The Financial Accounting Standards Board (FASB) concluded its deliberations of two proposals earlier today which will soon be finalized as standards.
One of the proposals focuses on the consolidation of variable interest entities while the other will amends existing guidance for when a company derecognizes transfers of financial assets.
A variable interest entity (VIE) is a business structure that allows an investor to hold a controlling interest in the entity, without that interest translating into possessing sufficient voting privileges to result in a majority.
After the FASB considered all of the feedback received on these original proposals exposed for comment in September last year, the board concluded its deliberations and expects to issue final standards by June 2009.
Both new standards need a number of new disclosures.
FIN 46(R) amends existing consolidation guidance for VIEs. The VIEs are generally thinly-capitalized entities and include many special-purpose entities (SPEs).
FASB's main amendment to FIN 46(R) relates to how a company determines if it must consolidate a variable interest entity. Under the Generally Accepted Accounting Principles (GAAP), a firm must consolidate any entity in which it has a controlling interest.
The new standard now requires a firm to perform a qualitative analysis in determining whether it must consolidate a variable interest entity.
Under the standard, if the firm has an interest in a VIE that provides it with control over the most significant activities of the entity (and the right to receive benefits or the obligation to absorb losses), the firm should consolidate the VIE.
Under the new standard, the quantitative analysis that is usually utilized previously is no longer, by itself, determinative. The newly-approved standard necessitates ongoing reassessments to find out if a firm should consolidate a variable interest entity. This is different from existing guidance, which requires a firm to determine if it consolidates a variable interest entity only when specific events occur. Under the existing guidance, as expected credit losses increased considerably as a result of unpredicted market events, some firms did not reconsider whether they should consolidate a variable interest entity. The new standard calls for a firmto update its consolidation analysis on an ongoing basis.
The new standard also requires a firm to offer added disclosures regarding its involvement with VIEs and any considerable changes in risk exposure resulting from that involvement.
A company will be asked to disclose how its involvement with a VIE impacts the firms financial statements.
For instance, if a firm consolidates a VIE and the assets of that consolidated entity are restricted, it must disclose the nature of those restrictions and the carrying amount of such assets. A company will also be asked to disclose any significant judgments and assumptions made in determining whether it must consolidate a VIE.
The second standard now headed for finalization Statement 140 enhances the information reported to users of financial statements by offering more transparency regarding transfers of financial assets and a companys continuing involvement in transferred financial assets. It removes the concept of a qualifying special-purpose entity from U.S. GAAP, changes the requirements for derecognizing financial assets, and requires added disclosures regarding a transferors continuing involvement in transferred financial assets.
An SPE is a legal entity created to fulfill narrow, specific or temporary objectives. SPEs are typically used by companies to isolate the firm from financial risk. A company will transfer assets to the SPE for management or use the SPE to finance a large projectthereby achieving a narrow set of goals without putting the entire firm at risk.
Qualifying special-purpose entities (QSPEs) are generally off-balance-sheet entities that are exempt from consolidation. The new standard removes that exemption from consolidation. Many qualifying special-purpose entities that are now off balance sheet will become subject to the revised consolidation guidance in the proposal on consolidations of variable interest entities.
The standard on derecognition limits when a firm can actually transfer a portion of a financial asset and account for the transferred portion as being sold. Existing guidance now allows firms to report many transfers of portions or components of financial assets as sales.
However, under the new standard, a transfer of a portion of a financial asset can be reported as a sale only when that transferred portion is a pro-rata portion of an entire financial asset, no portion is subordinate to another, and other restrictive criteria are met.
This clarifies the legal isolation requirements ensuring that a firm considers all of its involvements and the involvements of its consolidated entities to determine whether a transfer of financial assets may be accounted for as a sale. The newly approved standard also removes an exception that now allows a firm to derecognize certain transferred mortgage loans when it has not surrendered control over those loans.
The new standard also necessitates that a company to offer added disclosures regarding all of its continuing involvements with transferred financial assets. Continuing involvement can take many forms. For instance, recourse or guarantee arrangements, servicing arrangements, as well as offering certain derivative instruments. The new standard also necessitates that a company to provide expanded disclosures about its continuing involvement until it has no continuing involvement in the transferred financial assets. A company will also need to offer added information about transaction gains as well as losses resulting from transfers of financial assets during a reporting period.
Generally, the approved standards will be effective as of the start of 2010 and will apply to existing entities, such as existing qualifying SPEs. But, the amendments on how to account for transfers of financial assets will apply prospectively to transfers that happen on or after the effective date.
