Deloitte & Touche Deloitte & Touche LLP Telephone: (203) Ten Westport Road P.O. Box 820 Wilton, Connecticut

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1 Deloitte & Touche Deloitte & Touche LLP Telephone: (203) Ten Westport Road P.O. Box 820 Wilton, Connecticut Letter of Comment No: ~{ May 26,1999 File Reference: l r Date Received: Mr. Timothy S. Lucas Director of Research and Technical Activities Financial Accounting Standards Board 401 Merritt 7 P.O. Box 5116 Norwalk, Connecticut File Reference No. 194-B Consolidated Financial Statements: Purpose and Policy Dear Mr. Lucas: f (;. riff Enclosed is our letter of comment on the F ASB' s Exposure Draft, Consolidated Financial Statements: Purpose and Policy, dated February 23, If you have any questions concerning our comments, please contact Val R. Bitton at (203) , Joseph H. Cappalonga at (203) , or John T. Smith at (203) Yours truly, Enclosures Oeloitte Touche Tohmatsu

2 Deloitte & Touche Deloitte & Touche LLP Telephone: (203) Ten Westport Road P.O. Box 820 Wilton, Connecticut May 26,1999 Financial Accounting Standards Board 401 Merritt 7 P.O. Box 5116 Norwalk, Connecticut File Reference No. 194-B Consolidated Financial Statements: Purpose and Policy Dear Sirs: Weare pleased to comment on the F ASB' s Exposure Draft, Consolidated Financial Statements: Purpose and Policy (the ED), dated February 23, Although we support the project overall, we do not support the issuance of the ED as a final Statement as currently drafted for the reasons discussed in our previous letters to the Board and discussed further below. Further, we believe additional guidance is needed for certain issues. Without such guidance, the policy set forth in the ED may increase diversity in practice in areas where diversity does not currently exist, while not resolving the accounting treatment for certain issues, particularly special-purpose entities (SPEs), where diversity in practice does exist. As a result, consolidation may not occur when consolidated financial statements would be more meaningful, and conversely, consolidation may occur when separate financial statements would be more meaningful. Our letter focuses on three primary issues: (1) beneficial interest, (2) the presumption of control, and (3) special-purpose entities. First, we believe the final Statement should emphasize the importance of beneficial interest as a condition for consolidation and that, in some instances, beneficial interest may be more relevant than decision-making ability for purposes of consolidation. Secondly, we believe that control should not be presumed unless legal control exists. Effective control should be determined based on an evaluation of the relevant facts and circumstances. The presumptions of control set forth in the ED will be difficult to apply in practice without further guidance. Finally, we believe additional guidance is needed to specifically address consolidation of special-purpose entities. The ED, as currently drafted, does not provide clear guidance in this area, nor does it address the impact of the proposed consolidation policy on the specialized specialpurpose entity guidance that currently exists. Oeloitte Touche Tohmatsu

3 Mr. Timothy S. Lucas May 26,1999 Page 2 Although the F ASB is not addressing consolidation procedures as part of this project, some guidance in the final Statement is needed to clarify how to apply the consolidation policy established in the Statement. Without guidance regarding consolidation procedures, consistent application of the Statement will be difficult. For example, we believe it is essential to clarify the consolidation procedures for the holder of convertible securities that give that holder the unilateral ability to obtain the right to appoint a majority of a corporation's governing body. Should the holder's accounting be based on the holder's fully diluted ownership? How should the holder account for the current majority shareholder's interest if the holder consolidates the subsidiary? Our views on the key issues are summarized below. Our comments on the individual issues raised in the ED, as well as other comments, are discussed in the Appendix to this letter. Beneficial Interest Under the ED, the financial statements of a subsidiary should be consolidated with those of its parent if the parent has the ability to control the subsidiary. The definition of control in the ED involves nonshared decision-making ability and the ability to use that power to increase benefits and limit losses from a subsidiary's activities. The notion of "benefits" included in the second part of the definition of control suggests that beneficial interest in an entity should be considered in the determination of whether a parent should consolidate a subsidiary. However, the implementation guidance and examples provided in the ED focus on the first characteristic of control, nonshared decision-making ability. We believe that both nonshared decision-making ability and beneficial interest should be considered based on the relevant facts and circumstances. In some instances, beneficial interest may be more important than decision-making ability for purposes of consolidation. The Board has rejected beneficial interest as a separate criterion for consolidation; however, in paragraph 19 ofthe ED, the Board acknowledges that in some instances, assessment of control may focus on "whether an entity has... significant risks and rewards of ownership in that corporation." The footnote to that paragraph states: The level of ownership interest or rights to other benefits, by itself, does not make evident the presence or absence ofthe decision-making powers of control, but the party with the greatest opportunity to benefit (and suffer) from the activities of a closely held corporation is likely to have the strongest incentive to control that corporation's activities... The implementation guidance and examples in the final Statement should reflect the importance of beneficial interest in the decision to consolidate a subsidiary.

4 Mr. Timothy S. Lucas May 26, 1999 Page 3 Control As stated in our previous letters to the Board, we object to the presumption of control based on the conditions described in paragraphs 18(b) and 18( c). We believe control should be determined based on an evaluation of those conditions as indicators of control. Control is a matter of fact, not presumption, and effective control should not be presumed to override legal control. The relationship between a parent and subsidiary should be carefully evaluated based on the relevant facts and circumstances to determine whether effective control exists in the absence of legal control. The substance and economics of the arrangement should be considered before control is presumed. The discussion below focuses on the practical problems that may result from applying the ED's presumptions of control and, notwithstanding our views above, our recommendations to address those problems. Large Minority Interest In paragraph 18(b), the ED presumes that a company should consolidate an entity ifthe company holds a large minority voting interest and no other party or organized group of parties has a significant voting interest. The application of this presumption presents practical problems, such as: (1) how to assess the number of votes that will be placed in a given year in order to determine whether a large minority interest is effectively controlling an entity; (2) how to assess the satisfaction level of other shareholders (recognizing that the large minority voting interest is 'controlling' the subsidiary only at the pleasure of the other shareholders) for purposes of determining whether voting results may diverge from historical patterns; and (3) how to address situations where voting patterns may vary from year to year leading to consolidation in one year and deconsolidation in the next year. Additionally, the application of this presumption may place too much emphasis on past voting patterns which may not be relevant to current circumstances. Further guidance on implementing this presumption is needed. Ability to Obtain a Majority Voting Interest Paragraph 18( c) requires that a company consolidate an entity if it has the unilateral ability to obtain a majority voting interest or if the company owns convertible securities that would give it the right to appoint a majority of an entity's governing body. In addition, a company in these circumstances should consolidate over companies that meet the presumptions of control described in paragraphs 18( a) or 18(b). This provision overlooks current control- whether it is legal or effective, and would seem to indicate that by the mere existence of convertible securities, the original parent relinquishes control. We believe that the original parent continues to control until the securities are actually converted. The holder of convertible securities does not obtain nonshared decision-making ability until the securities are converted. This position seems consistent with the Board's conclusion in paragraph 9 of the ED that a company should consolidate an entity until control ceases to exist. Without further guidance that addresses this contradiction in the ED, two entities may consolidate the same subsidiary.

5 Mr. Timothy S. Lucas May 26,1999 Page 4 To illustrate further the conceptual and practical problems associated with this presumption, assume A owns a majority voting interest in X and has held the majority interest for several years. X (under direction from A) issues convertible preferred stock to an unrelated party, B, to meet immediate financing needs. Absent other factors that indicate that B effectively 'controls' X, the issuance of convertible preferred stock to B, in and of itself, should not lead to the presumption that X is no longer controlled by A. A maintains legal control of X through its majority voting interest, and until this control ceases to exist (i.e., B converts its preferred stock), or until B exercises effective control over X, we believe A should continue to consolidate X. In some instances, B may have no desire to exercise the conversion feature or exercise effective control of X (e.g., in the case of financial or passive investors). In some fact patterns, B, as an investor, may ultimately be given the choice to convert its preferred stock to voting or nonvoting securities. Clearly, all of the unique facts and circumstances should be evaluated, but control by B should not be presumed simply because it holds convertible securities. We believe the scenario above may, in some cases, be distinguished from one in which A and B establish a new company, X. A owns 55% of the voting interest in X and B owns 45% of the voting interest. B, however, is also issued convertible preferred stock that will, upon conversion, increase B's voting interest in X to 55%. In this scenario, the substance of the arrangement may be that B effectively controls X. We believe the final Statement should provide guidance for distinguishing between situations where one company substantively controls another and situations where one company has primarily provided financing for another. The ED implementation guidance and examples focus on declining interests in a company. For example, A grants B convertible securities in X which, if converted, result in B owning a majority voting interest in X. A's voting interest has declined and deconsolidation is appropriate based on guidance in the ED. We suggest adding an example in which X's voting stock is widely held (i.e., no shareholder, including A, owns more than 10%), and B is issued convertible preferred stock which permits B to obtain an additional 5% interest in X each year. The appropriate accounting treatment under the ED is unclear. Is control assessed when the percentage of shares owned by B, giving effect to currently exercisable preferred stock, exceeds 20% [triggering the presumption of control in paragraph 18(b)] or exceeds 50% [triggering the presumption of control in paragraph 18(c)]? At what point does B control, and thus consolidate, X? A further example that illustrates the difficulty of applying the presumption of control in paragraph 18(c) is in the case of warrants issued to B for up to a 55% interest in X. Assume the warrants are exercisable immediately, but the exercise price increases by 5% each year. Under this scenario, it is unclear which factors should be considered to determine ifthere is evidence that overcomes the presumption of control. For example, should one consider whether the warrant is currently in the money? If the warrant is slightly out of the money, should a "control premium" be attached to the stock for valuation purposes, thereby putting the warrant into the money? Should B's ability to

6 Mr. Timothy S. Lucas May 26,1999 Page 5 obtain funds to exercise the warrants, including consideration ofb's credit rating and credit availability, be considered? IfB's ability to obtain funding should be considered, how can that ability be objectively determined by a third party? Conversion Right Issues As illustrated above, there are a number of issues relating to conversion rights as a basis for assessing control, including: The impact of "in the money" and "out of the money" exercise prices The ED does not address how the economics of conversion rights should affect the assessment of control. To further illustrate, as market prices fluctuate, conversion rights may fluctuate between being "in the money" and "out of the money." The guidance in the ED does not address whether it would be appropriate to consolidate and deconsolidate each period based on market conditions. The impact of future or periodic conversion rights We interpret paragraph 18( c) to mean that even if future conversion rights are certain (i.e., contingent on the passage of time only), the holder should not consolidate until the conversion rights are exercisable. It is not clear, however, what the outcome would be if the conversion feature was structured such that the holder could choose to exercise its conversion rights periodically over a set timeframe (e.g., on a certain day of each quarter for a period of five years). If control is presumed to exist only when conversion rights are exercisable, a structure of this nature may yield unusual accounting results - if conversion rights are exercisable only on the last day of a reporting period, control may be presumed for purposes of preparing financial statements for that reporting period; however, if conversion rights are exercisable only on the second to last day of a reporting period, control may not be presumed for purposes of preparing financial statements for that reporting period, assuming the holder chose not to exercise its conversion rights the day before. The impact of other factors, such as economic constraints, affecting the likelihood of conversion The ED does not identify the nature and types of costs and benefits to be considered in the assessment of control. It is unclear whether a simple market price analysis should be performed, or whether more complicated or subtle factors should be considered. Furthermore, even once costlbenefit factors have been identified, the task of measuring those costs and benefits is extremely difficult and judgmental. Of significant concern is the fact that judgmental criteria may provide an opportunity for regulators and others to challenge reasonable judgments made by companies in the application of consolidation policy to specific fact patterns.

7 Mr. Timothy S. Lucas May 26,1999 Page 6 Cost-benefit factors related to conversion that may be difficult to measure and may result in differing interpretations and application of this ED include: (1) the foregone fixed return on a convertible security; (2) the requirement to recognize a proportional share of a company's losses (assuming an investor previously accounted for an investment at fair value or on the cost method); (3) the effect of consolidation on margins or other ratios; (4) whether companies with operating losses, yet significant market capitalization, are perceived by an investor as having a benefit; and (5) the current debt load, credit availability, and credit rating of a holder of convertible securities. The ED should address the practical problems associated with evaluating the costs and benefits of converting securities to ensure consistent application of the final Statement. To provide a framework for the consideration of the costs and benefits of converting securities to voting stock, we recommend modifying paragraph 18( c) as follows: c. Has a unilateral ability to (1) obtain a majority voting interest in the election of a corporation's governing body provided there are no significant economic or legal impediments that would be disadvantageous to obtaining a majority or (2)... Interaction of Presumptions of Control The interaction of the presumptions of control in the ED is unclear. For example, an entity may have the ability to obtain a large minority voting interest in a company through the exercise of convertible securities. Should control be presumed based on the combined application of paragraphs 18(b) and 18( c)? In the case of a limited partnership where the limited partners have the ability to remove the general partner (therefore, control by the general partner is not presumed), should the voting patterns ofthe limited partners be evaluated to determine whether the general partner's 'minority interest' should be considered 'controlling,' as in paragraph 18(b)? The ED should provide further guidance on how to apply the presumptions of control, individually and collectively. Exercise of Control The Board should consider adding criteria that focus on the demonstration of effective control before control is presumed. The exercise of control (e.g., actually appointing a majority of the board members) generally should be required to substantiate effective control. Evidence Required to Overcome Presumptions of Control While the ED acknowledges that evidence may exist that would rebut the presumptions of control, it does not provide examples of such evidence. Without examples of persuasive evidence, the application of these presumptions may lead to inconsistent and, in some cases, inappropriate conclusions about whether a parent should consolidate a

8 Mr. Timothy S. Lucas May 26, 1999 Page 7 subsidiary. Furthennore, without clear examples of evidence to overcome the presumptions, practice may move towards a model based on "intent" in order to support a lack of control. The ED should clarify that intent (to NOT convert securities and obtain a majority interest) must be coupled with substantive evidence in order to overcome the presumption of control when convertible securities are outstanding. Effects on Existing Guidance We note that the ED, specifically the presumption of control in paragraph 18( c), considers convertible securities differently than Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock (APB 18). The ED presumes the exercise of convertible securities for purposes of detennining which entity has control, while APB 18 looks to "currently outstanding securities whose holders have present voting privileges" for purposes of detennining whether an entity has significant influence. The Board should address this inconsistency in the final Statement. SPE Transactions SPEs may take many legal fonns, but are generally nonsubstantive entities created to accomplish narrow and well-defined objectives. Accounting for transactions involving SPEs has been difficult given their complex nature and the limited guidance available. SPEs are often created to operate on "automatic pilot," thereby making it difficult to assess whether effective control exists. The presumptions of control in paragraphs 18(b) and 18(c) are not relevant to SPEs because in many cases, the activities of the SPE are relegated to contractual provisions rather than voting rights. The factors described in paragraph 19 are useful when applied to SPEs, but not operational without further guidance. Additional factors indicating effective control in the context of SPEs should be provided in the final Statement. The F ASB has acknowledged the importance of convergence of accounting methodology on a global level. We believe the guidance in Interpretation 12, Consolidation - Special Purpose Entities, issued by the Standing Interpretations Committee (SIC) ofthe International Accounting Standards Committee, should be included in the final Statement. The SIC has concluded that the following factors may indicate effective control of an SPE by an entity: The SPE conducts activities on behalf of the entity, such as providing long-tenn capital or operational funding, or providing goods and services central to the entity's on-going operations. The entity has the ability to obtain control of the SPE or its assets, including the power to dissolve the SPE or change its charter or bylaws. The entity has the right to obtain the majority of the benefits of the SPE, including future cash flows, earnings, net assets, or residual interests. Significant residual risks related to the SPE fall to the entity, and outside investors' exposure to gains and losses is limited.

9 Mr. Timothy S. Lucas May 26,1999 Page 8 Incorporating the substance of these factors into the final Statement will provide more effective practical and operational guidance with regard to SPEs. Other factors to consider in the assessment of whether control exists may include management contracts between the entity and the SPE as well as arrangements whereby the SPE is effectively performing the same function that the entity performed prior to the SPE's creation. The guidance in the ED does not address whether or not current guidance is superceded, and accordingly, it is unclear how current accounting for SPEs will be affected by the ED. Specifically, the ED does not address the appropriate accounting for qualifying SPEs under Statement of Financial Accounting Standards No. 125, Accountingfor Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SF AS 125), other securitization transactions involving SPEs, or leasing SPEs. The final Statement should state that qualifying SPEs, within the scope of SF AS 125 dealing with transfers of financial assets and Emerging Issues Task Force (EITF) Issue No , Impact of FASB Statement No. 125 on Consolidation of Special-Purpose Entities, dealing with consolidation of qualifying SPEs, should not be consolidated. The final Statement also should specifically address other securitization transactions involving SPEs and the FASB's project to amend SFAS 125. The following illustrates the confusion that may result if these transactions are not specifically addressed. The F ASB has decided, for purposes of the SF AS 125 amendment project, that a call option is not necessarily a factor that would preclude removing assets from an entity's financial statements; however, under the guidance in the ED, a call option is required to be considered in assessing whether an entity should consolidate an investment in a subsidiary. The ED also should address the current literature guiding the accounting treatment for leasing SPEs. The concepts in various consensuses reached by the EITF should be incorporated into the consolidation guidance set forth in the ED as it applies to SPE transactions. The discussion below illustrates the confusion that may result without additional guidance and clarification. Practice has evolved to interpret a 3% equity interest in an SPE by a third party as a substantive residual equity capital investment under the provisions ofeitf Issue No , Impact ofnonsubstantive Lessors, Residual Value Guarantees, and Other Provisions in Leasing Transactions. The relevance of this 3% test may be inferred through several examples in the ED, however, the guidance is not explicit. In Example 8 in the ED, the key factor leading to Company LE's decision not to consolidate ABC Trust is that ABC Trust may be directed by the investors to engage in other business activities. This conclusion is not consistent with EITF Issue No , Implementation Issues in Accounting for Leasing Transactions involving Special-Purpose Entities, Question 1, regarding Multiple Properties within a Single SPE-Lessor, which

10 Mr. Timothy S. Lucas May 26,1999 Page 9 requires demonstration of cross-collateralization within the SPE to avoid consolidation of a portion of the SPE. Applying EITF Issue No to the Example 8 fact pattern in the ED would mean that, absent the ability to cross-collateralize, multiple SPEs may be created if ABC Trust were to enter into other business activities. Under that consensus, Company LE would consolidate the portion of ABC Trust related to the leased property. As other business activities are added or other property is acquired and leased to a different party, effectively, multiple SPEs would be created. The creation of these SPEs would not affect Company LE' s accounting for the original SPE that owns the leased property. The conclusion under this consensus is inconsistent with the guidance in the ED. Unless the guidance in Example 8 is clarified (specifically, paragraph 151), this example may lead to nonconsolidation where consolidation would be appropriate because companies may purposely craft SPE documents to specify that additional business activities may be entered into just to avoid consolidation. A company could also specify that future business activities may be entered into by the SPE with certain other entities meeting certain specific and limited criteria, so limited, in fact, that the feasibility of any other business activity is remote or even nonexistent. Yours truly, L.L;O

11 APPENDIX DELOITTE & TOUCHE COMMENTS FASB EXPOSURE DRAFT CONSOLIDATED FINANCIAL STATEMENTS: PURPOSE AND POLICY Definition of Control and Its Implementation Guidance Issue 1: This proposed Statement would define control as "the ability of an entity to direct the policies and management that guide the ongoing activities of another entity so as to increase its benefits and limit its losses from that other entity's activities. For purposes of consolidated financial statements, control involves decision-making ability that is not shared with others" (paragraph 6). In certain respects, that definition differs from the October 1995 proposed Statement that focused on decision-making powers for another entity's "individual assets" rather than its policies and management that in turn are used to direct activities, including the use of assets. The revised definition also encompasses a more explicit condition that the decision-making powers must provide the controlling entity with the ability to increase the benefits and limit the losses that it can derive from that decision-making power. (That latter revision is similar to the explicit condition included in definitions of control adopted in the United Kingdom and by the International Accounting Standards Committee.) Does the revised definition, together with the discussion of the characteristics of control (paragraphs 10-14) and descriptive guidance (paragraphs and 30-47), help clarify when one entity controls another entity? Will the revised definition and guidance lead to common understandings and application of this Statement's definition of control? The revised definition of control and discussion of the characteristics of control clarify when one entity controls another entity. We support the Board's efforts to encompass an explicit condition regarding a controlling entity's beneficial interest in a subsidiary in the definition of control. However, the final Statement should focus on the concept of beneficial interest as an important and substantive condition for consolidation, that in some instances, may be more important to the decision to consolidate than the existence of decision-making ability. The descriptive guidance in the final Statement should further discuss and illustrate this concept. The final Statement should indicate that the nature of beneficial interest may differ depending on the type of entity (e.g., for-profit, not-for-profit, special purpose). While the Board decided not to explicitly distinguish between the accounting for these entities in the ED, we believe the ED should recognize that because these entities are different in terms of their nature and purpose, beneficial interest may exist in different forms. These distinctions should be comprehended in the implementation guidance and examples so as to illustrate the concept of beneficial interest as it applies to all entities.

12 We commend the Board's efforts to "test" the ED's definition of control through the use of actual situations. The additional understanding gained through this "test" will be critical to detennining whether the revised definition of control and the guidance in the ED will lead to common understandings and consistent application of the definition of control. In addition, we encourage the F ASB to consider further due process, such as a public hearing. Issue 2: This proposed Statement would provide guidance for applying its definition of control. That guidance includes certain situations, which are identified in paragraphs 18 and 21 of this proposed Statement, that would lead to rebuttable presumptions of control. They are those circumstances in which an entity: a. Has a majority voting interest in the election of a corporation's governing body or a right to appoint a majority of the members of its governing body b. Has a large minority voting interest in the election of a corporation's governing body and no other party or organized group of parties has a significant voting interest c. Has a unilateral ability to (1) obtain a majority voting interest in the election of a corporation's governing body or (2) obtain a right to appoint a majority of the corporation's governing body through the present ownership of convertible securities or other rights that are currently exercisable at the option of the holder and the expected benefit from converting those securities or exercising that right exceeds its expected cost d. Is the only general partner in a limited partnership and no other partner or organized group of partners has the current ability to dissolve the limited partnership or otherwise remove the general partner. Will guidance in the form of rebuttable presumptions of control be necessary? Do the circumstances described in each of the situations above provide a reasonable basis for presuming that one entity controls another entity in the absence of evidence that demonstrates or proves otherwise? Are they sufficiently clear and operational? Are additional presumptions of control necessary for specific circumstances? (If so, please identify those circumstances.) We support the concept of effective control and consolidation when effective control currently exists. The concept of effective control may best be effected through indicators of control, rather than rebuttable presumptions of control. Notwithstanding that view, the rebuttable presumptions in the ED may be operational if further guidance is provided. As discussed in our letter, we do not believe the situations noted in (b) and (c) above provide a reasonable basis for presuming that one entity controls another entity. In addition, the final Statement should provide additional guidance about the kind of evidence that may overcome a presumption of control. As currently drafted, the ED's presumptions of control are not clear or operational. 2

13 Transition and Implications for Interim Reporting Issue 3: This proposed Statement would be effective for financial statements for annual periods beginning after December 15, 1999, and all interim periods in the year of adoption. With certain exceptions, it would be applied by restatement of comparative financial statements for earlier periods. Are the benefits of complete and comparative financial statements for all interim periods in the initial year of application sufficient to justify requiring, rather than permitting, that the provisions of this Statement be applied for the first and each subsequent interim period in the year of adoption? Are there specific circumstances surrounding the application of this proposed Statement that would justify delaying its application to interim periods in the year of adoption? We believe the benefits of complete and comparative financial statements for all interim periods in the initial year of application are sufficient to justify requiring that the provisions of the final Statement be applied in the first interim period in the year of adoption. This requirement is consistent with the requirements of Accounting Principles Board Opinion No. 20, Accounting Changes (APB 20). However, if a final Statement is issued in the third or fourth quarter of 1999, the proposed effective date would require entities to begin implementation within approximately six months of issuance in preparation for quarterly reporting. Six months may not provide sufficient time for entities that must renegotiate covenants and contracts, implement systems to conform fiscal periods and change accounting policies, and address other matters required to adopt the new Statement. Investors accounting for investments under the cost method or Statement of Financial Accounting Standards No. 115, Accounting/or Certain Investments in Debt and Equity Securities, will have only a short period to focus on the presumptions of control in the Statement and the effects of such presumptions on their accounting for investments. Therefore, while we support applying the final Statement to interim periods, we recommend that the effective date be delayed by one year (to fiscal years beginning after December 15, 2000) or at a minimum, allow delayed implementation to the fourth quarter for fiscal years beginning after December 15, Partnerships The ED requires that control be presumed if a company is the only general partner in a limited partnership and the other partners cannot dissolve the partnership or otherwise remove the general partner. The ED's definition of control recognizes that control encompasses an element of beneficial interest; however, additional guidance is needed to emphasize the importance of beneficial interest, particularly in a partnership arrangement, in order to preclude the inappropriate presumption of control by a general partner who, in substance, is acting as an agent. We believe a general partner that has not retained a significant portion of the risks and rewards of the partnership should not be presumed to control the partnership simply because the general partner cannot be removed. The facts and circumstances surrounding this type of arrangement should be carefully considered to 3

14 detennine whether, in substance, the general partner's role is that of an agent rather than a controlling partner. Alternatively, in some situations a general partner may have a significant portion of the risks and rewards of the partnership, however, the limited partners may have the right to remove the general partner. Additional guidance is also needed to ensure that the failure to meet all of the conditions of this presumption of control does not preclude consolidation by this general partner. Despite the ability of the limited partners to remove the general partner, the general partner may have current, non shared, decision-making ability, which, when coupled with a significant beneficial interest, results in a situation where consolidation is the most meaningful financial statement presentation. To illustrate, assume the same facts as Example 3 in the ED (paragraphs ), except assume that the limited partners do have the right to remove the general partner from the partnership. Also assume that the general partner is entitled to 75% of excess cash distributions, rather than 25%. Paragraph 107 states that "the specific level of Company E's equity interest... and exposure for partnership liabilities...is not relevant to its decision-making powers," which leads to an initial conclusion that solely because the general partner may be removed by the limited partners, control would not exist. We believe, however, the general partner's equity interest and risk ofloss should be relevant to the question of consolidation. Specifically, provided the general partner has current, nonshared, decision-making ability, since the general partner receives 75% of excess cash distributions and is liable for 100% of partnership losses, we believe that the general partner has assumed a significant beneficial interest in the partnership and should consolidate unless and until control is lost by removal or otherwise. This conclusion is consistent with our fundamental position that in certain circumstances, beneficial interest is more important than decision-making ability. As a point of clarification, we note that general partners may not always assume 100% of a partnership's liabilities given the complex legal structures entered into in today's environment (e.g., the general partner may actually be a subsidiary of an entity with the true economic interest in the partnership). Furthennore, nonrecourse debt may provide a viable financing alternative to a 100% guarantee by a general partner. Trusts Paragraph 74 of the ED states that in the context of a trust, "if a creator names itself or its affiliates as the only beneficiaries of a trust, it may compel its tennination and thus controls the trust." We believe this conclusion would not change in a scenario where the creator named itself or its affiliates as a less than 100% beneficiary of the trust, for example, a 95% beneficiary. When all ofthe risks and rewards of a trust flow to a beneficiary, we believe consolidation may be appropriate based on the premise that "decision-making ability" and other aspects of control, excluding beneficial interest, may be delegated for the mere purpose of avoiding consolidation. Ifthe entity in question exists solely or almost exclusively for the benefit of a parent company, then that parent company should consolidate the entity. Similarly, in other scenarios, if the activities of 4

15 an entity, in substance, are being conducted on behalf ofthe parent company that created the entity according to its business needs, consolidation may be appropriate regardless of decision-making ability. In Example 10 in the ED, we concur with the conclusion in paragraph 159 that Company K does not control Trust M based on the facts of the case; however, the relationship, if any, between Company K and Charity L should be analyzed to ensure that Company K is not receiving benefits from the income flowing to Charity L. If Charity L were associated with Company K or its business objectives, some may argue that Trust M should be consolidated by Company K. With regard to Charity L in this fact pattern, although the income stream generated by the trust flows to Charity L (i.e., beneficial interest), Charity L does not have the nonshared decision-making ability required to "control" Trust M. Accordingly, the ED concludes that Charity L should not consolidate Trust M. Some may argue, however, that decisionmaking ability in this fact pattern is nonsubstantive and may not be relevant to the decision to consolidate. Although Bank N has been appointed trustee and maintains decision-making ability over Trust M, Bank N exercises its decision-making ability in an agency capacity. Essentially, the trust may arguably operate on "automatic pilot" for the benefit of Charity L. Because Charity L is entitled to the income stream generated by the trust and no other entity is the substantive decision-maker, consolidation by Charity L may be the appropriate conclusion. We also point out that the fair value of the income stream flowing to Charity L will approximate the fair value of the assets in the trust such that consolidation by Charity L would have the same accounting result on L's consolidated financial statements as nonconsolidation. Finally, we note that the Board's analysis with respect to Bank N in paragraph 161 is inconsistent with the Board's analysis regarding limited partnerships (i.e., a general partner that cannot be removed by the limited partners "controls" the partnership and should consolidate). Bank N cannot be removed as trustee except for violation of the trust agreement, and while Bank N's role in this transaction differs from that of a general partner, the final ED should address the similarity with the limited partnership example even if the overall conclusion is not affected. In paragraph 163 of Example 10, Charity L does not account for the trust in its consolidated financial statements because its duty to manage the trust is of a fiduciary nature and current income flows to an unrelated beneficiary. These reasons do not create a compelling argument against consolidation given the fact that Charity L has a long-term beneficial interest in the trust's assets and controls the trust under an irrevocable designation as trustee. Because Charity L's designation as trustee is irrevocable, this scenario may be analogized to a general partnership in which the sole general partner may not be removed by the limited partners. Consistent with the Board's position on partnerships, it would seem that Charity L should consolidate the trust (regardless of beneficial interest). 5

16 Indirect Control Paragraph 8 of the ED states, in part, " it is widely recognized that consolidated financial statements are more meaningful than the separate statements of affiliated entities and that they are usually necessary for a fair presentation if one of the entities in the group of affiliates directly or indirectly controls the economic resources and activities ofthe other entities." [Emphasis added.] The definition of indirect control is not clear. For example, how would the concept of indirect control be applied to an entity (perhaps an SPE) whose purpose and function were defined by a creator for the benefit of the creator, yet the creator did not maintain "control" (as defined by the ED) over the entity? Would this arrangement qualify as indirect control? Would management contracts or lease agreements in place between the entity and the SPE result in a different conclusion? Temporary Control There is an inherent inconsistency between the ED and Accounting Principles Board Opinion No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions (APB 30). The ED requires consolidation when a parent controls a subsidiary unless control is deemed to be "temporary" at the date of acquisition. Otherwise, consolidation is required until control ceases to exist. However, APB 30 permits deconsolidation of a subsidiary if the subsidiary is considered a segment of a business and a measurement date for a planned disposal has been reached. The final Statement should address this inconsistency and the effect, if any, on APB 30. Other Paragraph 45 states, in part, In the United States, noncontrolling shareholders, limited partners, creditors, and others typically have protective rights that enable them to block specific actions that might affect their interest in a parent's subsidiary. Those protective veto rights, however, generally do not enable them to initiate policies or share in a parent's decision making for the ongoing activities of its subsidiary. (Emphasis added.) How does the concept of "initiating" policies fit into the definition of control? Must an entity be able to initiate policies in order to control an entity? The final Statement should address these questions and the consensus reached in EITF Issue No , Investor's Accountingfor an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights. The final Statement also should consider the consensus reached in EITF Issue No. 97-2, Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician Practice Management Entities and Certain Other Entities with Contractual Management 6

17 Arrangements, regarding the requirements for a "controlling financial interest" in a physician practice by a physician practice management entity (or other similar arrangements). The relevance of the criteria in the consensus to the Board's definition of control should be addressed. 7