FASB Consolidation Policy Project Tabled.

If you're a CFO and have an SPE that you're not consolidating, you're at risk. The SEC might challenge that treatment and say you need to consolidate it.

Don't expect a final statement or another exposure draft on the FASB's Consolidation Policy project in the second quarter, as previously

In January, the board announced it had determined that "there is not sufficient board member support to proceed with either a final statement on consolidation policy, or an exposure draft on entities with specific limits on their powers (SPEs)."

"Several dynamics are going on," says Ronald Bossio, the FASB senior project manager. The delay, he says, is due to timing and support. He explains that with terms expiring on June 30 for two board members who were part of the majority support and deadlines looming to complete other projects, "it just makes sense to shelve this for a few months." And, with two new board members beginning, Bossio notes, "Some refashioning and rethinking may be required of what we have in the document at this moment to regain sufficient support; whether that might be fine-tuning or considerable rethinking is yet to be seen.

Financial Executive asked Paul Munter to analyze the decision. Munter is a CPA and KPMG Professor and Chairman of the Department of Accounting at the University of Miami, and a developer of continuing education programs for financial and accounting executives. He spoke with FE Managing Editor Ellen M. Heffes.

Q What issues are involved in the Business Consolidation Policy project?

A The Consolidation Project has been on the FASB agenda for almost two decades, the genesis being accounting in financial statements for the different kinds of business arrangements and investments. Historically, the consolidation model has been driven by ownership and control -- controlling financial interest being the operational words.

With today's wider range of structures -- in terms of the investment in companies, businesses or activities beyond just ownership -- the nature of control is not so clear, for the present or future.

For example, instead of direct ownership, options, when exercised, give ownership; or convertible securities or contractual relationships, etc. Other issues make the decision to consolidate even more complicated. It might appear as if there is control over an entity; yet tweaking the structure mildly can provide a radically different financial presentation.

Q Where is it in the process, and why is it taking so long for a final document?

A The FASB has issued two different exposure drafts, the first in 1995 and a revision in 1999. Several times they planned to issue a final document and did not, [making it] obvious they didn't have enough board support for a final standard, at least in its current form. As an aside, since five of the FASB's seven board members are required to vote in favor of issuance, and since there was no document, it tells me at least three -- if not four -- were uneasy about the approach being taken.

Also, part of the decision is complicated by the mechanics of consolidation itself. Let me give an example. If I own 100 percent, I'm going to pick up all the assets, liabilities, revenues and expenses of that investee in the consolidated statements. If I own 80 percent, I'm still going to pick up all the revenues, expenses, assets, and liabilities. Then I'm going to back out the 20 percent minority interest. The problem, from a mechanical point of view, is suppose I own 25 percent of another entity, but decide I should still consolidate it. Now I'm picking it all up, then I'm going to back out 75 percent of this non-controlling interest. As I go down that "slippery slope," I get a smaller and smaller ownership percentage but still think I ought to consolidate. You can see how I'd run into some real mechanical problems.

To take this issue of control to the extreme, if it's not wedded to ownership, you could envision situations where you could argue control exists without any level of ownership. What do you do then? You pick up all the assets, liabilities, revenues, expenses, and back them all out? And what happens to the financial statements if we start applying it in situations where there is a smaller and smaller ownership interest? That, too, is a concern to board members.

Q What's the real impact of the FASB's announcement on the preparation of financial statements, and when they return to deliberate; what will they focus on?

A The thing that the board is going to focus on -- at least in the near term -- is the treatment of so-called "special purpose entities" (SPEs). One of the problems is we don't have a good definition for what constitutes a special purpose entity. Some have even said, "I don't know what makes an SPE so special."

The basic notion of an SPE is, you have an entity created and its activities are restricted to a specific thing, like leases. Or, an entity created to service my private-label credit card receivables.

It's a complicated thing we've had going back to FASB Statement No. 125 -- which has been replaced by FAS 140 -- that deals with transfers of assets and whether those transfers qualify as a sale or not. Suppose I've got a portfolio of private-label receivables -- as do J. C. Penny, Bloomingdale's, Sears, Home Depot, etc. -- and I want to get the cash out of them. I transfer them to a Citibank or Merrill Lynch; they pay me, and obviously there's a discount associated with it. So I get the cash. The question is: does that transfer constitute a sale of the receivables, or does it constitute a collateralized borrowing? There are requirements in 125 (again, replaced and brought forward in 140) that if you meet three tests, you've got a sale. The problem is often that those transfers are done using an SPE, and oftentimes the transferor retains a significant portion of the beneficial interest in the SPE. You say, "I transferred it to the SPE, it qualifies as a sale." But, if you turn around and say you've got to co nsolidate the SPE, you've basically undone the sale.

The Emerging Issues Task Force said, "Under certain circumstances (three criteria), you don't consolidate an SPE, subject to a transfer under 125 -- or now under 140." But, what about other SPEs? In issue 90-15, the EITF said, "Here's how we deal with it if you have an SPE associated with a lease arrangement." Then you ask, "How about these other SPEs?" The SEC staff issued an announcement (in EITF topic D-14) that basically says, "We're going to look at things on a case-by-case basis."

So if you're a CEO and have an SPE that you're not consolidating, you re at risk because the SEC might challenge that treatment and say you need to consolidate it. The lack of guidance in this several month-window [in which] we'll see no activity coming forward creates an ongoing risk for a CEO in terms of accounting for SPEs and other unconsolidated affiliates.

Q In the meantime, working under the status quo, what specifically should CFOs /companies do?

A If I were a CEO, first I'd look at the kinds of investees we've got that are not being consolidated. If there are questions, I'd have a thorough discussion with my auditor; if that's a national firm, bounce it up to the national level. Also, depending on how significant it is, the company might want to consider going to the SEC for a pre-clearance of matters and getting approval, hopefully, to not consolidate it.

On the one hand, there's a tendency to say, "It really doesn't matter whether I consolidate it or not, because I'm still going to end up with the same amount of net assets and net income," But in terms of your financial ratios, it makes a big impact because you're grossing up the balance sheet -- you're grossing up the income statement by consolidation -- so things like your profit margins oftentimes will look worse. Depending upon the structure of the investee, things like working capital numbers and debt-to-equity numbers look worse when consolidated.

Other examples include franchiser/franchisee business, the real estate industry and more. It goes quite deep. As an unnamed board member said, "It's like an onion; you peel off the first layer, then there's another layer, and another and another." You're looking at the issue of should you consolidate something. But then you start drilling down, and there are so many structures, possibilities and arrangements. There are a lot of areas where you could completely change the financial reporting structure of a business overnight so that it would look totally different.

Q What's your advice while waiting for the final document?

A I say, "Forewarned is forearmed." Get with your auditor and look at your situation in a variety of ways to assess your vulnerabilities. Become aware of which investees pose a potential challenge, Even now, [before the FASB ruling] the SEC could challenge your treatment. So, I wouldn't wait -- I'd want to be aware of where there are areas of potential challenge, even under the existing model.