The Financial Accounting Standards Board (FASB) Said Friday that it has issued Interpretation No. 46, Consolidation of Variable Interest Entities, in an effort to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity.
FASB said many variable interest entities have commonly been referred to as “special-purpose entities, SPE’s” or “off-balance sheet structures,” but the guidance applies to a larger population of entities. The FASB interest in the SPE’s was sparked when Enron’s bankruptcy revealed a mountain of debt the company was liable for through SPE’s which hadn’t previously shown up on its balance sheet.
FASB defined a variable interest entity as 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.
The board added that a variable interest entity often holds financial assets, including loans or receivables, real estate or other property and may be essentially passive, or it may engage in research and development or other activities on behalf of another company.
“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,” FASB said. “Until now, one company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests.”
According to the board, 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. Under the interpretation, a company that consolidates a variable interest entity is called the primary beneficiary of that entity.
FASB said 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. In an effort 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.
For variable interest entities created after Jan. 31, 2003, the consolidation requirements of Interpretation 46 will apply immediately. For older entities, the consolidation requirements apply in the first fiscal year or interim period beginning after June 15, 2003. The board also noted that certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established.
A full copy of the interpretation is available on the FASB’s website at www.fasb.org. Printed copies will be available on or about Jan. 22.
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