- Email: [email protected]
Accounting for special purpose transactions: ED 42 and in-substance debt defeasance
ACCOUNTING FOR SPECIAL PURPOSE TRANSACTIONS: ED 42 AND IN-SUBSTANCE DEBT DEFEASANCE
El) 42, .4i(-~)t,,rtiri,c(f;,r Special Prrrpow Trnrwncrior1.c. ~vas puhlishcd by the Accounting Stmdards Committee in 1988. The expocurc draft contain\ proposals ahout the manner 111which certain transactions, popularly rcfcrrcd to a\ ‘off-halancc sheet’ transaction\, should hc rcportcd. Rather than offu spcrltic guidance, El1 42 CDIIIC\ down in favour of offering general guidance. hascd on the criterion tfut J trantdctiotl’s accounting treatment should fairly rcflcct Its commercial ctfcct. Thi\ paper discmscs the approach adopted by El1 42 in the context uf one fornl of off-balance sheet transaction, namely in-suhstancc debt defcJsdncc. Finarlcinl reporting of thl\ type of arranguncnt is now mndardiscd in both the USA and Au\tr.lli.l. Although both the US md Australian stand.lrdc dppcar to LISC‘Suh\tmc~ over torn1 .I\ their basis ofrccomnicndcd accounting pr-,lctic.e, thcrc z-c impomnr dltfcrcnccc hctwccn the two standards.
1. INTRODUCTION In 1988 the Accounting
role,lscd Exposure Draft 42, El) 42 deals with financial reporting issues which arc often referred to by flnancial commentators in the context of ‘off-balance sheet financing’. But this term is rarely LISC~ in the exposure draft which prefers instead the term ‘special purpose transactions’. El> 42 (preface, paragraph 1 .ll) proposes to o&r general guidance which would be applicable to a variety of situations, and this approach is justified on the grounds that ‘it would be impractical for ASC to provide detailed rules to cope comprehensively with every development in a .4rcounting
&Y
Spuial
Standards Committee
Purpose
T~~~r~a~rtiorrs.
This paper describes a particular financial arrangcrnent: in-substance debt defeasance. Such arrangcmt‘nts have been used by US and Australian companies and both the US and Australian accounting standard setting bodies have found it necessary to issue detailed pr(~ll(~UIlcC’lllelItS dealing with in-substance debt defcasmcc. In 1983 the US Financial Accounting Standards I3oard (FAST) issued Stattment of Financial Accounting Standards No. 76 (SFAS 76), ~‘stir~l’is/lrnc//f of‘Drht and in 1988 the Australian Accounting Research Foundation (AARF) issued Statement of Accounting Standards, AAS 23, Set-~ff‘nrrti Estir!yrrisllrNrrlt of Debt. But, to date, thcrc is no evidence, so far as the authors arc‘ aware, of the use ofin-substance debt defcasancc schemes by UK cornpanics. We show what these arrangcmcnts involve and the problems that could arise if they became conlmonly used in the UK, so that reporting accountants would nrcd to look to authoritative statcmmts such as El> 42 for guidance.
2. L>ESCRIPTION
OF IN-SUBSTANCE ARRANGEMENTS
I)EUT
A debt is often regarded as satisfied from a strictly
DEFEASANCE
Iqn/ viewpoint
if:
(a) the debt is settled through normal repayment or rollover; or (b) the debtor is formally rcltxud from any further obligation through forgiveness by the creditor. or lqal judgemcnt. But an i~-s&srmzre debt dcfcasancc can take place cvcn if neither of the above conditions is satisfied. In-subctnncc debt defeasancc can be regarded as a device for renloving debt from the balance sheet, CVCII though the debt has not been repaid. This cm bc achieved in one‘ of two ways. One way is for a frrrst to be set up and the debtor company to pass over to the trust, irrevocably, suflicicnt securities to finmcc the future inturmt charges and principal repayment of the original debt. Alternatively, a liaOi2ity assurrq~~imrqrc’r’rrrcrrf could be entered into. 111this cast a third party, for a consideration, agrees to z~ssun~cthe responsibility of all future payments of interest rind principal of the original debt. For the remainder of this paper WC shall ~1s~‘the following terminology. The first party or creditor lends the original debt. The second party or debtor is the firm or company which cl~oos~s to enter into an in-substance
SPECIAL
PURPOSE
TABLE
TRANSACTIONS
I 30
1
debt defeasance arrangement. Obliger, in a general sense, means a person or entity which originally incurs, or later assumes responsibility for. an obligation. Third party refers to an entity which becomes primary obligor in a liability assumption agreement. Trust refers to a trust in which interest bearing securities are deposited by the firm which will cover the interest payments of the original debt and, eventually, the principal. Ikfeasancc is defined by the O~j>rd Eqqlisl~ DiCtjc)lltlrY (1989, p. 372) as ‘acquittance or discharge from an obligation or claim’ which would appear to encompass normal repayment, rollover, forgiveness and legal judgtment. However, the term ‘dcfeasancc’ now tends to bc used most frequently in the context of in-substance debt defcasance. Following this treild in thu use of the term, and in order to make the exposition less Culnbersomc, the term ‘defcasancc’ will henceforth be assumed to nlean ‘in-substance debt defeasancc’. A company which previously issued debt when market rates of interest wc‘rc low will find that an amount of cash resources smaller than the nominal value of the original debt will be sufficient to repay the interest and principal. Table 1 provides an illustration. Suppose that a company issued ~SOOm of debt on 1 January 1983 at an interest rate of 7% per annum. Interest is payable on 31 December in each year and the principal is repayable on 31 December 3992. By 1 J,‘muary 1090 the general lcvcl of intcrcst rates has risen to 12% and the directors decide to set up a trust into which the company will place securities bearing interest at the rate of 12% per annum, and their maturity will coincide with the repayment of the principal of the original debt, i.c. 31 IIc~cember 1002. Clearly, an amount less than ~11()Om will bc required to meet the servicing requirements of the original debt. The precise amount can be calculated using the formula in Appendix 1.
I-IO
_). Rij,M(:KII
ANI)
It.
1.
Wt:AI
The atnouttt required to be trattsfcrrcd tc, the trust turns out to bc o111) L;X7.901 nt, as shown itt Appendis 2. Since the fit-in h,ts retnovc~d Ail OOnt debt, but only ~~87-991 m cash front its balance sheet, it can record a gain of- ,f5124)09111 (i.c. lic11OOnt-~C7~991 in) in its incnttte statctttettt for the* year ended 31 I>cccmber 1990. Mcilkc &- Scifert (1’337, p. X0) suggest tlt.tt the ability to record gains in their inconte statenteuts at the titnc ot defeasancc is a prime motivation for cornpanics to set up these arrange111e11ts.
Table 1 shows the pattern of cash flows over the three years IWO to 1992. The interest charges relating to the original debt arc less than the interest generated by 12% government securities. An assumption in this calculation is that the difference between interest rcccived and interest paid (e.g. ,&3~559tn at the end of 1990) can be reinvested at 12%. By the 31 December 1092, the trust will have accumulated securities :tt~d cash with 3 total value of L 1OOtn which will be the csact amount required to repa) the original debt. A liability assumption agreement operates in a similar manner. A third party assumes the function of the trust and in return for a consideration of ~87.99ln1 agrees to finance the future interest and principal of the original debt. The balance sheet and income statement effects arc identical to those under a trust-based defeasancc. If a firm is partly financed by quoted debt, it may be reluctant to approach its debt holders and offer the defeasance amount (effectively the market value of the debt in the case of Table 1, ~37.991 tn) as full and final compensation in return for cancelling the debt. The debt holders may not act rationally or they may view the market valuation as ‘too low’ given their own expectations. Alternatively, if the market believes that the firm is anxious to redeem its cGting debt, this could push up the market price of the debt and therefore make it more expensive to r&em. Three interesting variations of dcfeasnnce are a~ follows. (n) Instmtnrwous
ill-rirhstamc
dcht di~$mnnct~
A firm issues debt and simultaneously drfeases the same debt. This may happen if a firm can take advantage of interest arbitrage opportunities and consequently report a gain in its income statement. Instantaneous defeasance has been noted where companies have incurred a debt in one country then immediately effected a defeasancc by investing the proceeds in securities carrying a higher rate of interest in another country (Decgan, 1985, p. 55). (h) Partial lkf’“s”nC’ Only a proportion of the interest and capital is defeascd. In the financial statements of the firm, a proportion of the original debt would appear in
13‘ll.lnce
70.7 I’)
c/t
future balance sheets and the same proportion appear in future income statements.
XY.?XO
of the interest charge
wo~dd
Either the principal or interest (but not both) is defeased. If a ‘principal only’ split defeasance is carried out, then the debt would disappear from future balance sheets, although the interest charges related to the original debt would continue to appear in future income statements. If an ‘interest only’ split defeasance is carried out, then the original debt would continue to appear in future balance sheets, but the interest charges would not appear in future income statements. Table 2 provides an illustration of a ‘principal only’ split defeasance. The firm places in trust suflicient securities which will accumulate to a total of ,&lOOm by 31 December 1992. The amount of securities required .1t 1 January 1990 is k71.17Xm (i.e., ~100n1(1.12)~ ‘). In its income stdtemcnt for IWO the firm can record a gain of L2X.X22m (i.e., ~~100111~71~17Xm). However, thejustification for recording such a gain is dubious since in its income statements for each of the years 195X--1992 the firn1 will still be required to record interest charges on the original debt of /c;7111 per annuni. 3. COMPARISON
OF US AND
AUSTRALIAN
APPROACHES
Neither SFAS 76 nor AAS 23 specifically refer to the concept of ‘econonlic substance over legal form’. However, both standards appear to acknowledge the relevance of the concept. Thus, SFAS 76 makes it clear that the \rotc on acceptance of the standard by the members of the FASB revolved .uound the concept of ‘substance over form’. The dissenting members of the FASB did not believe that:
142
_I.
ltijMM(:Kk.
ANI)
I<.
I’.
Wl:AlUN(;
c\tingui\hnr~llt ofdcht .~c~ount~~~~ .111drcwlt.lnt g:.nn or lo\\ 1n2,C,SIII~I~II \J)oIIJ~ 1~ cYtcllcicd to ~itu.ltloll\ \\.llCI.C tl1c “dchtor I\ 1101 Icg.1llv rCIC.I\cd t*oIll lWIl1~ tl1c primary ohligor under the dcht oblig:.~tion (SFAS 7(1. p. ‘5).
This view contrasted with the majority
view that:
in ccrt;un cil-cumstdncc\. d&t 5hotild lx cotl\iticrcd cstinguidd for tiii.lncisll I-cport~ng purpow CVCII though the debtor i< not Icgally rclc.wd fmnl hcing the prlnury ohligor under the dcht ohlig.ltitrn. (SFAS 70, p. 11).
It is clear from the above two quotes that those for and against the standard were divided essentially on the basis of substance versus form. AAS 23 contrasts ‘legal defeasancc’ and ‘in-substance drfcasance’: A lcgd dcfc~w~cc could take pl,lcc in .Ihwlutc tcnns, that is. the debt could CC;~X to csist for myonc (hy hcing forgivcii or set .&ic). or the creditor could form;lll~ rccognisc that s~nuthcr party has t.lkcn over the primxy ohlig;ltion for the debt (p‘l’“gr‘qh
6).
Whereas in-substance defeasancc is described as: The rclc.lsc ofa dchtor from the primary ohligJtio]l for .I debt nl,ly also hc .Ichlcvcd ‘in whstC~ncc’ by the debtor, cithcr by trmsfcrring to .I trust wet\ which xc ndcquatc to twct the servicing rcquircmcnts (both intcrcst md principal) of the debt md arc dcdicatcd to that purpwc, or by having a witahlc entity ;~ssumc rrcponsihility for those servicing requircmcnt5 (pxagrC~ph 7).
From this initial position both SFAS 76 and AAS 23 accept, in principle, the validity of removing debt from the balance sheet in the case of a trustbased defeasancc or a liability assumption agreement. Both the US and Australian standard setting bodies are agreed that passing debt over to a trust or third party can constitute ‘in-substance’ defeasance, provided certain conditions are complied with. These conditions are mainly concerned with making sure that the assets placed in the trust will have a high probability of meeting the debt-servicing requirements (interest and principal), or in the case of a liability assumption agreement, that the third party is credit worthy. Both the Australian and US standards require that the monetary assets of the trust should be ‘risk-free’ with regard to the type of monetary asset and also with regard to the timing of interest and principal payments. SFAS 76 (paragraph 4) rt q uires that the monetary assets of the trust shall: (1) be denominated in the currency in which the debt is payable; (2) be invested in government bonds; and (3) b e capable of providing cash flows that approximately coincide with the interest and principal payments of the original debt. AAS 23 (paragraphs 8 and 9) imposes virtually identical restrictions. As regards a liability assumption agreement, SFAS 76 (paragraph 18) only allows debt to be considered as extinguished for financial reporting purposes if the debtor is legally released from being the primary obligor.
SPECIAL
PURPOSE
143
TRANSACTIONS
AAS 23, by contrast, is considerably less stringent and simply requires (paragraph 10) that the third party should be a ‘risk-free entity’. Technical Bulletin 84-4 (Financial Accounting Standards Board, 1’9x4) modified SFAS 76 so that instantaneous defeasancc is now disallowed. However, AAS 23 permits instantaneous defeasancc, provided that the other conditions are complied with. Deegan (1985, p. 55) cites the example ofthe US corporation, Pepsi Co., which in early 1984 issued debt denominClted in Deutschmarks on the US bond market. At the Tame time Pepsi Co. was able to purchase West German government securities yielding higher interest rates. This transaction provided Pepsi Co. with a real not now be allowed economic gain. Although such a transaction would to he treated as defeasance for reporting purposes by a US company, following the release of Technical Bulletin 84-4, AAS 23 IPOI~/~allo~v such a transaction for an Australian company. Whittrcd & Zimmer (1988, p. 132), writing before the publication of AAS 23, give the example of a firm which places debt in a country where irltercst rates in the late 1980s are relatively low (sa). Europe) and use the proceeds to buy government bonds in a country where interest rates in the late 1980s are relatively high (say USA). Th‘ IS can expose the firm to risk if the currency of the European country should appreciate relative to that of the country in which the government bonds were purchased. Such practices can no longer be treated as extinguishment of debt by Australian companies since paragraph 9 of AAS 23 rcquircs that the risk-free assets should be denominated in the same currency as the debt being defeascd. 4. ED 42 AN11 CHOICE
OF ACCOUNTING
TREATMENT
El> 42 states (preface, paragraph I .15) that a transaction’s accounting treatment should fairly reflect its commercial effect. But the document thcu goes on to state (preface, paragraph 1.16) ‘this principle should be distinguished from the statetnent that substance should take precedence over form’. ED 42 does not explain why such a distinction is necessary or useful. We believe that ‘substance over f-arm’ or ‘economic substance over legal form’ are terms which have usefully been employed in the past (at times by the ASC itself). While ‘substance over form is a controversial concept and the term itself is subject to different interpretations, it does have the advantage of providing a signal about the nature of the debate, .md it JOCXnot seem to be a positive step for the AXI to move away from this terminology. As mentioned in the introduction, we are not aware of any UK companies having used in-substance debt defeasance arrangements to date, Jthough the broad approach adopted by ED 42 may in fact stimulate the use of defensance arrangements. The question we wish to ask is this. Will
14-k
j.
RijMM(.Kt>
ANI)
I<.
1.
WhAKINC;
the approach outlined in El> 43. or the eventual standard. colltain sufficient guidance to allow rcportin, cr accountants to determine whether to account for the relevant amounts ‘on-balance sheet’ or ‘off-bala~~ce sheet’? If we USC‘commercial effect’ or ‘substance over fornl’ as our guiding principle, it could be plausibly argued that the company has c;fti~ti~c/y set aside an amount which, in all probability, will cover the future interest and capital repayment of the original debt. This was the view eventually reached by the FASB. However, it was by no means a unanimous decision, and of the seven members who voted on the standard, three (including the chairman) dissented. Those voting against believed that extinguishment of debt could occur only where the debtor is legally released from being the primary obliger under the debt obligation. A prudent approach to this issue would suggest that the company should be regarded still as the primary obligor (the factual legal position) and therefore the relevant items should be kept ‘on-balance sheet’. An approach which stressed substance at the expense of form and prudence would take an opposite view and suggest that the items should be kept ‘off-balance sheet’. We take it as axiomatic that the greater the scope for professional judgement, the less comparability there will be between financial statements. III considering how a UK company should report dcfeasancc arrangements, it is useful to compare the approaches adopted by SFAS 70 and AAS 23.
A UK reporting accountant would not find a definitive answer by looking to SFAS 76 or AAS 23 since they offer conflicting guidance. The choice of accounting treatment would therefore depend on the exercise of professional judgemcnt, with the result that comparability will be reduced. Suppose further that a company wishes to account for instantaneous defeasance and the securities purchased are not government bonds and/or are not denominated in the same currency as the original debt. It is possible that the resulting accounting treatment would be inconsistent with both SFAS 76 and AAS 23. It is interesting to note that requiring a firm to disclose, on its balance sheet, debt which it has been able to defease at a profit will increase its gearing. An increase in the level of gearing will mean that the firm will have to offer further issues of debt at higher rates of interest and hence erode any comparative advantage it has in finding advantageous arbitrage opportunities. (b) Partiul drfeasmcv
SFAS 76 and AAS 23 adopt similar approaches, but the UK reporting accountant would still need to exercise professional judgement about whether the purchased securities are suf5ciently ‘risk-free’.
SPECIAL
PURPOSE
TRANSACTIONS
I 45
(c) Split defeasance If a UK company wished to report a ‘principal only’ split defeasancc, the auditor could be placed in a difficult position for two reasons. Firstly, over whether the transaction should be recognised as a defeasance, given that SFAS 76 and AAS 23 both disallow these arrangements. Secondly, even if the transaction were to be reported as a defeasance, professional judgement would need to be exercised over whether to recognise and, if so, how to measure the liability relating to future interest payments on the original debt. (d) Liahiliry assumnption agreement Suppose that a UK company entered into a liability Jssumption agreement where the company was not legally released from being the primary obligor. SFAS 76 would reject, whereas AAS 23 would allow this arrangement. Again, the UK reporting accountant would need to exercise professional judgemcnt over the choice of an appropriate accounting treatment. It can be appreciated that if defeasance were to become a popular form of financial arrangement in the UK, there would be a potential for widely differing reporting treatments, even though the underlying events for a number of companies could be identical. It should be remembered that companies have an incentive to undertake these arrangements since they can report a gain in their income statements in the year in which the defeasance occurs. Auditors could be under pressure, therefore, to accept these arrangements and this could in turn lead to pressure on the ASC to come up with more detailed guidance than is provided for by ED 42. El) 42 contains a brief discussion of the characteristics of XI asset (paragraphs 14-21) and the characteristics of a liability (paragraphs 22-27) but these provide inadequate guidance for determining the accounting treatment of off-balance sheet financial arrangements. It would be interesting to speculate. for instance, on the reporting treatmerrt for .I UK compmv setting up this arrangement but transferring quoted shares to the trust, instead of government securities. Finally, there are two further issues which may not have been adequately addressed by the FASB or AARF. One concerns the assumption that, at 31 December in each of the years 1990 and 1901, the trust will be able to purchase additional government securities where the timing of the interest receipts and rnaturity exactly matches that of the original debt. This may not always be possible. A second difficulty concerns the assumed level of interest rates over the period 1990 to 1992. Actual interest rates during this period are likely to fluctuate, in which case the cash and investnrents held by the trust will, by 31 December 1992, be greater or less than ~1OOm. This is because interest on interest may not be carned at the initial market rate.
146
J.
I
ANI)
R.
‘I.
W/tAIIIN(;
Suppose that market rates ofintercst uncspcctedly fall after the defca+ ancc is carried out, Then the firm would need to inject a further arn~>unt into the trust at 31 I~ccembcr 1002. The longer the period bctwccn defeasance and repayment of the original debt, the greater sucl~ deficits or gains are likely to be. The firm can, of course, minimicc the possibility of a deficit at 31 December 1902 by assuming a low, or cvc’ti zero, rate of interest on reinvested interest. Such an assumption would incrcace the amount of securities required to be placed in the trust at defcasance. However, this policy increases the probability that the trust will record a gain at 31 l)ecrnlber 1902. Thus, there is a direct trade-OK between the probability of the trust recording a gain and recording a deficit. The more the firm attempts to reduce the probability of a deficit. the greater the likelihood that the trust will record a gain, and vice versa. The above issue raises an important conceptual problem, since the essence of dcfeasance is that the firm has distanced itself from the obligations related to its original debt. It has also relinquished control over the securities placed irrevocably in trust. However, if future market rates of interest unexpectedly change (a reasonable assumption) thcrc will be consequences for the firm. This provides a fairly strong argulnent which could be used by those opposed to the concept of defeasancc reporting. It also suggests that some aspects of- dcfeasancc arrangements could be reported in terms of contingent liabilities. 5. CONCLUSION In the absence of specific guidance from the ASC or a clearer guide to asset and liability measurement and recognition, it is difficult to see how in-substance debt defeasancc schemes could bc accounted for in the UK on a comparable basis. This conclusion is reached for two reasons. Firstly, members of the FASB could not reach a unanimous decision, which tends to reflect the diversity of views held about off-balance sheet finance in general. One solution is for standard-setting bodies to vote separately on each type of arrangement. This would ensure comparability for a subset of off-balance sheet financial arrangements, although not necessarily for these arrangements taken as a whole. Secondly, it should be remembered that SFAS 76 and AAS 23 are not identical. This raises the question as to how UK accountants could reach consistent decisions over an appropriate accounting treatment. The approach of ED 42, and its reliance 011 the principle that a transaction’s accounting treatment should fairly reflect its commercial effect, is consonant with the general approaches of SFAS 76 and AAS 23. Nevertheless, we have shown that the approach of ED 42 w its oww may not be sufficient to etlsure an acccptablc level of conlparability between financial statements.
SPECIAL
PURPOSE
TRANSACTIONS
l-I7
Would the approach favoured by ED 42 assist accountants in deciding how to account for these types of financial arrangement? We believe that, in the absence of more detailed guidance, accountants are likely to differ in their views on how these arrangements should be reported, and this would inevitably lead to a loss of comparability both nationally and internationally between firms’ published financial statements, unless UK accountants were prepared to seek guidance from the US or Australian standards. One could argue that the AX has a responsibility to provide &icient guidance to avoid the situation where UK reporting accountants would need to look to foreign standards in order to reach a decision as to the desirable treatment to be adopted in the UK. But even then, looking to foreign accounting standards would not ensure full comparability. given the differences in approach between SFAS 7ti and AAS 23. This raises an interesting issue. Should accounting standard-setting bodies wait until a crisis develops before issuing guidance, or do they have a responsibility to try to forestall such situations by making pronouncements before the need for them is obvious? The approach taken by El) 42 is that general guidance will be suitable in most situations. Thus, accountants can try to compare situations with which they are familiar and if they appear to be similar then the appropriate forrn of accounting treatment should suggest itself. This approach implies that specific guidance will not be required. However, in the case of defeasancc, some issues cannot be resolved without arbitrary judgements. For example. deciding exactly which types of monetary assets are ‘risk-free’ involves judgements about principal risk, interest risk, perhaps foreign exchange risk also. Given the potential complexity and variety of dcfeasancc arrangements, the El) 42 approach may turn out to be too general. It should not be assumed that, because UK firms have not used these schemes in the past, they will not wish to use them in the future. The ASC has adopted a position of favouring a choice among possible accounting treatments which relies on fairly reflecting the commercial effect of a transaction. Adopting this criterion is likely to have two effects. Firstly, company financial statements will be less comparable than if specific guidelines were published. Secondly, the USC ofthis criterion could actually signal to firms that defeasancc arrangementc are valid in principle and, therefore, increase the probability that firms will use defcasance schemes in future. Adopting a general approach (as in El1 42) is arguably an inefficient process since reporting accountants will need to resolve issues on an individual basis, which could be settled by one body. Although it is feasible to assume that reporting accountants will reach similar conclusions where problems are tractable, where problems arc intractable arbitrar), judgemcnts will be needed, with an inevitable reduction in comparabilit) between financial statements. It may be more cost effective, if arbitrar)
138
_I.
judgetncnts
KijM(.Kl:
w1i.57be ma&,
tht
ANI)
thy
I<.
ilt-s\lbstallce
ddx
dckasancc
Wt.AKIN(.
be ma& by ,I sittglc ~t,ttidardreporting accoutitattts.
sliould
setting body, r,tther than by ittdividud using
I.
as an
example
of;111
ctff-balaIlcc~
shzet
financial ;trratqqxt~tlt. this paper has sought to dctnonrtrate the types of problems which would ned to be tackled by Ctccoutltmts in choosing m appropriate accoutitinh cr treatntcnt. ‘%c ASC nndc to strike ;1 rcasottablc balance bctwccn overprescription and UtidCrpr~sCri?‘ti011. In the CJSCof special purpose transactions the ASC may have I~nrd too fxr in tlx dircctioti of utld~rl-‘r~s’riptiotl.
AI’PENIIIX
where: II* = v.~luc of sccuritics rcquircd D = nominal
vhc
for dcfcasnncc.
of d&t,
C‘= coupon (nominal) w = market (current)
r:ltc ofintcrcst. rate ofqintcrcst.
1
,)* = Ioo (I +M7 (3.3744)) (I +0.11(3.3744))
El) 42, .4i(-~)t,,rtiri,c(f;,r Special Prrrpow Trnrwncrior1.c. ~vas puhlishcd by the Accounting Stmdards Committee in 1988. The expocurc draft contain\ proposals ahout the manner 111which certain transactions, popularly rcfcrrcd to a\ ‘off-halancc sheet’ transaction\, should hc rcportcd. Rather than offu spcrltic guidance, El1 42 CDIIIC\ down in favour of offering general guidance. hascd on the criterion tfut J trantdctiotl’s accounting treatment should fairly rcflcct Its commercial ctfcct. Thi\ paper discmscs the approach adopted by El1 42 in the context uf one fornl of off-balance sheet transaction, namely in-suhstancc debt defcJsdncc. Finarlcinl reporting of thl\ type of arranguncnt is now mndardiscd in both the USA and Au\tr.lli.l. Although both the US md Australian stand.lrdc dppcar to LISC‘Suh\tmc~ over torn1 .I\ their basis ofrccomnicndcd accounting pr-,lctic.e, thcrc z-c impomnr dltfcrcnccc hctwccn the two standards.
1. INTRODUCTION In 1988 the Accounting
role,lscd Exposure Draft 42, El) 42 deals with financial reporting issues which arc often referred to by flnancial commentators in the context of ‘off-balance sheet financing’. But this term is rarely LISC~ in the exposure draft which prefers instead the term ‘special purpose transactions’. El> 42 (preface, paragraph 1 .ll) proposes to o&r general guidance which would be applicable to a variety of situations, and this approach is justified on the grounds that ‘it would be impractical for ASC to provide detailed rules to cope comprehensively with every development in a .4rcounting
&Y
Spuial
Standards Committee
Purpose
T~~~r~a~rtiorrs.
This paper describes a particular financial arrangcrnent: in-substance debt defeasance. Such arrangcmt‘nts have been used by US and Australian companies and both the US and Australian accounting standard setting bodies have found it necessary to issue detailed pr(~ll(~UIlcC’lllelItS dealing with in-substance debt defcasmcc. In 1983 the US Financial Accounting Standards I3oard (FAST) issued Stattment of Financial Accounting Standards No. 76 (SFAS 76), ~‘stir~l’is/lrnc//f of‘Drht and in 1988 the Australian Accounting Research Foundation (AARF) issued Statement of Accounting Standards, AAS 23, Set-~ff‘nrrti Estir!yrrisllrNrrlt of Debt. But, to date, thcrc is no evidence, so far as the authors arc‘ aware, of the use ofin-substance debt defcasancc schemes by UK cornpanics. We show what these arrangcmcnts involve and the problems that could arise if they became conlmonly used in the UK, so that reporting accountants would nrcd to look to authoritative statcmmts such as El> 42 for guidance.
2. L>ESCRIPTION
OF IN-SUBSTANCE ARRANGEMENTS
I)EUT
A debt is often regarded as satisfied from a strictly
DEFEASANCE
Iqn/ viewpoint
if:
(a) the debt is settled through normal repayment or rollover; or (b) the debtor is formally rcltxud from any further obligation through forgiveness by the creditor. or lqal judgemcnt. But an i~-s&srmzre debt dcfcasancc can take place cvcn if neither of the above conditions is satisfied. In-subctnncc debt defeasancc can be regarded as a device for renloving debt from the balance sheet, CVCII though the debt has not been repaid. This cm bc achieved in one‘ of two ways. One way is for a frrrst to be set up and the debtor company to pass over to the trust, irrevocably, suflicicnt securities to finmcc the future inturmt charges and principal repayment of the original debt. Alternatively, a liaOi2ity assurrq~~imrqrc’r’rrrcrrf could be entered into. 111this cast a third party, for a consideration, agrees to z~ssun~cthe responsibility of all future payments of interest rind principal of the original debt. For the remainder of this paper WC shall ~1s~‘the following terminology. The first party or creditor lends the original debt. The second party or debtor is the firm or company which cl~oos~s to enter into an in-substance
SPECIAL
PURPOSE
TABLE
TRANSACTIONS
I 30
1
debt defeasance arrangement. Obliger, in a general sense, means a person or entity which originally incurs, or later assumes responsibility for. an obligation. Third party refers to an entity which becomes primary obligor in a liability assumption agreement. Trust refers to a trust in which interest bearing securities are deposited by the firm which will cover the interest payments of the original debt and, eventually, the principal. Ikfeasancc is defined by the O~j>rd Eqqlisl~ DiCtjc)lltlrY (1989, p. 372) as ‘acquittance or discharge from an obligation or claim’ which would appear to encompass normal repayment, rollover, forgiveness and legal judgtment. However, the term ‘dcfeasancc’ now tends to bc used most frequently in the context of in-substance debt defcasance. Following this treild in thu use of the term, and in order to make the exposition less Culnbersomc, the term ‘defcasancc’ will henceforth be assumed to nlean ‘in-substance debt defeasancc’. A company which previously issued debt when market rates of interest wc‘rc low will find that an amount of cash resources smaller than the nominal value of the original debt will be sufficient to repay the interest and principal. Table 1 provides an illustration. Suppose that a company issued ~SOOm of debt on 1 January 1983 at an interest rate of 7% per annum. Interest is payable on 31 December in each year and the principal is repayable on 31 December 3992. By 1 J,‘muary 1090 the general lcvcl of intcrcst rates has risen to 12% and the directors decide to set up a trust into which the company will place securities bearing interest at the rate of 12% per annum, and their maturity will coincide with the repayment of the principal of the original debt, i.c. 31 IIc~cember 1002. Clearly, an amount less than ~11()Om will bc required to meet the servicing requirements of the original debt. The precise amount can be calculated using the formula in Appendix 1.
I-IO
_). Rij,M(:KII
ANI)
It.
1.
Wt:AI
The atnouttt required to be trattsfcrrcd tc, the trust turns out to bc o111) L;X7.901 nt, as shown itt Appendis 2. Since the fit-in h,ts retnovc~d Ail OOnt debt, but only ~~87-991 m cash front its balance sheet, it can record a gain of- ,f5124)09111 (i.c. lic11OOnt-~C7~991 in) in its incnttte statctttettt for the* year ended 31 I>cccmber 1990. Mcilkc &- Scifert (1’337, p. X0) suggest tlt.tt the ability to record gains in their inconte statenteuts at the titnc ot defeasancc is a prime motivation for cornpanics to set up these arrange111e11ts.
Table 1 shows the pattern of cash flows over the three years IWO to 1992. The interest charges relating to the original debt arc less than the interest generated by 12% government securities. An assumption in this calculation is that the difference between interest rcccived and interest paid (e.g. ,&3~559tn at the end of 1990) can be reinvested at 12%. By the 31 December 1092, the trust will have accumulated securities :tt~d cash with 3 total value of L 1OOtn which will be the csact amount required to repa) the original debt. A liability assumption agreement operates in a similar manner. A third party assumes the function of the trust and in return for a consideration of ~87.99ln1 agrees to finance the future interest and principal of the original debt. The balance sheet and income statement effects arc identical to those under a trust-based defeasancc. If a firm is partly financed by quoted debt, it may be reluctant to approach its debt holders and offer the defeasance amount (effectively the market value of the debt in the case of Table 1, ~37.991 tn) as full and final compensation in return for cancelling the debt. The debt holders may not act rationally or they may view the market valuation as ‘too low’ given their own expectations. Alternatively, if the market believes that the firm is anxious to redeem its cGting debt, this could push up the market price of the debt and therefore make it more expensive to r&em. Three interesting variations of dcfeasnnce are a~ follows. (n) Instmtnrwous
ill-rirhstamc
dcht di~$mnnct~
A firm issues debt and simultaneously drfeases the same debt. This may happen if a firm can take advantage of interest arbitrage opportunities and consequently report a gain in its income statement. Instantaneous defeasance has been noted where companies have incurred a debt in one country then immediately effected a defeasancc by investing the proceeds in securities carrying a higher rate of interest in another country (Decgan, 1985, p. 55). (h) Partial lkf’“s”nC’ Only a proportion of the interest and capital is defeascd. In the financial statements of the firm, a proportion of the original debt would appear in
13‘ll.lnce
70.7 I’)
c/t
future balance sheets and the same proportion appear in future income statements.
XY.?XO
of the interest charge
wo~dd
Either the principal or interest (but not both) is defeased. If a ‘principal only’ split defeasance is carried out, then the debt would disappear from future balance sheets, although the interest charges related to the original debt would continue to appear in future income statements. If an ‘interest only’ split defeasance is carried out, then the original debt would continue to appear in future balance sheets, but the interest charges would not appear in future income statements. Table 2 provides an illustration of a ‘principal only’ split defeasance. The firm places in trust suflicient securities which will accumulate to a total of ,&lOOm by 31 December 1992. The amount of securities required .1t 1 January 1990 is k71.17Xm (i.e., ~100n1(1.12)~ ‘). In its income stdtemcnt for IWO the firm can record a gain of L2X.X22m (i.e., ~~100111~71~17Xm). However, thejustification for recording such a gain is dubious since in its income statements for each of the years 195X--1992 the firn1 will still be required to record interest charges on the original debt of /c;7111 per annuni. 3. COMPARISON
OF US AND
AUSTRALIAN
APPROACHES
Neither SFAS 76 nor AAS 23 specifically refer to the concept of ‘econonlic substance over legal form’. However, both standards appear to acknowledge the relevance of the concept. Thus, SFAS 76 makes it clear that the \rotc on acceptance of the standard by the members of the FASB revolved .uound the concept of ‘substance over form’. The dissenting members of the FASB did not believe that:
142
_I.
ltijMM(:Kk.
ANI)
I<.
I’.
Wl:AlUN(;
c\tingui\hnr~llt ofdcht .~c~ount~~~~ .111drcwlt.lnt g:.nn or lo\\ 1n2,C,SIII~I~II \J)oIIJ~ 1~ cYtcllcicd to ~itu.ltloll\ \\.llCI.C tl1c “dchtor I\ 1101 Icg.1llv rCIC.I\cd t*oIll lWIl1~ tl1c primary ohligor under the dcht oblig:.~tion (SFAS 7(1. p. ‘5).
This view contrasted with the majority
view that:
in ccrt;un cil-cumstdncc\. d&t 5hotild lx cotl\iticrcd cstinguidd for tiii.lncisll I-cport~ng purpow CVCII though the debtor i< not Icgally rclc.wd fmnl hcing the prlnury ohligor under the dcht ohlig.ltitrn. (SFAS 70, p. 11).
It is clear from the above two quotes that those for and against the standard were divided essentially on the basis of substance versus form. AAS 23 contrasts ‘legal defeasancc’ and ‘in-substance drfcasance’: A lcgd dcfc~w~cc could take pl,lcc in .Ihwlutc tcnns, that is. the debt could CC;~X to csist for myonc (hy hcing forgivcii or set .&ic). or the creditor could form;lll~ rccognisc that s~nuthcr party has t.lkcn over the primxy ohlig;ltion for the debt (p‘l’“gr‘qh
6).
Whereas in-substance defeasancc is described as: The rclc.lsc ofa dchtor from the primary ohligJtio]l for .I debt nl,ly also hc .Ichlcvcd ‘in whstC~ncc’ by the debtor, cithcr by trmsfcrring to .I trust wet\ which xc ndcquatc to twct the servicing rcquircmcnts (both intcrcst md principal) of the debt md arc dcdicatcd to that purpwc, or by having a witahlc entity ;~ssumc rrcponsihility for those servicing requircmcnt5 (pxagrC~ph 7).
From this initial position both SFAS 76 and AAS 23 accept, in principle, the validity of removing debt from the balance sheet in the case of a trustbased defeasancc or a liability assumption agreement. Both the US and Australian standard setting bodies are agreed that passing debt over to a trust or third party can constitute ‘in-substance’ defeasance, provided certain conditions are complied with. These conditions are mainly concerned with making sure that the assets placed in the trust will have a high probability of meeting the debt-servicing requirements (interest and principal), or in the case of a liability assumption agreement, that the third party is credit worthy. Both the Australian and US standards require that the monetary assets of the trust should be ‘risk-free’ with regard to the type of monetary asset and also with regard to the timing of interest and principal payments. SFAS 76 (paragraph 4) rt q uires that the monetary assets of the trust shall: (1) be denominated in the currency in which the debt is payable; (2) be invested in government bonds; and (3) b e capable of providing cash flows that approximately coincide with the interest and principal payments of the original debt. AAS 23 (paragraphs 8 and 9) imposes virtually identical restrictions. As regards a liability assumption agreement, SFAS 76 (paragraph 18) only allows debt to be considered as extinguished for financial reporting purposes if the debtor is legally released from being the primary obligor.
SPECIAL
PURPOSE
143
TRANSACTIONS
AAS 23, by contrast, is considerably less stringent and simply requires (paragraph 10) that the third party should be a ‘risk-free entity’. Technical Bulletin 84-4 (Financial Accounting Standards Board, 1’9x4) modified SFAS 76 so that instantaneous defeasancc is now disallowed. However, AAS 23 permits instantaneous defeasancc, provided that the other conditions are complied with. Deegan (1985, p. 55) cites the example ofthe US corporation, Pepsi Co., which in early 1984 issued debt denominClted in Deutschmarks on the US bond market. At the Tame time Pepsi Co. was able to purchase West German government securities yielding higher interest rates. This transaction provided Pepsi Co. with a real not now be allowed economic gain. Although such a transaction would to he treated as defeasance for reporting purposes by a US company, following the release of Technical Bulletin 84-4, AAS 23 IPOI~/~allo~v such a transaction for an Australian company. Whittrcd & Zimmer (1988, p. 132), writing before the publication of AAS 23, give the example of a firm which places debt in a country where irltercst rates in the late 1980s are relatively low (sa). Europe) and use the proceeds to buy government bonds in a country where interest rates in the late 1980s are relatively high (say USA). Th‘ IS can expose the firm to risk if the currency of the European country should appreciate relative to that of the country in which the government bonds were purchased. Such practices can no longer be treated as extinguishment of debt by Australian companies since paragraph 9 of AAS 23 rcquircs that the risk-free assets should be denominated in the same currency as the debt being defeascd. 4. ED 42 AN11 CHOICE
OF ACCOUNTING
TREATMENT
El> 42 states (preface, paragraph I .15) that a transaction’s accounting treatment should fairly reflect its commercial effect. But the document thcu goes on to state (preface, paragraph 1.16) ‘this principle should be distinguished from the statetnent that substance should take precedence over form’. ED 42 does not explain why such a distinction is necessary or useful. We believe that ‘substance over f-arm’ or ‘economic substance over legal form’ are terms which have usefully been employed in the past (at times by the ASC itself). While ‘substance over form is a controversial concept and the term itself is subject to different interpretations, it does have the advantage of providing a signal about the nature of the debate, .md it JOCXnot seem to be a positive step for the AXI to move away from this terminology. As mentioned in the introduction, we are not aware of any UK companies having used in-substance debt defeasance arrangements to date, Jthough the broad approach adopted by ED 42 may in fact stimulate the use of defensance arrangements. The question we wish to ask is this. Will
14-k
j.
RijMM(.Kt>
ANI)
I<.
1.
WhAKINC;
the approach outlined in El> 43. or the eventual standard. colltain sufficient guidance to allow rcportin, cr accountants to determine whether to account for the relevant amounts ‘on-balance sheet’ or ‘off-bala~~ce sheet’? If we USC‘commercial effect’ or ‘substance over fornl’ as our guiding principle, it could be plausibly argued that the company has c;fti~ti~c/y set aside an amount which, in all probability, will cover the future interest and capital repayment of the original debt. This was the view eventually reached by the FASB. However, it was by no means a unanimous decision, and of the seven members who voted on the standard, three (including the chairman) dissented. Those voting against believed that extinguishment of debt could occur only where the debtor is legally released from being the primary obliger under the debt obligation. A prudent approach to this issue would suggest that the company should be regarded still as the primary obligor (the factual legal position) and therefore the relevant items should be kept ‘on-balance sheet’. An approach which stressed substance at the expense of form and prudence would take an opposite view and suggest that the items should be kept ‘off-balance sheet’. We take it as axiomatic that the greater the scope for professional judgement, the less comparability there will be between financial statements. III considering how a UK company should report dcfeasancc arrangements, it is useful to compare the approaches adopted by SFAS 70 and AAS 23.
A UK reporting accountant would not find a definitive answer by looking to SFAS 76 or AAS 23 since they offer conflicting guidance. The choice of accounting treatment would therefore depend on the exercise of professional judgemcnt, with the result that comparability will be reduced. Suppose further that a company wishes to account for instantaneous defeasance and the securities purchased are not government bonds and/or are not denominated in the same currency as the original debt. It is possible that the resulting accounting treatment would be inconsistent with both SFAS 76 and AAS 23. It is interesting to note that requiring a firm to disclose, on its balance sheet, debt which it has been able to defease at a profit will increase its gearing. An increase in the level of gearing will mean that the firm will have to offer further issues of debt at higher rates of interest and hence erode any comparative advantage it has in finding advantageous arbitrage opportunities. (b) Partiul drfeasmcv
SFAS 76 and AAS 23 adopt similar approaches, but the UK reporting accountant would still need to exercise professional judgement about whether the purchased securities are suf5ciently ‘risk-free’.
SPECIAL
PURPOSE
TRANSACTIONS
I 45
(c) Split defeasance If a UK company wished to report a ‘principal only’ split defeasancc, the auditor could be placed in a difficult position for two reasons. Firstly, over whether the transaction should be recognised as a defeasance, given that SFAS 76 and AAS 23 both disallow these arrangements. Secondly, even if the transaction were to be reported as a defeasance, professional judgement would need to be exercised over whether to recognise and, if so, how to measure the liability relating to future interest payments on the original debt. (d) Liahiliry assumnption agreement Suppose that a UK company entered into a liability Jssumption agreement where the company was not legally released from being the primary obligor. SFAS 76 would reject, whereas AAS 23 would allow this arrangement. Again, the UK reporting accountant would need to exercise professional judgemcnt over the choice of an appropriate accounting treatment. It can be appreciated that if defeasance were to become a popular form of financial arrangement in the UK, there would be a potential for widely differing reporting treatments, even though the underlying events for a number of companies could be identical. It should be remembered that companies have an incentive to undertake these arrangements since they can report a gain in their income statements in the year in which the defeasance occurs. Auditors could be under pressure, therefore, to accept these arrangements and this could in turn lead to pressure on the ASC to come up with more detailed guidance than is provided for by ED 42. El) 42 contains a brief discussion of the characteristics of XI asset (paragraphs 14-21) and the characteristics of a liability (paragraphs 22-27) but these provide inadequate guidance for determining the accounting treatment of off-balance sheet financial arrangements. It would be interesting to speculate. for instance, on the reporting treatmerrt for .I UK compmv setting up this arrangement but transferring quoted shares to the trust, instead of government securities. Finally, there are two further issues which may not have been adequately addressed by the FASB or AARF. One concerns the assumption that, at 31 December in each of the years 1990 and 1901, the trust will be able to purchase additional government securities where the timing of the interest receipts and rnaturity exactly matches that of the original debt. This may not always be possible. A second difficulty concerns the assumed level of interest rates over the period 1990 to 1992. Actual interest rates during this period are likely to fluctuate, in which case the cash and investnrents held by the trust will, by 31 December 1992, be greater or less than ~1OOm. This is because interest on interest may not be carned at the initial market rate.
146
J.
I
ANI)
R.
‘I.
W/tAIIIN(;
Suppose that market rates ofintercst uncspcctedly fall after the defca+ ancc is carried out, Then the firm would need to inject a further arn~>unt into the trust at 31 I~ccembcr 1002. The longer the period bctwccn defeasance and repayment of the original debt, the greater sucl~ deficits or gains are likely to be. The firm can, of course, minimicc the possibility of a deficit at 31 December 1902 by assuming a low, or cvc’ti zero, rate of interest on reinvested interest. Such an assumption would incrcace the amount of securities required to be placed in the trust at defcasance. However, this policy increases the probability that the trust will record a gain at 31 l)ecrnlber 1902. Thus, there is a direct trade-OK between the probability of the trust recording a gain and recording a deficit. The more the firm attempts to reduce the probability of a deficit. the greater the likelihood that the trust will record a gain, and vice versa. The above issue raises an important conceptual problem, since the essence of dcfeasance is that the firm has distanced itself from the obligations related to its original debt. It has also relinquished control over the securities placed irrevocably in trust. However, if future market rates of interest unexpectedly change (a reasonable assumption) thcrc will be consequences for the firm. This provides a fairly strong argulnent which could be used by those opposed to the concept of defeasancc reporting. It also suggests that some aspects of- dcfeasancc arrangements could be reported in terms of contingent liabilities. 5. CONCLUSION In the absence of specific guidance from the ASC or a clearer guide to asset and liability measurement and recognition, it is difficult to see how in-substance debt defeasancc schemes could bc accounted for in the UK on a comparable basis. This conclusion is reached for two reasons. Firstly, members of the FASB could not reach a unanimous decision, which tends to reflect the diversity of views held about off-balance sheet finance in general. One solution is for standard-setting bodies to vote separately on each type of arrangement. This would ensure comparability for a subset of off-balance sheet financial arrangements, although not necessarily for these arrangements taken as a whole. Secondly, it should be remembered that SFAS 76 and AAS 23 are not identical. This raises the question as to how UK accountants could reach consistent decisions over an appropriate accounting treatment. The approach of ED 42, and its reliance 011 the principle that a transaction’s accounting treatment should fairly reflect its commercial effect, is consonant with the general approaches of SFAS 76 and AAS 23. Nevertheless, we have shown that the approach of ED 42 w its oww may not be sufficient to etlsure an acccptablc level of conlparability between financial statements.
SPECIAL
PURPOSE
TRANSACTIONS
l-I7
Would the approach favoured by ED 42 assist accountants in deciding how to account for these types of financial arrangement? We believe that, in the absence of more detailed guidance, accountants are likely to differ in their views on how these arrangements should be reported, and this would inevitably lead to a loss of comparability both nationally and internationally between firms’ published financial statements, unless UK accountants were prepared to seek guidance from the US or Australian standards. One could argue that the AX has a responsibility to provide &icient guidance to avoid the situation where UK reporting accountants would need to look to foreign standards in order to reach a decision as to the desirable treatment to be adopted in the UK. But even then, looking to foreign accounting standards would not ensure full comparability. given the differences in approach between SFAS 7ti and AAS 23. This raises an interesting issue. Should accounting standard-setting bodies wait until a crisis develops before issuing guidance, or do they have a responsibility to try to forestall such situations by making pronouncements before the need for them is obvious? The approach taken by El) 42 is that general guidance will be suitable in most situations. Thus, accountants can try to compare situations with which they are familiar and if they appear to be similar then the appropriate forrn of accounting treatment should suggest itself. This approach implies that specific guidance will not be required. However, in the case of defeasancc, some issues cannot be resolved without arbitrary judgements. For example. deciding exactly which types of monetary assets are ‘risk-free’ involves judgements about principal risk, interest risk, perhaps foreign exchange risk also. Given the potential complexity and variety of dcfeasancc arrangements, the El) 42 approach may turn out to be too general. It should not be assumed that, because UK firms have not used these schemes in the past, they will not wish to use them in the future. The ASC has adopted a position of favouring a choice among possible accounting treatments which relies on fairly reflecting the commercial effect of a transaction. Adopting this criterion is likely to have two effects. Firstly, company financial statements will be less comparable than if specific guidelines were published. Secondly, the USC ofthis criterion could actually signal to firms that defeasancc arrangementc are valid in principle and, therefore, increase the probability that firms will use defcasance schemes in future. Adopting a general approach (as in El1 42) is arguably an inefficient process since reporting accountants will need to resolve issues on an individual basis, which could be settled by one body. Although it is feasible to assume that reporting accountants will reach similar conclusions where problems are tractable, where problems arc intractable arbitrar), judgemcnts will be needed, with an inevitable reduction in comparabilit) between financial statements. It may be more cost effective, if arbitrar)
138
_I.
judgetncnts
KijM(.Kl:
w1i.57be ma&,
tht
ANI)
thy
I<.
ilt-s\lbstallce
ddx
dckasancc
Wt.AKIN(.
be ma& by ,I sittglc ~t,ttidardreporting accoutitattts.
sliould
setting body, r,tther than by ittdividud using
I.
as an
example
of;111
ctff-balaIlcc~
shzet
financial ;trratqqxt~tlt. this paper has sought to dctnonrtrate the types of problems which would ned to be tackled by Ctccoutltmts in choosing m appropriate accoutitinh cr treatntcnt. ‘%c ASC nndc to strike ;1 rcasottablc balance bctwccn overprescription and UtidCrpr~sCri?‘ti011. In the CJSCof special purpose transactions the ASC may have I~nrd too fxr in tlx dircctioti of utld~rl-‘r~s’riptiotl.
AI’PENIIIX
where: II* = v.~luc of sccuritics rcquircd D = nominal
vhc
for dcfcasnncc.
of d&t,
C‘= coupon (nominal) w = market (current)
r:ltc ofintcrcst. rate ofqintcrcst.
1
,)* = Ioo (I +M7 (3.3744)) (I +0.11(3.3744))