The Financial Accounting Standards Board (FASB) today published new US accounting rules which analysts fear will force off-balance sheet transactions back on to corporate balance sheets, hammering the collateralised debt obligation (CDOs)and asset-backed commercial paper markets.
The new FASB rules on reporting of for special purpose vehicles, off-balance sheet structures and similar entities – Interpretation No. 46, Consolidation of Variable Interest Entities, to give them their proper title – follow revelations about Enron’s use of off-balance sheet financing, which is thought to have helped propel the Texan energy company into bankruptcy.
In general, says the FASB, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate or other property. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company.
FASB says the objective of Interpretation 46 is not to restrict the use of variable interest entities but to improve financial reporting by companies involved with variable interest entities. Until now, one company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests. Interpretation 46 changes that by requiring a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. A company that consolidates a variable interest entity is called the primary beneficiary of that entity.
Consolidation by a primary beneficiary of the assets, liabilities and results of activities of variable interest entities will provide more complete information about the resources, obligations, risks and opportunities of the consolidated company. To further assist financial statement users in assessing a company’s risks, the Interpretation also requires disclosures about variable interest entities that the company is not required to consolidate but in which it has a significant variable interest.
The consolidation requirements of Interpretation 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established.
To order a hard copy of Interpretation 46, contact the FASB’s Order Department at 1-800-748-0659.