Accounting & Auditing

Accounting Standards Update No. 2009-17 (ASU 2009-17) codified Statement of Financial Accounting Standards No. 167 (FAS 167), Amendments to FASB Interpretation No. 46(R). This new standard improves the financial reporting of those entities involved with a variable interest entity (VIE) and provides more relevant and reliable information to financial statement users.

This standard responds to the consolidation model’s perceived shortcomings highlighted most recently by the economic downturn. Those include concerns about the preparer’s ability to structure transactions under the current guidance to avoid consolidation, balanced with the need for more relevant, timely and reliable information about an entity’s involvement in a VIE.

Highlighting More Significant Amendments

FAS 167 amends many provisions of FIN 46(R). The more significant amendments are summarized below.

Elimination of the QSPE Exemption

Consistent with the elimination of the Qualified Special Purpose Entity (QSPE) concept in FAS 166, Accounting for Transfer of Financial Assets – an Amendment of FASB Statement No. 140, FASB removed the related QSPE scope exception from FIN 46(R). Therefore, all QSPEs that exist on the effective date will be subject to FIN 46(R) as amended by FAS 167.

Changes in Determining Whether a Contractual Arrangement Is a Variable Interest

The criteria for determining if a service provider or decision maker has a variable interest have changed. As a result, certain contracts will no longer be variable interests.

Changes to Triggering Events for Reconsideration of an Entity’s Status as a VIE

Reconsideration of whether an entity is a VIE is still based on triggering events, with the following amendments:

• Removal of the troubled debt restructuring exception
• An additional criterion is established relating to a change in how the entity is controlled

Identifying the Primary Beneficiary of a VIE

Under FAS 167, an entity is deemed to have a controlling financial interest if it meets both of the following criteria:

1. The power criterion – The entity must have power, through voting or similar rights, to direct the activities that have the biggest effect on the VIE’s economic performance
2. The losses/benefits criterion – The entity should have an obligation to absorb the expected losses of the VIE or the right to receive anticipated returns

Only one entity, if any, will be the primary beneficiary of a VIE. Although more than one entity could meet the losses/benefits criterion, only one entity, if any, will have the power to direct the VIE activities that have the biggest effect on the entity’s economic performance.

Reconsideration of a VIE’s Primary Beneficiary

FIN 46(R) required entities to reconsider whether they were a VIE’s primary beneficiary only if specific events arose. FAS 167 requires such an assessment each reporting period.

Narrows Use of Removal or “Kick-out” Rights

This standard offers fewer instances when removal or “kick-out” rights can be considered in determining whether an entity is a VIE, and who is the VIE’s primary beneficiary. In either evaluation, the ability to remove or kick out a decision maker can be considered only if a single party (including its related parties) can unilaterally exercise that right.

Impact on Trust Preferred Securities

Our evaluation indicates FAS 167 will not affect the current treatment of trust preferred securities; in other words, the trust will not be consolidated. In most cases under FIN 46(R), the sponsor did not consolidate the trust because the sponsor did not have a significant variable interest. From the sponsor’s perspective, neither the residual interest held (since it is not viewed as equity at risk because it was never funded in cash), nor the loan payable to the trust would be considered variable interest (since they create variability). In addition, the sponsor’s unconditional guarantee of the trust preferred securities is irrelevant, since in substance, the sponsor is guaranteeing its own obligations.

Presentation

The primary beneficiary should present these items separately on the face of the balance sheet (statement of financial position):

• The assets of a consolidated VIE that can be used only to settle obligations of the consolidated VIE
• Liabilities of a consolidated VIE for which creditors (or beneficial interest holders) do not have recourse to the general credit of the primary beneficiary

Disclosure

The four principal objectives of the disclosures introduced in the standard are to provide financial statement users with an understanding of:

• Significant judgments and assumptions made by the entity in determining whether it must consolidate a VIE and/or disclose information about its involvement with a VIE
• The nature of restrictions on a consolidated VIE’s assets and on the settlement of its liabilities reported by an entity in its consolidated balance sheet, including the carrying amounts of such assets and liabilities
• The nature of, and changes in, the risks associated with an entity’s involvement with the VIE
• How an entity’s involvement with a VIE affects its balance sheet, earnings and cash flows

In all cases, the content and extent of the disclosure necessary to satisfy the objectives will vary with the facts and circumstances of the particular VIE.

Specific Required Disclosures about VIEs

In addition to disclosures required by other standards, the following scenarios will require additional disclosures specific to the VIE. When the entity:

• Is the primary beneficiary of a VIE or an entity that holds a variable interest in a VIE, but is not the entity’s primary beneficiary
• Is the primary beneficiary of a VIE
• Holds a variable interest in a VIE, but is not the VIE’s primary beneficiary

Effective Date & Transition

ASU 2009-17 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2009, and for interim periods within that fiscal year, with earlier adoption prohibited. It must be applied to all entities previously subject to FIN 46(R) and to former QSPEs that exist on the date of adoption.

Considerations

The amendments FAS 167 makes to FIN 46(R) are significant and are expected to result in changes in conclusions about consolidation (both new consolidations and deconsolidations). Adoption may be complicated and require significant effort from management. In addition, companies should begin evaluating the implications of the revised requirements as they negotiate the financing and business arrangements that potentially involve VIEs. Entities will need to re-evaluate whether any entities in which they hold variable interests are VIEs and who the primary beneficiary is under this new ASU.

Off-balance sheet arrangements are used by many financial and nonfinancial companies for a variety of reasons, including managing risk and reducing borrowing costs. These new reporting requirements could bring more of these arrangements onto a company’s books. The impact could reach beyond financial reporting to include current and future business ventures, financing, financial metrics, operations, stakeholder communications, internal control and information technology systems.

For more information about these changes, contact your BKD advisor.