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Monday, September 3, 2012

Accounting: How special purposes entities work

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Special Purpose Entities (SPEs) are legal structures such as trusts that provide financial benefits to companies seeking to enhance their financial management. To illustrate, SPEs facilitate 'asset securitization', a form of borrowing against reorganized assets that can lower the cost of capital. Moreover, although more difficult with increased regulation, SPEs allow for off-balance sheet debt that are an advantage to organizations due to 'cleaner' appearing financial statements. In addition to the protection of assets that would otherwise be exposed to legal claims per Robbins, Salman & Patt, Ltd., special purpose entities also allow alternative options for depreciating assets according to the CPA Journal.

SPEs have come under increased scrutiny due to abuse of these financial mechanisms in the past. A corporation named Enron created a financial scandal large enough to spur more focused accounting rules because SPEs were the mechanism used to manipulate accounting data and deceive investors. However, in the CPA Journal, Jalal Soroosh Phd and Jack T. Ciesielski CPA state these regulations are insufficient to stem problems associated with misleading shareholders. For example, in the past, by not owning 50 percent or more of an SPE, but maintaining control of it, corporations avoided consolidating SPE financials such as debt into their own balance sheet.

It is important to note the date of accounting commentary such as that in the CPA Journal as it can predate ensuing accounting regulation of SPEs. The Financial Accounting Standards Board (FASB) continually establishes official accounting standards that companies must follow when preparing financial statements; this includes the aforementioned rules pertaining to special purpose entities. Furthermore, official accounting rulings such as FASB Statements 166 and 167 eliminated 'qualifying special purposes entities' and increased corporate disclosure requirements for organizations utilizing SPEs.

Federal Accounting Standards Board regulation of SPEs does not eliminate their use however. Moreover, although the size of loans assumed by special purpose entities must be  accounted for under newer FASB rules, loan transactions via SPEs can still qualify for off-balance sheet documentation  according to BDK, LLP. Jon McDowell of BDK, LLP describes this 'loan participation' as involving proportionate ownership and full exchange of assets between interest holders that can in cases excluding 'sales' of loans qualify for off-balance sheet recording. 

Despite the continued existence of SPEs, The Basel Banking Committee reaffirms the added affect FASB rulings 166 and 167 have on SPEs. Specifically, the committee states the changes made in 2010 “significantly reduce the ability of certain transactions to qualify for off-balance sheet treatment.” In any case, when investing knowing if a company makes use of SPEs, which set of accounting rules a corporation is subject to i.e. International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP), and closely examining corporate disclosures can all assist in being better aware of that businesses' financial activities.

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