Consolidating SPEs

CFA Level II FRA
#1

Guys I’m confused about consolidating SPEs.

Schweser says that consolidating increases assets and equity. I thought it increased assets and liabilities?

( this is in relation to a question about the impact on ROE.)

would really appreciate an explanation, thanks all .

#2

Yup me too, I’ve seen a fair bit of ambiguity within the CFAi texts and Schweser. Can anyone help with a definitive answer?

#3

Yeah what the hell, I dont understand this aswell

I just came past a question where a company was accounting for SPE’s with the equity method and now is required to ‘consolidate’. The question is asking for impact on ROA and ROE

If they are using the equity method for SPE doesnt that mean that its technically already consolidated? I would have thought that there would be no effect on Return on assets because you are removing one asset (equity asset) and adding the SPE as an asset?

Help???

#4

i also think it increase assets and liability, anyone can give a hand?

#5

Under equity method the SPE is not consolidated

If you switch to consolidated, you have to bring the SPE on your balance sheet, hence assets go up & equity goes up.

Does that help?

#6

Thanks Andrew. What about if an SPE holding receivables had (say) issued bonds? Is it then that the parent ends up with the receivables AND the cash from the bond proceeds as assets, the bond liability and then the rest as equity?

#7

I think you’re thinking too much there… find an example question in the text and post it if you want

#8

The question was in a schweser mock. It was basically ‘company x has been accounting for an SPE using the equity method, what would be the effect on ROE if it had to be consolidated’.

Can you please go through exactly how the income statement and balance sheet would be affected by this? I thought I had this down and now it’s driving me nuts.

Thanks!!

#9

for this question I think you just have to refer to the table that states that ratios are better with the equity method. Therefore ROE would be lower here.

#10

The equity method only shows only a one-line consolidation of the target’s earnings, so the SPE is not consolidated under the equity method. Typically, SPEs are created to securitize assets, usually receivables of the sponsor. The SPE issues debt to purcahse the receivables and the debt is repaid as soon as the receivables are collected.

#11

Was solving this Q and a google search brought me to this thread.

Still not being able to understand how the consolidation of the SPE is going to increase Equity. Anybody to help out on this?

#12

I think it may depend on the purpose of the SPE. for the simple example when it’s used to securitize receivables, there is no change in equity for the parent upon consol.

remember if the parent creates an SPE with 5mill of cash, its equity for the SPE, but an asset for the company. so upon consol. the investment in the SPE goes and the cash increases 5mill. no change in equity there.

But I think if the entity is functioning like a company there would be retained earnings etc that would come back to the parent. Can you post the reference to the schweser question?

#13

I saw this Question in the Schweser Practice Tests 2011 edition Volume 1 Exam 2 (PM) Q 83

The question deals with the effect of classifying an SPE into a VIE and consolidating the entity rather than using the equity method. Impact on ROE is asked

#14

Maybe something like assets go up by 100, liabilities go up by 75 and equity goes up by 25 (which is the cash you invested in the spe).

#15

Bumping this thread in case anybody’s got any new insight…

#83 Schweser Mock 2 PM - What is the likely effect of the required change in accounting for SPE’s on Samilki’s:

ROA, ROE

Decrease, Decrease

I know why ROA decreases (consolidating an SPE instead of using the equity method will add it’s assets and liabilities to your balance sheet) - but why does it increase equity too? According to the answer key, equity will increase due to a minority interest account. I don’t for the life of me understand how there can be a minority interest in a consolidatd SPE…

#16

Yeah. I think it should be

Dr Asset X

Cr Liability X

Equity remains unchanged

Any thought?

#17

yea, this confused the hell out of me too. I went back and read the section on SPEs again, apparently you can have non-controlling interests in SPEs. Mainly at the bottom of P148 “… if there are noncontrolling interests in the VIE, these would also be shown on the consolidated balance sheet and consolidated income statement of the primary beneficiary.”

#18

there should be minority interest, i.e. those who have voting rights but not control.In the securitization process, SPEs do sell securities to outside investors. Just think SPE as the target company in the acquisition.

#19

could that be after the SPE consolidation,

the Net Income need to adjust the previous gain due to SPE securitization,

Adjusted Retained earning = Retained earning - gain,

Total equity reduced,

overall, Net income and Total Equity reduced, so ROE decrease?