1.Transferred assets have been isolated from the transferor.
2.Transferees have obtained the right to pledge or exchange either the transferred
assets or beneficial interests in the transferred assets.
3.The transferor does not maintain effective control over the transferred assets
through an agreement to repurchase or redeem them before their maturity or
through the ability to unilaterally cause the holder to return specific assets.Proponents of the financial component approach believe that the aspect of control
is the most relevant factor in determining whether financial assets should be recorded
on an entity’s books. This discussion masks the fact that frequently the sale of fi-
nancial assets to an SPV is via an equitable assignment rather than a legal sale. Thus,
the bank retains a legal right or receivable, continues to maintain the customer rela-
tionship, and continues to collect cash flows from the debtor. The bank incurs an ob-
ligation to pass cash flows through to the SPV and may assume other roles with re-
spect to the SPV (e.g., trustee, manager, or service agent). Importantly, the bank may
enter into currency and interest rate swaps with the SPV to enable the SPV to issue
securities with a different term structure than the underlying financial assets (e.g., the
SPV might issue US$-denominated securities secured against euro-denominated fi-
nancial assets). As described in SFAS No. 140, a legal vehicle that has a standing at
law distinct from the transferor and whose activities are permanently limited by the
legal documents establishing it as a qualifying SPV under SFAS No. 160, qualifying
SPVs should not be consolidated.
Certain countries do not have specific accounting standards for SPVs and apply
the consolidation concepts applicable to operating entities. Others, like the United
States, have complex accounting rules surrounding SPVs, with different rules apply-
ing to qualifyingversusnonqualifyingSPVs. Nonqualifying SPVs are not required to
be consolidated if certain conditions are met. Problems in this area are alleged to un-
derlie some of Enron’s problems. The relevant conditions for nonconsolidation in-
clude (1) the independent owners must take a substantive equity investment of at
least 3% of the SPV’s assets throughout the entire life of the SPV, and (2) the inde-
pendent owners must exercise control of the SPV. Although the official line of the
FASB and the SEC has been that the literal application of such rules should result in
an accounting treatment that is not misleading, practice has adhered closely to the 3%
equity condition regardless of the risks in the structure. The FASB currently has a
project to promulgate new standards to address these issues.
(l) Derivatives. A particularly controversial current topic concerns accounting for
financial instruments that generally have no net initial investment (i.e., no initial cost)
and are sometimes entered into to hedge interest rate, exchange rate, and commodity
price risks. Recent standards have moved to require all derivatives to be recognized
at fair value in the balance sheet with immediate recognition of gains and losses in
the income statement unless the instrument qualifies for hedge accounting.
The concept of hedge accounting is an important one because derivatives held for
speculative purposes are conceptually and inherently different from those derivatives
held to hedge an identified risk. Companies hold speculative derivatives to take ad-
vantage of potential market movements, while they hold hedging derivatives to min-
imize the potential loss on existing assets or expected future cash flows. Because of
this fundamental difference, separate accounting rules should be applicable based on
the company’s intent and the derivative’s use. Both IAS and U.S. GAAP contain ex-
12.6 FINANCIAL STATEMENT EFFECTS 12 • 27