Menu
Home
Log in / Register
 
Home arrow Business & Finance arrow Executive finance and strategy

Special purpose vehicles or entities -off-balance sheet activities

The term 'structured entity' is defined in Appendix A of IFRS 12 Disclosure of Interests in Other Entities:

an entity that has been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity, such as when voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements.

the definition adds 'paragraphs B22-B24 provide further information about structured entities'.

The illustration below is simplified but explains why off-balance sheet finance and activities ought to be disclosed in accounts, although some readers may disagree; particularly for private companies, standard setters consider that all stakeholders need to know what is going on.

Company P is a parent with three investments being 49 per cent ownerships of three identical companies; the parent claims that it is an investor, exercising no control. At the date of investment, the balance sheet would look as shown in Table 12.9, a 'slim' or 'lite' balance sheet with no borrowing and few assets.

TABLE 12.9 Parent company balance sheet - with no subsidiaries

Parent company balance sheet - with no subsidiaries

The three 'non-subsidiaries' Q are all identical, with considerable assets and liabilities including significant borrowing (Table 12.10).

TABLE 12.10 'Non-subsidiary' balance sheets

'Non-subsidiary' balance sheets

If the reality is that P controls the three Q companies, a consolidated group balance sheet would be as in R (Table 12.11).

This much-simplified illustration outlines one aspect of the Enron scandal, that is, the pretence that borrowings were low - a pretence which, it would appear, credit agencies were happy to go along with.

Another aspect of off-balance sheet items is that the entities may generate good profits and elevated cash flows, which are passed up to the parent. There, the illusion of high profits from low capital employed becomes manifest.

TABLE 12.11 'Real' group balance sheet

'Real' group balance sheet

The real cheat, if that is not too strong a word, is that investors in the likes of P may be shielded (a good thing) or deceived (fraud - a bad thing) from the risks of the whole enterprise.

A recent (2014) IFRS and similar FASB standard aims to address these problems.

 
Found a mistake? Please highlight the word and press Shift + Enter  
< Prev   CONTENTS   Next >
 
Subjects
Accounting
Business & Finance
Communication
Computer Science
Economics
Education
Engineering
Environment
Geography
Health
History
Language & Literature
Law
Management
Marketing
Mathematics
Political science
Philosophy
Psychology
Religion
Sociology
Travel