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Taking a new look at variable interest entity
accounting rules
Construction
firms with interests in separate yet related businesses such as real estate
holding or development companies need to take a second look at the way they
handle financial reporting for those interests. A recent interpretation by
the Financial Accounting Standards Board (FASB) of Accounting Research
Bulletin 51 may change the way these firms prepare their financial
statements.
In Interpretation No. 46, Consolidation of Variable Interest Entities,
FASB said it did not intend to limit use of variable interest entities
(defined loosely as businesses that depend on other businesses to survive)
but to improve financial reporting by the companies involved with them.
For contractors, that means considering whether each business in which they
hold an interest can be reported separately or must be consolidated for
reporting purposes.
Risks and returns
Such interests need not be equity interests to come under the scope of the
FASB interpretation. The level of financial risk a contractor assumes for an
equipment rental company, for example, or the residual returns expected for assuming
that risk, may qualify the contractor as a primary beneficiary of the
equipment rental company.
Financial reporting requirements for primary beneficiaries — those that
assume most of the risk or receive most of the benefit — are different from those
that hold lesser interests. As a result, contractors should consult their
certified public accountants to determine whether variable interest entities
must be consolidated into their financial statements for fiscal years
beginning June 15, 2003.
Debt implications
Contractors also must determine how consolidated statements will affect their
debt-to-worth ratios, especially in the case of long-term debt that has until
now been off their balance sheets. Those currently negotiating lines of
credit should pay particular attention to such potential changes.
Finally, contractors should be ready to prepare multiple financial
statements, as different creditors and organizations may require different
reports.
FASB said that it issued the interpretation to make it easier to compare
enterprises involved in similar activities, even when some of those
activities are conducted through variable interest entities.
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