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Cherry — Scsi he-ff» _

During the late 19805, Cherry grew rapidly and moved into areas it believed fit its basic

business plan: buy or clcvclop an asset, such as pipeline or power plant, and then expand

it by building a wholesale or retail business around the asset. During the period from

1986 to l993, we are tolcl. approximately 60% of Cherry's earnings were generated from

business in which Clterry was not engaged ten years earlier, and some 30% to 40% were

generated from business in which Cherry was not engaged five years earlier.

Much of this growth involved large initial capital investments that were not

expected to generate significant earnings or cash flow in the short term. While Cherry

believed this investmrznt would be beneficial over a period oftime, they placed

immediate pressure on Cherry‘s balance sheet. Cherry already had a substantial debt loan

A funding the new investment by issuing additional debt was unattractive. Alternatively,

funding the investment by issuing additional equity was also unattractive.

One perceived solution to this problem was to find outside investors willing to

enter arrangement that would enable Cherry to retain risks it believed it could manage

effectively, and the related rewards. Thesejoint investments typically were structured as

separate entities to \'-'ltit;li (jiicrry and other investorr; crmtributccl assets or other

consideration. These cn!.tr-:.s could borrow directly from outside lenders, although in

many cases a guarantee or credit support was required. i

For financial statement purposes, Cherry management treated these entities as an

investment by Cherry because it would enable Cherry to present itselfmore attractively

as measured by the ratios Favored by Wall Street Analyst and rating agencies.

Question:

l. What are Special Purpose Entities?

2. What is the c0t'|(:Ct accounting treatment for SPE?

Comment on Cherry management treatment for its...
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