On July 1, 2002, the Financial Accounting Standards Board released a draft of its proposed rules for consolidation of special purpose entities (SPEs), including the types that kept debt off Enron's balance sheet.
The proposal explains that SPEs are used for all kinds of purposes, ranging from leasing, hedging, and securitization to research and development. The most troublesome SPEs from an accounting perspective are those that are controlled by a business through some means other than through clear-cut ownership of voting interests. A common way to get this kind of control is by providing financial support to the SPE, (e.g., through a loan, lease, management contract, referral agreement, purchase contract, guarantee, or credit enhancement). Under the proposed rules, the determination of whether or not an SPE should be consolidated will depend in large part on the specifics of how the SPE gets its financial support.
Initially, the FASB considered establishing a "bright line test" that would allow a company to exclude an SPE from its consolidated financial statements if there was an outside investment of 10% (up from the 3% in the current rules). The final proposal allows for some exceptions and gives companies a little more flexibility, both of which add complexity to the standard. The Wall Street Journal quoted General Electric Comptroller Phillip Ameen as saying preliminary drafts of the rules were "stunning in their complexity and ambiguity." ("New Partnership Rules Are Readied." July 1, 2002.)
Still the proposal is expected to result in consolidation of more SPEs and additional debt for some companies. This "step in the right direction" may be sufficient to address the criticism that emerged from the Enron collapse.
The proposed Interpretation, "Consolidation of Certain Special-Purpose Entities," will apply to businesses of all sizes, both public and private. However, an exception is made for not-for-profit organizations.
FASB's workplan calls for issuance of the final Interpretation in the fourth quarter of this year with the expectation that the new rules will take effect in the second quarter of 2003, meaning calendar year-end companies would need to apply the guidance on April 1, 2003. Comments are requested by August 30, 2002.
Download the exposure draft.