How FIN 46(R) Is Affecting Financial Reporting For Construction Companies

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June 15, 2006

For many construction companies FIN 46(R), Consolidation of Variable Interest Entities, issued by the Financial Accounting Standards Board, has affected financial reporting for the first time this year. FIN 46(R) became effective for nonpublic companies with annual reporting periods beginning after December 15, 2004, and is effective immediately for entities created after December 31, 2003. FIN 46(R) clarifies existing guidance on when consolidated financial statements are required. Before FIN 46(R), the need to consolidate was based mainly on the shareholder with the most voting rights.

FIN 46(R) provides guidance for consolidating entities on a basis other than voting rights. As a result, FIN 46(R) often requires entities to be consolidated when, under the previous standard they would not. Even when consolidation is not required, FIN 46(R) has significant disclosure requirements on information reported in the financial statements.

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The types of entities typically considered for FIN 46(R) include the following:

  • Separate legal entities set up to acquire and hold office buildings, equipment yards and storage facilities used or rented by the construction company
  • Joint ventures created between entities
  • Separate legal entities designed to acquire and hold equipment rented by the construction company
  • Separate legal entities created to expand service offerings or to venture into new markets

How to approach applying FIN 46(R) in financial statements

Many construction companies struggle with changing financial statement presentation in response to FIN 46(R). The fundamental change of FIN 46(R) is that more information is provided to financial statement users, either by requiring consolidation or by adding additional disclosures. The key to a successful implementation of these changes is communication with the users to ensure understanding of the changes and the reasons for it. Equally important is providing the users of the statements with enough information to compare historical statements with the current presentation.

We encourage companies to address the impacts of FIN 46(R) with the users of their financial statements, which are typically lenders, bonding agents, and underwriters. These professionals are knowledgeable about the impacts of FIN 46(R) and use these discussions to learn more about their clients.

Meeting with the banker or surety provides an opportunity to explore reporting options, including comparability between years, if consolidation is now required under FIN 46(R). A great way to provide comparability is to include a supplemental schedule that reports separately the original construction company, the entity being consolidated, and the consolidated totals. This schedule will give users of the statements the information necessary to evaluate the individual companies and the changes these entities have undergone from a historical perspective. It will also allow users to calculate and utilize ratios they have previously used to evaluate the company.

Action steps to consider for FIN 46(R)

  • Become familiar with the general rules of FIN 46(R). This will allow you to identify and consider the potential impact of transactions or investments on the financial statement presentation.
  • Discuss related party relationships and contemplated transactions with accounting professionals who can help with considering FIN 46(R).
  • Address changes in reporting with users of the financial statement to ensure the reports meet their needs and they understand the nature and reason for the change.

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