The consolidation guidance for leasing entities under common control is currently being considered for alternative reporting by private companies. This directly affects companies that have an operating lease with another company that is owned by the same majority shareholder or owners.
Under current standards, private companies apply consolidation guidance for variable-interest entities (VIEs) under common control leasing arrangements. In common control scenarios, the common owner has power over the operations and flow of resources of both entities in the related party leasing arrangement. Based on the current standards and a Financial Accounting Standard Board (FASB) Staff Position (FSP) example, the typical result is consolidation of the two entities.
The Private Company Council (PCC) voted to propose a Generally Accepted Accounting Principles (GAAP) alternative for private companies for applying this consolidation guidance. The alternative in the proposal would exempt a private company from evaluating whether a legal entity is a VIE when the private company and the legal entity are under common control, they have a leasing arrangement and all of the activities between them relate substantially to the leasing activity. Essentially, private companies would be exempt from applying consolidation guidance for VIEs under common control leasing arrangements.
If this alternative is selected, a private company would have to make new disclosures about the lessor entity including the terms of the leasing arrangement, the amount of debt and/or significant liabilities of the lessor and the key terms of its debt agreements. The design of this proposal is to require disclosure that is better aligned with information that private company financial statement users typically use.
The general consensus is that the current standard lacks relevance for private companies. The FASB staff evaluated VIE guidance for common control leasing arrangements to determine whether the consolidated financial statements of the lessee entity provide relevant information to its users at a reasonable cost. FASB staff believes that VIE guidance for common control leasing arrangements is costly and complex to implement.
The primary users of private company financial statements (lenders) have stated that they do not find consolidating a related party leasing entity (lessor) with a lessee to be useful. Most private company lenders believe that the consolidation of the lessor distorts the financial statements of the lessee. Those users often have to make adjustments to the lessee’s financial statements for their analysis by requesting a “consolidating” schedule. Accordingly, the FASB staff believes that VIE guidance for common control leasing arrangements does not provide user-relevant information.
The PCC was established in May 2012 by the Financial Accounting Foundation (FAF) to improve the process for setting accounting standards for private companies. The PCC works jointly with the FASB in mutually agreeing upon a set of criteria to decide whether and when exceptions or modifications to U.S. GAAP are warranted for private companies. Based on the criteria, the PCC will review and propose exceptions or modification to U.S. GAAP to address the needs of users of private company financial statements.
The PCC’s proposal was released as PCC Issue No. 13-02, Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements. Like all PCC proposals, this one is subject to endorsement by the FASB, which would then seek public comment.
The proposal will be drafted by FASB’s staff and presented to FASB for endorsement at a future meeting. If FASB endorses it, the proposal will be exposed for public comment. The PCC then would have the opportunity to make changes and forward a final recommendation to FASB. Upon a second endorsement by FASB, the change for private companies would be written into GAAP.
More information about the proposal and the PCC can be found on the FASB Website.
For further information on how this would affect your company and consolidation, please contact Aronson LLC’s Philip Steigner (301-222-8280).