Brandon Seiter and Dr. Kay Stice, School of Accountancy and Information Systems
In 2002 the FASB, which sets all accounting standards for US publicly traded companies, met with its international counterpart the IASB in what is know as the Norwalk Agreement. The two organizations released a joint statement announcing their intentions to create a project that would converge the two accounting standards. It was my goal to understand how the convergence process was coming along. Originally I planned to look at foreign companies’ 20-F forms, a reconciliation from their foreign GAAP to US GAAP. Unfortunately as I started looking at several 20-F forms I realized that only recently have companies adopted IFRS and that a comparison would not provide much information. Comparing a new 20-F form that reconciles US GAAP to IFRS to an older 20-F form which reconciles US GAAP to a country specific GAAP would be like comparing apples to oranges and would tell me nothing about how the convergence process has occurred over the previous three years.
To replace my previous research topic, I chose to research a very specific accounting issue that affects large financial firms. The accounting issue involves the release of FIN-46R, a FASB statement which clarifies the consolidation and disclosure of Variable Interest Entities. VIE’s, also known as Special Purpose Entities (SPE’s), were made famous by the Enron scandal. Enron used VIE’s to hide millions of dollars in losses and improve their balance sheet. The FASB set out to clarify what constitutes a VIE and how they must be reported.
A major issue clarified by FIN-46R was that financial control of VIE’s is not only dependent on a majority voting interest, but on other factors as well. Before FIN-46R, companies created SPE’s where they owned no share or only a minority share of the voting rights, but still had control of the entity due to the large amount of debt extended to the entity. A company would negotiate terms which allowed it to collect its set interest payments, plus a share of the disposable net income. Basically, they were in control of an entity that would normally be consolidated to their financial statements. Instead these companies kept all of the entity’s financial information off their books, often times improving the quality of their balance sheet.
The goal of my research was to understand more about how companies were disclosing their involvement in VIE’s and also compare disclosure of VIE’s in US GAAP to foreign GAAP.
Here is a highlight of a few companies I researched:
Citigroup: The 2004 financial statements mention they adopted FIN-46R as of January 1, 2004. The company was involved in several VIE’s with its asset management group and its private equity group. On page 25 of these financial statements, the company summarizes all its activities in VIE’s in which it consolidated to their main financial statements. These VIE’s constituted in $1.6 Bn in assets that were not consolidated before the acceptance of FIN 46-R. There is also a great deal more disclosure about Citigroup’s unconsolidated VIE’s. VIE’s with which Citigroup had significant involvement held $116.6 Bn in assets as of 12/31/03. This amount would not be disclosed of prior to adopting FIN-46.
JPMorgan: The 2004 financial statements have much to say about VIE’s and FIN-46R. The company consolodated $50.7 bn in assets that were part of VIE’s. The company details in two pages how they account for VIE’s and what type of VIE’s they are involved in for each division, far more extensive than Citigroup’s disclosure.
Deutsche Bank: The 2004 financial statements have over 31/2 pages dedicated to explaining their accounting for VIE’s including a history of its adoption of FIN-46 and FIN-46R along with the totals of changes to assets as a result of each adoption. Its interesting to note that the company reported a decrease of €12.5 bn in assets due to FIN 46-R. This was a result of the deconsolidation of guaranteed mutual funds, something not mentioned in Citigroup and JPMorgan’s 10-K’s.
Banco Do Brazil: This company, which does not report its data in conformance to US GAAP, has no mention of any VIE’s. It does, however, disclose three separate Special Purpose Companies (SPC’s). Under Note 13 – Funds Obtained in Foreign Capital Markets, the company tells of three companies formed to specifically sell securities in the foreign market. Due to the nature of the bank, it is likely that the company has VIE’s similar to DB, JPM, and Citigroup but is not disclosing of them separately.
Lloyds Bank: In 2004 the company stated that they would be adopting IFRS as of January 1, 2005 and listed several areas where this adoption would create large differences. It mentioned SPE’s as an area where the company would have to report additional assets that were not reported in UK GAAP. The company’s financial statements reported in UK GAAP make no mention of VIE’s or SPE’s. Lloyds’ 20-F form, which reports US GAAP results, however does explain its involvement in VIE’s with respect to FIN-46R. As of December 31, 2004, the company had £4.5 bn in assets that are consolidated under FIN-46R. The company’s disclosure is similar to that of JPMorgan in that it breaks down the VIE activities in the company’s different divisions.
After researching several companies’ VIE disclosure both in and out of the US, I found that not all companies disclose their involvement in VIE’s in the same manner. It was interesting to see that even companies using US GAAP differed greatly in the explanations of their interpretations of FIN-46R and in the amount of disclosures included in the notes to the financial statements. Even more interesting was to look at a company like Banco do Brazil and see that it did not separately disclose its involvement in VIE’s with the exception to three small SPC’s.