Off Balance Sheet Accounting Case Study

Off-balance sheet accounting boils down to the simple question: should the sponsoring entity consolidate or not? From the 1980s to the 1990s it was common for sponsoring companies to avoid consolidations despite the fact that they maintained control of assets of special purpose entities (SPEs). Ultimately, this allowed sponsoring companies to hide losses and debt from their own financial statements. From a principles-based view, companies should have to report the assets of a SPE on their financial statements if the sponsoring company has maintained control of the assets, if the risk has not been transferred to the special purpose entities (SPE), and/ or the SPEs is not independent.

In 1996 the Financial Accounting Standards Board (FASB) issued FAS 125: Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities to address off-balance sheet (OBS) accounting. FAS 125 required the recognition of assets an entity controls and the liabilities it incurred after the transfer of financial assets. And subsequently, the entity must de-recognize assets and liabilities when it no longer controls them. FAS 125 also defined the

The exception was that if the SPE contained only passive assets, then they could categorize it as a QSPE and did not have to consolidate it (Greenspan Slept as Off-Books Debt Escaped Scrutiny, 2008). Overall, the application of VIE did somewhat help provide more transparency by forcing more companies to have to consolidate. Even though the investor obtained less than a majority-owned interest, the variable interest entity (VIE) had to be consolidated if the sponsoring company controlled the majority of the variable interest; in other words is a primary beneficiary of a