Special purpose entities

Definition

Special Purpose Entities (SPEs) are legal entities created for a narrow and specific purpose, often to isolate financial risk. They are commonly used in complex financing arrangements to hold assets or liabilities off the balance sheet of the parent company.

5 Must Know Facts For Your Next Test

1. SPEs can be used to hide debt and inflate profitability, contributing to fraudulent financial reporting.
2. Enron's scandal is one of the most famous cases involving misuse of SPEs to manipulate financial statements.
3. The Sarbanes-Oxley Act (SOX) introduced stricter regulations on SPEs to improve transparency and accountability in financial reporting.
4. Companies must consolidate SPEs into their financial statements if they have significant control over them, according to accounting standards.
5. Internal controls are crucial in monitoring the use of SPEs to prevent fraudulent activities.

Review Questions

• How can Special Purpose Entities be misused in financial reporting?
• What role did SPEs play in the Enron scandal?
• What changes did the Sarbanes-Oxley Act bring regarding the regulation of SPEs?

Related terms

Sarbanes-Oxley Act:

A law passed in 2002 aimed at improving corporate governance and reducing fraud through stricter regulatory requirements.

Internal Controls:

Processes implemented by a company to ensure the integrity of financial and accounting information, promote accountability, and prevent fraud.

Financial Statement Fraud:

The deliberate misrepresentation or omission of financial information with the intent to deceive stakeholders.