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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks before the 2009 AICPA National Conference on Current SEC and PCAOB Developments


Arie S. Wilgenburg

Professional Accounting Fellow, Office of the Chief Accountant
U.S. Securities and Exchange Commission

Washington, D.C.
December 7, 2009

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect those of the Commission or of the author's colleagues upon the Staff of the Commission.


Good morning. Today, I will provide a few observations related to two new accounting standards, both of which include significant changes to U.S. GAAP and have wide-ranging applicability. The first is FASB Statement No. 167, which amends the consolidation framework for variable interest entities. The second is EITF 08-1, which amends the framework for separating revenue arrangements with multiple deliverables.


First, let me hit on the current status of Statement 167. While this Statement has an effective date of January 1, 2010, for many companies, the FASB recently added a project that, if finalized, will defer the guidance for certain investment entities. I imagine the FASB staff will have more to say on this open project during their remarks, so I will focus mine on a few of the key changes that are not the subject of this open project.

Controlling Financial Interest

One significant change in the consolidation model that I'll highlight is the replacement of the prior, often quantitative-based risks and rewards analysis with a more qualitative assessment of who should consolidate a variable interest entity.

The core principle of Statement 167 is that a reporting enterprise should consolidate variable interest entities in which it has a controlling financial interest. This core principle is based on a control concept that is described as a combination of power over the entity and exposure to losses or benefits of the entity.

When evaluating these two elements, it is important to note that each is necessary to have control. Like Frank Sinatra's rendition of Love and Marriage, they "go together like a horse and carriage." I'll stop there and spare you all the song and dance portion of my speech. The point is that power and economics go together.

Now let's spend a few minutes on the relationship of one to the other. First, as it relates to power, it's not just any power. It's power over the activities that most significantly impact an entity's economic performance. But power alone is not a sufficient basis for consolidation. The model requires it be combined with a significant financial interest in the entity.

So what is a significant financial interest? Well, Statement 167 describes such an interest as one that either obligates the reporting enterprise to absorb losses of the entity or provides a right to receive benefits from the entity that could potentially be significant. That description leaves us with an important judgment to make regarding what could potentially be significant.

In the past few weeks, the staff has been thinking about this concept. While there is no "bright-line" set of criteria for making this assessment, I thought it would be helpful to provide some thoughts in this area.

First, similar to how we have talked in the recent past about materiality assessments being based on the total mix of information, we believe that assessing significance should also be based on both quantitative and qualitative factors. While not all-inclusive, some of the qualitative factors that you might consider when determining whether a reporting enterprise has a controlling financial interest include:

  1. The purpose and design of the entity. What risks was the entity designed to create and pass on to its variable interest holders?

  2. A second factor may be the terms and characteristics of your financial interest. While the probability of certain events occurring would generally not factor into an analysis of whether a financial interest could potentially be significant, the terms and characteristics of the financial interest (including the level of seniority of the interest), would be a factor to consider.

  3. A third factor might be the enterprise's business purpose for holding the financial interest. For example, a trading-desk employee might purchase a financial interest in a structure solely for short-term trading purposes well after the date on which the enterprise first became involved with the structure. In this instance, the decision making associated with managing the structure is independent of the short-term investment decision. This seems different from an example in which a sponsor transfers financial assets into a structure, sells off various tranches, but retains a residual interest in the structure.

As previously mentioned this list of qualitative factors is neither all-inclusive nor determinative and the analysis for a particular set of facts and circumstances still requires reasonable judgment.

Shared Power and Economic Substance

In the vein of encouraging the use of reasonable judgment, it is worth noting that only substantive terms should be considered when applying Statement 167. Determining whether something is substantive or non-substantive is likewise a matter of judgment and depends on the facts and circumstances.

Keeping with the topic of considering the economic substance of a transaction, the staff has recently become aware of several proposed structures designed to achieve deconsolidation of underperforming assets, including past due loans, securities, and real estate. These assets are likely presenting business performance and prudential regulatory compliance issues. In order to address these issues, several structures have been proposed in which owners transfer the underperforming assets to a structure designed to technically comply with the consolidation literature and perhaps create the appearance of shared power among equity holders. However, the economic result leaves substantially all of the risks of ownership with the original owner rather than a more substantive sharing of the risks.

For example, assume a company has transferred assets to a structure to be managed by a third party, but the manager's equity interest in the structure is minimal and appears to be guaranteed given the management fee structure. In addition, assume the manager can be removed by the reporting enterprise if the manager's performance is unsatisfactory. The combination of the above factors indicates that the company may not have relinquished control; rather the manager may simply be acting as an agent on behalf of the reporting enterprise.

We have also seen other, similar structures that include a buy-sell clause rather than a removal right, as a mechanism for dissolving the structure. However, if the manager does not have the financial ability to exercise its rights under the buy-sell provision, the substance of this provision may be a call option by the transferor. Again, this may be an indication that the manager is simply acting as an agent on behalf of the reporting enterprise.

In summary, and consistent with our report to Congress on off-balance sheet arrangements, the staff continues to believe that use of transaction structuring to achieve accounting and reporting goals that do not conform to the economic substance of the arrangements reduces transparency in financial reporting.1

Standalone Value

I will now spend a few minutes discussing EITF 08-1, which significantly changes the accounting for revenue arrangements with multiple deliverables.

This issue addresses how to determine whether a revenue arrangement involving multiple deliverables contains more than one unit of accounting. While the old separation model included three criteria, the Task Force has removed one of the criteria, namely the requirement that there be objective and reliable evidence of fair value of the undelivered item(s). New arrangements that would have failed this criterion in the past may be eligible for separation under the new model, assuming the two remaining criteria are met.

I'd like to focus on the first of these remaining criteria, which requires the delivered item to have value to the customer on a standalone basis. A deliverable has value on a standalone basis (a) if it is sold separately by any vendor or (b) the customer could resell the delivered item on a standalone basis.

While this analysis may be straightforward in many cases, other arrangements may be more complex. Since we are here in Washington, with Health Care Reform in the air, let's ponder an example from the medical field.

Consider an arrangement that contains the following two deliverables:

  1. Delivered Item: Biotech License of Technology
  2. Undelivered Item: Proprietary Research and Development Services

In this example, assume the Biotech owns certain technology that will be used in the development of a new drug, and since we're being creative; let's imagine it's a drug that can cure hair loss without any side effects. This technology is unique, such that no other vendor sells a similar item. Also, assume the Biotech will never sell this technology on its own; rather it will always be sold with the R&D services, which are essential in order to derive value from the technology. Finally, as a protective measure, the Biotech has included a contractual restriction that prevents the customer from sub-licensing or reselling the technology.

Given this set of facts, the license does not have standalone value. First, the technology is not sold separately by anyone. Second, the customer cannot resell the technology. Therefore, the license should be combined with the R&D services as a single unit of accounting.

However, there may be a number of ways in which this fact pattern could be modified such that the license would have standalone value. For example, what if the R&D services are not proprietary; rather such services can be, and in some circumstances are, provided by other vendors. Even though the license is useless without the R&D services and the customer is contractually restricted from reselling the technology, the fact that other vendors provide such R&D services is an indication that the license might have standalone value. This is because the vendor can license the technology separately while another vendor provides the on-going R&D services.

In summary, the analysis of standalone value must be based on the individual facts and circumstances for each arrangement.

This concludes my prepared remarks. I look forward to addressing some of your questions later in the session.


1 Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002 On Arrangements with Off-Balance Sheet Implications, Special Purpose Entities, and Transparency of Filings by Issuers, June 2005


Modified: 12/08/2009