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.
l. What are Special Purpose Entities?
2. What is the c0t'|(:Ct accounting treatment for SPE?
Comment on Cherry management treatment for its...