SEC Issues Report on Off-Balance Sheet Transactions

We have all become aware of the Sarbanes-Oxley Act of 2002 (the Act, SOX), as it has been cast into the spotlight over the past few years. The Act has been the topic of much discussion for both public and non-public entities, and the impetus for many changes. One section of the Act lead to the SEC issuing a staff report on off-balance sheet activity on July 15, 2005. Section 401(c) of the Act required the SEC to conduct a study and issue a report on off-balance sheet activity, which encompasses the extent of such transactions, the reflection of the true economic effect on the financial statements, and recommendations for improving the transparency and quality of reporting off-balance sheet activity in the financial statements.

The performance of this study included collecting and analyzing filings from a sample of two hundred SEC registrants. Off-balance sheet arrangements reviewed in this study include equity investments, asset transfers, retirement arrangements, derivatives, contingent obligations and guarantees, leases, and other contractual obligations. The study also reviews the use of special purpose entities (SPEs). It should be noted that this report is based on information reported through filings, therefore it may not have included all off-balance sheet arrangements.

The Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002 on Arrangements with Off-Balance Sheet Implications, Special Purpose Entities, and Transparency of Filings by Issuers includes a section discussing the findings in relation to each of the activities mentioned in the second paragraph. These findings note the activities’ rate of occurrence in the sample, and extrapolates the rate of occurrence to the entire population of issuers. The findings sections also contain an estimate of the related dollar amounts for each activity.

As a result of the study, the SEC staff has compiled a listing of initiatives to improve transparency in reporting and a set of standard-setting recommendations to aid in realizing the initiatives. The initiatives to improve transparency in reporting are:

• Promote the use of transaction structures which ultimately reflect the economic transaction, instead of structures that are motivated by accounting and reporting goals.
• Reduce the complexity of accounting standards by implementing objectives-oriented standards.
• Improve the quality (consistency and relevance) of financial statement disclosures, especially those relating to financial instruments.
• In relation to financial reporting, change the issuers’ focus from mere compliance with standards to striving to make financial information and disclosures clear and useful to users.

The standard-setting objectives defined by the SEC staff are as follows:

• Continue the advancements in guidance for the consolidation of entities.
• Accounting guidance relating to defined benefit pension plans and other post-retirement plans needs to be updated. The study indicated that there is approximately $535 billion in retirement obligations not recognized by issuers on their respective balance sheets.
• Accounting guidance for leases needs to be updated. The results of the study indicated there may be approximately $1.25 trillion in non-cancelable operating lease obligations which are not recognized on issuers’ balance sheets.
• The use of fair value accounting for all financial instruments should continue to be researched.
• A framework should be developed to create more useful and organized disclosures.

The report concludes there is much work to be done, but steps have been taken since the passage of the Act, such as FIN 46, SFAS, 150, SFAS 123R, and FIN 45. The SEC hopes to work with FASB in designing and implementing some of these standards because of their belief “that investors – and the market as a whole – are best served by financial information that is presented fully and clearly” (SEC, 2005).

For more information please refer to:

• The SEC's Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002
• FASB News Release Related to SEC Report
• The Sarbanes-Oxley Act of 2002

Contact Nichols, Cauley & Associates by Email, phone, or online form with your questions.

Site visitors should keep in mind that the content is generally designed to be of general applicability. Particular state laws, regulations and special contractual provisions can greatly impact rights, responsibilities and legal obligations. Only a competent attorney, accountant or other professional looking at all the pertinent facts and circumstances of a particular situation can provide definitive guidance for you. Please refer to our important legal discalimer which can be accessed from the bottom of any BankAudit.net webpage.