Rethink Off-Balance-Sheet Reporting: SEC

One hundred companies moved nearly $8 billion in assets with outstanding liabilities off their balance sheets, according to the commission's report...
Lisa YoonJune 20, 2005

Accounting authorities should rethink current guidance on how to report the financial results of leases and defined-benefit pension plans and continue to explore the possibility “of reporting all financial instruments at fair value,” the Securities and Exchange Committee asserted in a long-awaited staff report on off-balance-sheet arrangements and special-purpose entities released last week.

Further, the Financial Accounting Standards Board should press on with the task of improving current guidance on whether public companies should consolidate SPEs on their balance sheets, according to the SEC report, which was issued in compliance with Section 401c of the Sarbanes-Oxley Act.

Especially striking is the report’s findings (see Ron’s Rant) that of the 200 issuers of stocks and bonds studied, the top 100 companies moved nearly $8 billion in assets with outstanding liabilities off their balance sheets. By contrast, retained interests actually reported on balance sheets equaled about $1.6 billion.

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The SEC singled out lease accounting as an area in special need of more transparency. The report’s authors note that current rules treat lease contracts as if either all or none of the performance occurs at the beginning of the lease. That approach doesn’t let the balance sheet show that both parties in a lease agreement have some interest in the assets, receivables, or payables connected to the lease. The method results in economically similar arrangements getting different accounting treatments based on which side of the all-or-nothing performance at the beginning of the lease they fall. The effect is that about $16 billion in cash flows related to capital leases were undiscounted in the sample of companies studied. Further, the SEC reported that “there may be approximately $1.25 trillion in non-cancelable future cash obligations committed under operating leases that are not recognized on issuer balance sheets.”

The commission also took issue with a company’s option, under current rules, to delay recognition of certain gains and losses in pension plans and the sources of funding for the plans. The study suggests that about $414 billion in pension liabilities remain off balance sheet. Another $71 billion in liabilities related to other retirement plans are also off balance sheet.

The SEC determined that accounting and disclosure of financial instruments such as derivatives can be misleading, and hence a shift to uniform fair-value reporting should be mulled. “In an extreme example, an issuer could conceivably own three of the exact same corporate debt instruments, and account for each in a different manner,” according to the report.

The commission also wants the current guidance on the consolidation of SPEs to be simpler. “Clearly, the current consolidation guidance is complicated, despite the consistent objective of requiring consolidation when an investor controls another entity,” according to the SEC. One of the commission’s goals in improving the guidance is to make the convergence between U.S. and International Accounting Standards Board strictures easier.

In the report, the SEC also identified four goals for improving transparency in reporting:

• Discourage transactions and transaction structures motivated primarily by favorable accounting and reporting implications.

• Expand the use of objectives-oriented standards.

• Improve the consistency and relevance of disclosures.

• Focus financial reporting on communication with investors, rather than just compliance with rules.

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