Start Consolidating special purposes entities

Consolidating special purposes entities

FIN 46 divides legal entities into two groups: those consolidated through “voting interests” (the original definition) and those consolidated by “variable interests.” The acknowledgement of variable interest entities (VIEs) expands the requirement for consolidation.

Off-balance sheet financing, or external funding not recognized on the issuing company’s financial statements, has garnered its fair share of attention recently, primarily due to the collapse of the Enron Corporation.

Enron’s management extensively utilized a specific form of off-balance sheet financing, the creation of Special Purpose Entities (SPEs).

An SPE is a separate legal structure created by a firm to provide liquidity and/or obtain favorable external funding.

Assets are isolated within the new entity, and securities issued by the entity are backed by these assets as collateral.

SPEs are used to securitize, acquire, and lease assets.

Securitization was popularized first by mortgage markets.

In a synthetic lease, a firm sets up an SPE to hold a property’s title and then leases the property back at rates below those of a traditional lease.

Synthetic leases were popularized in the late 1990’s by technology companies such as Cisco Systems and are used frequently by retailers and others who require large investments in real estate.[3] However, because of Enron, 2002 was not the time to use a synthetic lease.

In addition, the required outside equity increased from 3 percent to 10 percent.[5] FIN 46 is broad enough and SPE structures are complex enough that it will take some time before accounting professionals fully understand the implications of the ruling.

However, it is clear that all parties involved with entities, including those without any nominal equity interest or voting rights, will need to analyze their relationships to the SPE to determine if they must now consolidate.

FASB adopted Financial Accounting Interpretation (FIN) 46, effective January 31, 2003, for newly created entities.