Risk & Compliance

The End of the Entity?

FASB considers changes to FAS 140, dictating treatment of the qualifying SPE, and ponders replacing the concept.
Alan RappeportMay 30, 2007

The Financial Accounting Standards Board pushed ahead Wednesday with plans to revise Statement 140, which accounts for transfers and servicing of financial assets.

The rule dictates the treatment for qualifying special-purpose entities (QSPE), the dummy units that corporations may create to own assets that a company doesn’t want on its own books for various reasons. But as securitization products have grown more complex and varied over the last several years, FAS 140 has become considered an archaic tool.

Enron’s legacy brought tighter government scrutiny in recent years to the use of the entities, called SPEs by the now-defunct energy trader before they were exposed as being laced with conflicts of interest under their creator, ex-CFO Andrew Fastow. Regulators have remained cautious in their treatment of QSPEs, though, also because of the associations with Enron.

“The only reason to pursue the QSPE model is if we thought it was providing good information to investors,” said FASB member Leslie Seidman. Investors “do not view this accounting standard as providing them information that reflects the economic situation.”

To correct this, the board on Wednesday was considering a move away from the Passive Asset/Liability (PAL) model, which allows only “passive” assets and liabilities to be used in a QSPE. An alternative being considered by FASB is the simpler Linked Presentation (LP) model, which the board says eliminates the QSPE concept and “creates specific criteria” for determining when assets and liabilities that arise from transfers of assets should be linked on a balance sheet.

That potential change would entail removing a line containing the QSPE concept from the ninth paragraph of FAS 140, and inserting the gross amounts of the item from the balance sheet’s footnotes, thus raising the “derecognition” threshold.

“Users of financial statements tell us they don’t think we’ve done a good job of providing information on transfers of financial assts,” said FASB’s Patricia Donoghue, FAS 140 project manager, describing the current version of the rule. “That’s very troubling to us. The model just isn’t working.”

FASB is now considering what a change in the derecognition threshold could mean for a company’s right to pledge or exchange receivable assets. The board is determining the extent that a party’s continuing involvement with an asset must be considered for it to be “recognized.”

Removing the QSPE concept would affect other rules, as well, including Financial Interpretation 46R, the economic test that asks who stands to gain or lose the most from a QSPE. The board would have to determine which situations would pass the test of eligibility for the LP model.

FASB hopes to have the draft of a revised FAS 140 by the end of the year, and final statement ready by late 2008, according to Donoghue.