VIE Rule Clarified; UK Eyes Audit Industry; More

To quell confusion and differences in approach, the Financial Accounting Standards Board has given companies some additional guidance on how to determine whether the results of a variable interest entity should be consolidated into a company’s financial statements.

FASB finished its recent staff position, FIN 46(R)-6, Determining the Variability to be Considered in Applying FASB Interpretation No. 46(R), to specify that it wants companies to look more carefully at the design of such an entity as they analyze the risks and benefits associated with it, says Randall Sogoloff, a partner with Deloitte & Touche and a former practice fellow at FASB.

A variable interest entity is an entity held by a parent company that either doesn’t have investors who hold voting rights, or doesn’t have adequate capital to sustain itself. It often holds assets, including loans, receivables, real estate or other property. It was the stuff of off-balance-sheet accounting made famous by the fall of Enron and addressed post-haste by FASB in FIN 46 and FIN 46(R).

Sogoloff

Earlier guidance established that companies had to consolidate the results of such entities and show them on the balance sheets based on an analysis of who bears the lion’s share of the risk and the benefits associated with such entities. With that, however, companies have developed different approaches to defining, identifying and measuring variability created by the risks, Sogoloff explains. Some companies focused on cash flow as a way of identifying and measuring risk and variability, others on fair value.

FASB’s latest staff position establishes that companies must analyze the design of the entity to determine if an interest is a variable interest for purposes of complying with FIN 46(R). It focuses attention on the nature of the risks that the variable interest entity was designed to manage and pass along to interest holders, Sogoloff says.

Bahnson

“VIEs are specifically designed separating ownership and access to benefits,” says Paul Bahnson, accounting professor at Boise State University and a former FASB member. “FIN 46 said that it is the benefits that determine who consolidates the VIE. Often the benefits are divided into separate components that can be either fixed or variable, for example a percentage of profits or losses. The interpretation provides guidance on how to evaluate these variable benefits in deciding who is the primary beneficiary.”

The latest FASB staff position can be found in the box above, right.

U.K. Regulators Study Audit Competition, Consolidation

Regulators in the United Kingdom are planning to explore ways they can address growing concerns about competition and choice among audit firms.

The Financial Reporting Council will meet this week to discuss the findings of a study it commissioned jointly with the Department of Trade and Industry that describes a virtually impenetrable dominance of Big 4 firms auditing Britain’s largest companies along with limited options for companies to change auditors. The study, “Competition and Choice in the U.K. Audit Market,” says conditions prohibit second-tier firms from gaining any audit business from the FTSE 350 (the 350 largest companies in the United Kingdom) and that the loss of a Big 4 firm would create serious compliance problems and a loss of investor confidence.

Back in August 2003, the U.S. GAO published a similar accounting industry study—mandated under Sarbanes-Oxley—which said that smaller firms faced significant barriers in competing with the "tight oligarchy" of the Big Four (see box at right for related studies).

The U.K. FRC will hear from the study authors and others who want to air concerns about audit competition, to examine any risk it presents for public interest issues and consider prospective solutions. The FRC says it may explore measures to reduce barriers that prevent second-tier firms from breaking into big-company audits, to minimize the likelihood of a Big 4 failure, and to cope with the fallout if such a failure were to occur.

Boyle

“A well-functioning market for audit services is essential to ensure confidence in corporate reporting and governance,” Paul Boyle, chief executive of FRC, said in a statement. “The report raises a number of issues about the structure of the audit market in the UK.”

Choice and competition among audit firms is an evergreen topic of hand-wringing and discussion in the United States, but government officials have not undertaken or proposed any kind of rulemaking related to the concern.

PCAOB Raps Firm For Ignoring Client’s Bogus Filing

Accounting regulators have slapped the wrist of a small San Francisco accounting firm for looking the other way while its sole public issuer client filed false financial statements.

The Public Company Accounting Oversight Board censured Reuben E. Price & Co. after it client, Universal Communication Systems Inc., filed financial statements accompanied by a draft audit report that was never finalized, the PCAOB said. UCS is a developer of solar energy systems traded over the counter and on the Pink Sheets.

According to the censure order, Price knew its client filed with an incomplete audit but didn’t report that detail until the audit was about to be inspected by the PCAOB. The censure amounts to a reprimand but doesn’t preclude the firm from continuing to audit public issuers.

The findings and sanctions can be found in the box at right, as can related Compliance Week coverage of other PCAOB actions.