Though 2002 had its share of blowups, another defining characteristic of the year was the focus on, and potential threat of sweeping changes in accounting, specifically with regards to off-balance-sheet assets and risk.

Center stage was (and still is) the consolidation project. Responding to loopholes and abuses of special purpose entities, particularly as exploited by Enron Corp.'s failure, the Financial Accounting Standards Board has spent 2002 re-examining existing generally accepted account principles (GAAP) through open meeting discussions, an exposure draft and several redeliberations.

A near final draft, released to certain "insider" parties for comments in late December, is being worked on by FASB. One major change in the language of the draft and indicative of the direction FASB has chosen is that SPEs (which dropped out of the discussions during the fall because the board was unable to specifically define them) are now referred to as Variable Interest Entities, or VIE for short. The final rules are scheduled for a mid-January release, though market talk speculates that FASB will not be able to meet that launch date. Regardless, according to FASB, VIEs established after a two-week period following the final release will be immediately subject to the new interpretation. For pre-existing VIEs, public companies will be required to implement the new guidelines for their first reporting period beginning after June 15, 2003 (the third quarter of this year for calendar year companies).

An enterprise that must consolidate under the new guidelines will be required to disclose the nature, purpose, size and activities of the VIE, as well as its maximum exposure to loss as a result of its involvement with the VIE. Also, apparently non-consolidating enterprises that are significantly involved with the VIE will disclose the same information.

According to Marty Rosenblatt of Deloitte & Touche, the new draft draws two paths for deciding whether or not an "entity" is to be consolidated by the enterprise in question. Cited from Deloitte's summary, an entity is either one "which voting interests are used to determine consolidation (this is the most common situation)" or one "for which variable interests are used to determine consolidation (the subject of this Interpretation)."

As has been the case throughout most of the 2002, FASB has set forth various guidelines and thresholds to determine whether or not an entity has a substantial enough equity investment to be deemed independent. The next condition involves the nature of the actual equity investments in the entity, whereby for the entity to avoid being consolidated, its equity investors would need to meet or rather fail certain conditions proving a limited role as a controlling party.

FASB is still intending to exempt FAS 140 qualifying-SPEs from the consolidation analysis. However, the auto exemption does not apply if the variable interest holder in the QSPE is in a position that would have prevented derecognition of the assets if it had been the transferor.

"There will be complications in trying to apply that standard to non-transferors, including determining legal isolation, allowable derivatives, and ability to participate in auction calls," said Rosenblatt.

Some specific uncertainties

Similar to exposure draft discussion, in the most current rendition of FASB's guidelines, the board does not satisfactorily clarify how to calculate expected loss, which is a key component in determining an enterprise's interest in a VIE, and whether or not (or how much) of the VIE it is to consolidate, said one accountant familiar with the situation.

It is possible, for example, for the sum of each party's estimated expected loss to exceed the expected loss of the entire portfolio of assets (because of diversification).

According to one accountant, another area triggering a stir, multi-seller ABCP conduits as they exist today would probably be consolidated onto the balance sheet of the bank sponsor. Throughout the year, there was much talk of a "silo" approach, whereby the transferors or sellers in a conduit become part of the analysis, and in certain situations would consolidate their portions of the asset pool. In that case, the bank would not bring the silo-ed assets onto its balance sheet.

Since the original exposure draft, however, the silo approach for transferors to multi-seller conduits has been tightened considerably to only include situations where the transferred assets are essentially the only source of payment for specified liabilities, said Deloitte's Rosenblatt.

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