HAMBURG UNIVERSITY FOR ECONOMICS AND POLITICS
MASTER OF INTERNATIONAL BUSINESS ADMINISTRATION

‘Objectives and Techniques to consolidate Special Purpose
Entities under the Framework of International Financial Reporting
Standards and United States Generally Accepted Accounting Principles’

by:
Yelena Russakova

January 2003

CONTENT

Abbreviations
Key Definitions
Introduction

I. SPEs: characteristics, formation, structure, usage
1.1 Common features of SPEs
1.2 Typical structures of SPEs

II. The objectives of SPE consolidation
2.1 The objectives of financial accounting and reporting
2.2 The legal advantages of SPE consolidation
2.3 Separate accounting purposes of SPEs

III. Consolidation of special entities under US GAAP
3.1 Existing accounting guidance
3.2 Qualifying and nonqualifying SPEs
3.3 SPE consolidation based on voting and variable interests
3.4 Consolidation procedures, techniques and initial measurement

IV. Consolidation of SPEs under IFRS
4.1 Accounting guidance under IFRS
4.2 Main conclusions on SPE consolidation under SIC 12
4.3 SPE consolidation under IAS 27
4.4 Consolidation techniques in acquisition accounting

Summary and conclusions

Sources
Appendices

INTRODUCTION

Until recently, many people in the accounting profession, never heard of SPEs. Some who heard of these esoteric financing vehicles knew little about how they operated or the accounting standards that guide the accounting and financial reporting by companies who sponsor SPEs. Reports in the popular press that preceded Enron′s case in December 2001 introduced many accountants for the first time to the topic of SPEs. Even though SPE financing vehicles have been around for about two decades, they failed to capture the attention of many participants in the mainstream of accounting discourse.

The origin of SPEs can be traced to the way large international projects were financed. Let’s say a company wants to build a gas pipeline in Kazakhstan and needs to raise $1 billion. It may find that potential investors of the pipeline would want their risk and reward exposure limited to the pipeline, and not be subjected to the overall risks and rewards associated with the sponsoring company. In addition, the investors would want the pipeline to be a self- supported, independent entity with no fear that the sponsoring company would take it over or sell it. The investors are able to achieve these objectives by putting the pipeline into a special purpose entity that is limited by its charter to those permitted activities only. Thus a common historical use of SPE was to design it as a joint venture between a sponsoring company and a group of outside investors. The SPE would be limited by charter to certain permitted activities only – hence the name. Such an SPE is often described as brain-dead or at least on auto-pilot. Cash flows from the SPE’s operations of the project are to be used to pay its investors.

Also called special purpose vehicles, SPEs typically are defined as entities created for a limited purpose, with a limited life and limited activities, and designed to benefit a single company. They may take the legal form of a partnership, corporation, trust, or joint venture. SPEs began appearing in the portfolio of financing vehicles that investment banks and financial institutions offered their business customers in the late 1970s to early 1980s, primarily to help banks and other companies monetize, through off-balance-sheet securitizations, the substantial amounts of consumer receivables on their balance sheets. Current accounting standards require an enterprise to include subsidiaries in which it has a controlling financial interest in its consolidated financial statements.

Transactions involving SPEs have become increasingly common, and the existing accounting literature related to VIEs is fragmented and incomplete. Under US GAAP the accounting guidance established by FASB for consolidation of SPEs will be effective only after March 15, 2003. FIN 46 will apply to any business enterprise— both public and private companies—that has an ownership interest, contractual relationship or other business relationship with an SPE. The Board changed the name of FIN 46 to Consolidation of Variable Interest Entities mainly because the term “special-purpose entities” is not sufficiently defined in current accounting pronouncements and its common use does not match its use FIN 46. Therefore, VIE is now the term now used by the FASB in place of the older term SPE. Also, since the crash of Enron, SPE has a negative connotation. The FASB now prefers the term VIE to depict a special entity in which the developing sponsor may have a varying interest in the financial risk.

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