Jacob Myers Deloitte & Touche, LLP

sprocketflipOil and Offshore

Nov 8, 2013 (3 years and 10 months ago)

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Jacob Myers

Deloitte & Touche, LLP

Agenda


Introduction


Background
-

FIN 46(R), FAS 140, FAS 167


Comparisons to newly issued FAS 167
guidance


Research tools


Case study


Audit issues


Questions & Comments






Introduction


Jacob Myers


Deloitte Senior Manager


Assurance Services


Service clients in various industries


Financial Services, Software, Agriculture


St. Louis University


Majors
-

Accounting and Finance


Other organizations


St. Louis Variety Club


Finance Committee


St. Louis University Business School Alumni Board







Why Consolidation Guidance


Add transparency and consistency to the financial
statements


Many firms were avoiding reporting debt and losses
from special purpose entity (SPE) deals


Enron


Recent credit crisis


Impact of consolidation in marketplace


Financial ratios


Loan covenants


Regulatory capital


Cost to implement guidance, processes


FIN 46(R)


Variable Interest Entities


VIEs


Special Purpose Entities


SPEs, off balance sheet


Form & Purpose of VIEs


Trust, Partnership, joint ventures, or Corporation


Facilitate transactions


Transfer of Assets, leasing, hedging, R&D


Low
-
cost financing structure


Characteristics of VIEs


Activities are limited


Equity investor role minor


less than 10%


Sponsoring firm’s involvement


Guarantees


Contribution of Capital


Risks and rewards

FIN46(R)


Consolidation of VIEs


Prior GAAP
-

ARB 51


Consolidated based on voting rights


Identifying if a VIE exists


Equity at risk not sufficient to permit the potential VIE
to finance its activities


Equity investors lack one of the following:


Direct or indirect ability to make decisions about entity
through voting or similar rights


An obligation to absorb the expected losses of the entity


Rights to receive the expected residual returns of the entity



FIN46(R)


Identification of the Primary Beneficiary of the VIE


Requires the primary beneficiary to consolidate


Characteristics include (mirror equity investors in a VIE):


The direct or indirect ability to make decisions about the VIEs
activities


The obligation to absorb the entity’s expected losses


The right to receive the entity’s expected residual returns


Assessment of control


Entity that bears the majority of the risk

FIN46(R)


Disclosure Requirements


For Primary Beneficiaries


VIE’s nature, purpose, size and activities


Carrying amount and classification of consolidated assets


Lack of Recourse (if any)


Significant Variable Interest (Not Primary Beneficiary)


Nature of involvement with VIE


Nature, purpose and size of VIE


Exposure to losses

FAS 140


Transfers of financial assets


Mortgage loans, accounts receivable, credit card
receivables


Qualifying Special
-
Purpose Entities
-

QSPE’s


Indicated that financial assets transferred to a QSPE
are typically derecognized by the transferor


Legal isolation concept


Permits derecognition of a portion or a
component of a financial asset


Relates to FIN 46(R) because QSPE’s are exempt
from consolidation requirements


Potential Primary Beneficiary

Potential VIEs

Guarantees Debt































ABC Data Center, LLC

Max Return 6%

95% Debt owed by
JP Morgan







Leases Data Center









5% Equity
Microsoft













Unrelated
Shareholders
& Debt
holders

Facebook


Shares of Intel



70% Equity





Investment
of 1%
Outstanding





30% Debt







XYZ Office Leasing



95% of Debt owed
by Goldman Sachs





Leases Office Space





5% Equity Non
Voting
Metlife

FAS 167


Recently issued guidance for consolidations


Why FAS 167


Needed to expand disclosure requirements of FIN 46R
and address elimination of QSPEs


Broader Scope:


Includes Entities covered under FIN46R and QSPE’s


FAS 166 eliminated the concept of a QSPE


Amends derecognition guidance in FAS 140


Expands the Consolidation and Disclosure
Requirements associated with VIE’s

Comparison

FIN 46(R)

1.
QSPE’s are generally exempt



2.
Primary Beneficiary
-

Quantitative Reasoning:


Based on Risks and Rewards



3.

Shared Power:


Focus is on absorbing
expected losses or receiving
expected returns


FAS 167


1.

Transferors, sponsors, and
investors in QSPE’s need to
consider consolidation and
disclosure

2.

Primary Beneficiary
-

Qualitative Reasoning:


Power and economics model


Power to direct activities


Obligation to absorb losses

3.


Shared Power:


Power to direct activities


Do decisions require the
consent of both parties


Comparison

FIN 46(R)

4. Reconsideration of
Primary Beneficiary:


Changes in contractual
agreement


Addition or disposal of
interest


5. Reconsideration of VIE:


Interest holders reconsider
whether entity is a VIE if
certain events occur


FAS 167

4. Reconsideration of
Primary Beneficiary


Continuous reconsideration




5.
Reconsideration of VIE:


An additional event requires
reconsideration

Comparison

FIN 46(R)

6. Presentation Requirements:


Not required to present
consolidated VIE separately
on Balance Sheet

FAS 167

6. Presentation Requirements:


Must present separately on
the face of Balance Sheet the:


Assets used to settle
obligations


Liabilities for which creditors
do not have recourse against
primary beneficiary

FAS 167 Disclosure Requirements


Financial preparers must disclose method for
determining whether they are the primary beneficiary
of a VIE


Disclose significant judgments and assumptions made


Must disclose the details of any financial or other
support provided to a VIE


Disclose reasons for providing the support


Disclose all terms of arrangements and agreements with
VIE


If Shared Power between multiple parties


Disclose Significant Factors and Judgments made in
determination

Research Tools


Orginal FASB pronouncements


Third party service providers


Lawyers, accountants, etc.


Online research tools


Other company disclosures


Other publications


AICPA, SEC, public accounting firms, state societies

Case Study

XYZ Oil is an established oil drilling company that wants to expand
its operations to offshore drilling platforms in the Gulf of
Mexico. XYZ determines that it can obtain the $350 million
needed to lease the platform by issuing debt at an annual
interest rate of 5%.

Instead of leasing the platform itself, XYZ decides to establish a
separate legal entity, Saltwater Drilling Co., to lease the drilling
platform. In doing so it can obtain the $350 million needed at an
annual rate of 4%.

An outside investor contributes $30 million for 100% of the
nonvoting shares in Saltwater Drilling Co. The remaining $320
million is raised through a debt offering, of which XYZ is the
guarantor. XYZ must also pay the investor for any losses incurred
if the asset is sold at the end of the lease term.

Questions


Would Saltwater Drilling Co. qualify as a VIE under FIN 46?
Under FAS 167?


Could Saltwater Drilling have obtained financing without XYZ
guaranteeing the debt?


Does the equity investor have the ability to make decisions about the
entities’ activities?


Does the equity investor bear the risk of loss?


Does the equity investor receive the expected residual returns?


Would XYZ qualify as a primary beneficiary?


Does XYZ have the power to direct the activities of Saltwater?


Does it bear the risk of loss or have the right to receive benefits?


Would it qualify as a primary beneficiary under FIN 46? FAS 167?


Questions


What documents would you need to examine to
determine that Saltwater is a VIE with XYZ as its
primary beneficiary?



Should Saltwater be consolidated into XYZ?


How should this be presented on the Financial
Statements?


Answers


Would Saltwater Drilling Co. qualify as a VIE under FIN 46(R)? Under
FAS 167?


The answer is probably ‘Yes’ under both. The equity investor has an
insignificant (less than 10% ownership) and the entity probably
couldn’t finance the operations without XYZ’s support.


The investor also bears little risk as they are guaranteed their money
back if the asset is sold at a loss at the end of the lease.


Would XYZ Qualify as a Primary Beneficiary?


Probably ‘Yes’ under both FIN 46(R) and FAS 167


The investor doesn’t appear to bear much risk and since they own
non
-
voting stock their influence may not be significant.


XYZ appears to bear the risk of loss since they are guaranteeing the
debt.


Examination of the agreements would be needed to see who has the
power to direct activities and the obligation to absorb losses and
receive benefits.


Answers


So, should Saltwater Drilling Co. be
consolidated into XYZ?


If it is determined that Saltwater Drilling Co. is
both a VIE and XYZ Oil is its primary beneficiary
then it should be consolidated into the Financial
Statements


Under
FAS 167,
certain assets
and liabilities
would
be required to be presented separately on the
face of the financial statements and additional
disclosures would be required


Audit Issues


Audit evidence


Company’s accounting memo


Entity documents


By laws


Security holder agreements


Legal Opinions


Consideration of an effective control environment


Timing of closing process for the SPE


Use of specialist/expert


International coordination


Language barriers and translation issues


Legal environment




Questions or Comments?


jacmyers@deloitte.com