses the consolidation of special-purpose entities (SPEs). Accounting Research Bulletin (ARB) No. 51 (AICPA 1959), Consolidated Financial Statements, does not apply to SPEs because they have no voting interests nor are they subject to control by means other than voting shares. This paper presents the views of the American Accounting Association's Financial Accounting Standards Committee (hereafter, the Committee) with respect to the ED. (1) For an insightful description of the history of and accounting for SPEs, see Hartgraves and Benston (2002). In brief, SPEs tend to be entities created by a sponsor--usually a single company-for a limited purpose. SPEs' legal forms vary and include corporations, partnerships, trusts, and joint ventures. They have been used for decades in asset securitization transactions, leasing, and R&D activities. Often the legal structure allows the SPE to be considered "bankruptcy remote"--that is, the assets of the SPE are not subject to bankruptcy claims against the sponsoring company. Additionally, the legal structure often allows the SPE to borrow at favorable rates, for example, through the isolation and credit enhancement of its assets. The structure also can enable the SPE to effectively disperse risks via, for example, the pooling of contracts that are then securitized. The major accounting issue affecting SPEs is whether they should be consolidated and by whom. The ED calls for consolidation of SPEs by the entity that has a controlling financial interest therein--the primary beneficiary--whether this interest is due to voting shares or other forms of control. As such, the ED provides guidance on identifying and measuring variable interests--the basis for determining control when SPEs are not subject to control through voting interests. Variable interests are defined as "the means through which financial support is provided to an SPE and through which the providers gain or lose from activities and events that change the values of the SPE's assets and liabilities" (ED, para. 7). Variable interests can arise from contractual rights and obligations, such as those in loan agreements, from residual interests in transferred assets, and from nonvoting interests such as limited partnership interests. The entity with the majority of variable interests in the SPE or with a variable interest that is significantly more than the any other party's variable interest is said to be the SPE's primary beneficiary, and should consolidate the SPE. The sponsoring entity that created the SPE may or may not be the primary beneficiary. Because the ED specifically excludes "qualifying SPEs" as defined in SFAS No. 140 (FASB 2000), Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, the ED does not require SPEs that effectively disperse risk to be consolidated. However, many common forms of synthetic leases and a variety of other activities that use SPEs but do not effectively disperse risks will be consolidated under the ED. (2) A PERSPECTIVE ON A PRINCIPLES-BASED CONSOLIDATION STANDARD Basis for Consolidation The Committee recognizes that there remains considerable disagreement over the principles that should govern the development of an appropriate consolidation policy standard. (See, for example, the issues raised in FASB [1991a, 1995, 1999].) This disagreement is reflected in the various unsuccessful attempts by the FASB to revise consolidation standards (FASB 1995, 1999). In past comment letters, the Committee has sided with the economic unit concept of consolidated financial statements and the broader definition of effective economic control as the basis for consolidation (AAA FASC 1994, 1995, 1996). …