When to consolidate a special purpose entity.

• Author: Davis, A. Christine
• Position: Accounting and Auditing - Brief Article

Generally accepted accounting principles require that companies consolidate all entities in which they have a controlling financial interest, including special purpose entities. Although FASB has not defined "controlling financial interest," it has identified situations in which an SPE should be consolidated, thereby presenting various examples of a controlling financial interest.

CURRENT GUIDANCE

Current authoritative guidance on SPEs and their consolidation can be found primarily in EITF Issue 90-15, EITF Topic D-14, and EITF Issue 96-21. Guidance on consolidation in general is provided by ARB 51 and FAS 94.

While most of the guidance specific to SPEs involves leasing activities, it has been applied to all types of SPEs, such as those purchasing or receiving assets and, in turn, issuing commercial paper backed by the transferred assets.

An SPE is created for a specific purpose or transaction and does not have the elements of a normal operating company, such as employees and long-lived assets.

Once an entity is determined to be an SPE, a determination must be made whether it should be consolidated with its "creator," also known as the transferor (of the assets) or the sponsor (in a financing arrangement). In making that determination, the presence of a controlling financial interest in the SPE is a significant consideration. If there is no controlling financial interest in the SPE, no consolidation is required.

NO CONTROLLING FINANCIAL INTEREST

To establish that the creator has no controlling financial interest, the following conditions must be met:

* The majority SPE owner(s) is an independent third party with a substantial residual equity capital investment in the SPE. EITF 90-15 states that 3 percent or more is considered substantial;

* SPE activities are controlled by the owners, not the creator;

* The independent third-party owner possesses the substantive risks and rewards of SPE ownership, generally meaning that the investment and related returns are "at risk" and not guaranteed by another party.

SPEs with these characteristics are known as "substantive" SPEs and receive off-balance sheet treatment. It is this treatment that creators find highly desirable since they are able to raise lower-cost funds without reflecting the debt on their balance sheets. Recently, however, the representational faithfulness of those balance sheets has been questioned.

NEW INTERPRETIVE GUIDANCE

In early June, FASB will issue an exposure draft with new...