FASB Issues Final Consolidation Guidance for Private Companies Leasing from Commonly Controlled Entities
On March 20, 2014, the Financial Accounting Standards Board (FASB) finalized accounting guidance on consolidation discussed in BKD’s article published earlier this month, applicable to certain common control leasing arrangements. The Accounting Standards Update (ASU) allows private companies to elect an accounting policy that applies to all current and future lessor entities meeting specified criteria. Private companies electing to use the accounting alternative must apply it to all leasing arrangements that meet the criteria.
Under current standards, a company is required to consolidate an entity in which it has a controlling financial interest. Many private company owners establish separate legal entities to own assets that are leased to a commonly owned private company—primarily for tax, estate planning and legal liability purposes. Many times the company is determined to have a controlling financial interest in the leasing entity and therefore consolidates it in its financial statements. Under U.S. generally accepted accounting principles (GAAP), controlling financial interest is determined using one of two models: a variable interest entity (VIE) model or a voting interest model. To determine which model applies, the reporting entity first must determine whether it has a variable interest in the entity evaluated for consolidation and whether that entity is a VIE. When the reporting entity, e.g., lessee, has a controlling financial interest in another entity, e.g., lessor, it is required to consolidate that entity.
FASB has provided relief to private companies. ASU 2014-07 (ASU), Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements gives private company lessees the option of not applying the VIE guidance to a lessor under common control, when the leasing arrangement meets certain criteria. Unless otherwise required under GAAP, the private company no longer is required to consolidate the lessor entity in which it has a controlling financial interest.
In addition to the lessee and lessor being under common control and having a leasing arrangement with each other, to qualify for the exception, substantially all of the activities between the lessee and lessor must be related to the leasing activities—including supporting leasing activities—between those two companies.
With issuance of the ASU, FASB clarified the last criterion to qualify for the exception regarding private company guarantee and collateral arrangements with the commonly controlled lessor entity to read as follows:
“If the lessee explicitly guarantees or provides collateral for any obligation of the lessor related to an asset it leases, then the principal amount of the obligation at inception of the guarantee or collateral arrangement must not exceed the value of the asset.”
A private company electing the alternative will replace VIE disclosures with more robust disclosures about the leasing arrangement, including the following:
- The amount and key terms of liabilities recognized by the lessor that expose the lessee to providing financial support to the lessor (For example, a lessee exposed to the lessor’s debt should disclose information such as the amount of debt, interest rate, maturity, pledged collateral and guarantees associated with the debt)
- A qualitative description of circumstances not recognized by the lessor that expose the lessee to providing financial support to the lessor (For example, certain commitments and contingencies)
Private company lessees also should consider exposure to implicit guarantees and whether they should be disclosed in the financial statements. Some items to consider while evaluating for such guarantees: Does the private company lessee have an economic incentive to provide a guarantee? Would a guarantee provided by a private company lessee create a conflict of interest? Has the private company lessee issued guarantees in similar situations in the past?
Private companies electing the alternative will continue to apply consolidation guidance other than the VIE guidance in ASC 810. Private companies also will need to consider guidance that may not have been applicable when it consolidated the commonly controlled lessor entity, such as ASC 460, Guarantees, and ASC 840, Leases, as well as related-party and contingency disclosures.
The ASU should be applied retrospectively to all periods presented and is effective for annual periods beginning after December 15, 2014, and for interim periods within annual periods beginning after December 15, 2015. Early adoption is permitted: An eligible private company could elect to apply the alternative in its 2013 financial statements as long as the financial statements have not yet been made available for issuance. When a private company no longer meets the four criteria for applying the alternative, it no longer qualifies for the exception and should apply the VIE guidance in ASC 810.
Public business entities, as defined in ASU 2013-02, Definition of a Public Business Entity – An Addition to the Master Glossary, as well as not-for-profit organizations and employee benefit plans, are not eligible to apply the private company accounting alternatives. BKD’s article from February 2014 offers a more thorough discussion of the definition of a public business entity.
Look for BKD’s white paper in the near future on the accounting and reporting implications of electing the exemption. In the meantime, if you have additional questions about this topic, contact your BKD advisor.