Recent moves by the FASB in
response to negative comment on FIN 46 follow a familiar
pattern.
Scope creep is often a problem when
accounting guidance attempts to tackle complex problems
like off-balance sheet entities or derivatives. Just
like when FAS 133 was first introduced to put all
derivatives on the balance sheet almost everything came
to be viewed as a potential derivative (or something
with a potential derivative embedded in it); so too has
FIN 46’s effort to put off-balance sheet entities (SPEs)
on someone’s balance sheet ended up casting a wide net.
The FASB’s initial attempts to define SPEs as Variable
Interest Entities (VIEs), subject to consolidation tests
that would put such structures on the balance sheets of
their primary beneficiaries, similarly and, arguably,
purposefully cast a wide net with a tight mesh, so as to
not let any sought after fish get away.
After considerable push back from firms who did think they had anything
resembling SPEs (including many franchise operations), like with FAS
133's derivatives, the scope of entities subject to FIN
46 is being refined. In particular, those so-called VIEs
that are established for a business purposes, e.g., JVs
and franchises, and not as financial structures,
distinguishing them from what the SEC’s Chief
Accountant calls “the
SPEs of old,” have been reconsidered and the non-SPEs
will now be scoped out for the most part. Further,
constinuents will have more time to make sense of the
changes, but only for non-SPE VIEs (see deferral of
effective date below).
SPEs or “SPEs of old” have now been
"defined" by the FASB as those entities to which
enterprises would have previously applied the relevant
accounting literature for pre FIN 46 SPEs, which would
include EITF Issue No.’s 90-15, 96-20, 97-1, and Topic
No. D-14.
This is an important and instructive
outcome, showing how the FASB allows comment (and other
forms of constituent input) to come up with logical
counterarguments to its tentative guidance, which tends
to narrow and loosen the wide and tight nets it casts in
response to calls to improve financial reporting. All
the more reason that due process is important and
comment by knowledgeable constituents is critical.
The scope change and other modifications
to FIN 46 will be issued shortly in a new FIN 46-R. To
help everyone involved make sense of these changes, and
the FSP that continue to be issued, the effective date
for FIN 46-R has been delayed, until the end of Q1/04
for most firms (see below). However, and it is an
important one, the application of FIN 46 to “SPE’s of
old” has not been delayed--much to the dismay of the
Bond
Market Association/American Securization
Forum and others. The effectiveness of comment
and the ability to change the FASB's collective mind
does have its limits.
Major scope change
At the December 10 board meeting, the FASB
came to the significant decision to scope out many of
the business-oriented VIEs from FIN 46. Per the
FASB’s release, the Board decided to:
Provide that an enterprise need not
apply Interpretation 46 to an entity that is a business
as to be defined in the final Interpretation, unless one
of more of the following conditions exist, (Other
generally accepted accounting principles would apply to
such entities):
- The reporting enterprise and its
related parties* were involved in the formation of the
entity. However, this condition would not apply if the
entity is an operating joint venture under joint
control of the reporting enterprise and one or more
independent parties [franchises will be
included as well in this exception, per the December
17 meeting].
- Substantially all of the activities
of the entity involve or are conducted on behalf of
the reporting enterprise or its related parties.
- The reporting enterprise and its
related parties provide more than half of the equity,
subordinated debt or other forms of subordinated
financial support to the entity.
- The activities of the entity
primarily relate to securitizations, leasing
arrangements, or other forms of asset-backed
financing.
*The term related parties
as used in this list of conditions refers to all parties
identified in paragraph 16, except de facto agents under
item 16 (d)(i).
Deferral of effective
date
In conjunction with the scope out and
other revisions to FIN 46 in FIN 46-R, the FASB agreed
to Board Member Ed Trott’s proposal to establish three
buckets of firms--public entities, public small business
entities and non-public entities, with different
deferrals.
As a result most firms will have roughly a
quarter to digest, implement and have audited their
application of the revised, FIN 46-R. Since for most
SPE’s of old the changes in FIN 46-R are negligible, the
FASB sees this as a realistic proposition. [Leslie
Seidman and George Batavick, however, continue to hold
dissenting views, suggesting that the FIN 46-R changes
are far from trivial and believe the effective date for
SPEs should be deferred as well. Ms. Seidman points to
changes in guidance touching on derivatives, service
contracts and equity investment treatment that may take
a significant amount of time for constituents to digest.
She is also concerned, for example, that divergence in
market practice for expected return/loss calculations
may cause different conclusions on VIE consolidation
tests to be reached across firms.]
Non-small business public
entities will still have to apply FIN 46, or
early adopt FIN 46-R, for all SPEs created prior to
February 1, 2003 at the end of the first interim or
annual reporting period ending after December 15, 2003.
Unless the entity decides to early adopt FIN 46-R, its
provisions must be applied as of the end of the first
interim or annual reporting period ending after March
15, 2004. For all other VIEs that still fall within the
scope of FIN 46-R and were created prior to February 1,
2003, non-small business public entities must adopt FIN
46-R at the end of the first interim or annual reporting
period ending after March 15, 2004 (they may also elect
to early adopt the revised guidance at year end).
The same holds true for all entities (SPEs of old or
not) created after January 31, 2003 that were required
to be accounted for under FIN 46: FIN 46 will continue
to apply, unless they choose to early adopt FIN 46-R,
until periods after March 15, 2004, when FIN 46-R
applies to all entities.
Public small business
entities will have until the end of the first
interim or annual period after December 15, 2004, an
additional year, to adopt FIN 46-R for SPEs created
after January 31, 2003, though they are free to early
adopt. Like larger firms, however, they must adopt
pre-revision FIN 46 provisions for SPEs created prior to
February 1, 2003, but they have until periods after
December 15, 2004 to adjust for the FIN 46-R change
