assets of the SPE (including residuals). Conversely, the SEC staff believes that noncon-
solidation... [is] not appropriate... when the majority owner of the SPE makes only
a nominal capital investment, the activities of the SPE are virtually all on the sponsor’s
or transferor’s behalf, and the substantive risks and rewards of the assets or the debt of
the SPE, rest directly or indirectly with the sponsor or transferor.^1In 1995, the FASB issued an Exposure Draft (ED), “Consolidated Financial State-
ments: Policy and Procedures” and in 1999 issued a revised ED, “Consolidated Fi-
nancial Statements: Purpose and Policy.” The 1999 ED addresses only consolidation
policy issues while the 1995 ED deals with both consolidation policy and proce-
dures. This section discusses the consolidation policy changes proposed in the 1999
ED.
According to the 1999 ED, “ The purpose of consolidated financial statements is
to report the financial position, results of operations, and cash flows of a reporting en-
tity that comprises a parent and its affiliates essentially as if all of their assets, liabil-
ities, and activities were held, incurred and conducted by a single entity with one or
more branches or divisions. What binds separate legal entities into a single reporting
entity is the parent’s decision-making authority, direct or indirect, over each of the
entities in the group and the parent’s consequent ability to direct their activities, in-
cluding the use of their assets.”^2
The purpose of consolidated financial statements as stated in the 1999 ED differs
little in substance from language used in earlier pronouncements, What is new is the
reference to decision-making authority as the basis of control, without specific regard
to the ownership of voting shares.
The 1999 ED would still require the consolidation of all controlled companies but
it would change the definition of control. Control would no longer be defined as the
majority ownership of the voting stock of the entity. The ED provides the following
definition of control: “Control—the ability of an entity to direct the policies and man-
agement that guide the ongoing activities of another entity so as to increase its ben-
efits and limit its losses from that other entity’s activities, For purposes of consoli-
dated financial statement, control involves decision-making ability not shared with
others.”^3
This definition and the ensuing discussion in the 1999 ED recognize two versions
of control, legal control and effective control. Legal control involves the uncondi-
tional ability to select a majority of an entity’s governing board, and is typically in-
dicated by direct or indirect control of a majority of the entity’s voting shares. Effec-
tive control achieves the needed decision-making ability by other means, typically a
large minority ownership position and other factors that enable the parent to domi-
nate the entity’s governing board and, accordingly its decision-making process.
Determining whether effective control exists is largely a matter of judgment. The
ED provides implementation guidance consisting of presumptions of effective con-
trol in business organizations and ten specific examples of applying the notion of ef-
fective control when the conclusion is not obvious.
The ED suggests that the presumptions of effective control exists when an entity
(including its subsidiaries):
18.5 ACCOUNTING FOR INVESTMENTS IN SUBSIDIARIES 18 • 7(^1) FASB, EITF Abstracts, 1990.
(^2) Paragraph 7, 1999 ED.
(^3) Paragraph 6, 1999 ED.