Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements—A Consensus of the PCC

By: Art Winstead

The Private Company Council (PCC) was successful in having four of its recommendations accepted and issued by the Financial Accounting Standards Board (FASB). One of these recommendations was issued by FASB in March of last year. In March 2014, FASB issued Accounting Standards Update (ASU) 2014-07 which relates to the consolidation guidance in Topic 810. ASU 2014-07 provides an accounting alternative for non-public entities (excluding nonprofit organizations [NPOs]), and employee benefit plans when applying variable interest guidance to “common control leasing arrangements.” Ever since the issuance of FASB Interpretation (FIN) 46(R), the discussion of the practicable and cost/benefit application of consolidating entities, under common control that only conducted the business of “leasing real or personal property,” has been considerable. The most common of these arrangements is a real estate entity renting its only asset to an operating entity, while both entities have common control through ownership.

The PCC added this issue to its agenda because private companies and users of private company financial statements indicated the benefits of the applying variable interest entity (VIE) guidance to a lessee, and related lessee under common control, do not justify the related costs. Those companies and users believed that in general, a common owner establishes a lessor entity separately from the private company lessee for tax, estate-planning, and legal-liability purposes, and not to structure off-balance-sheet debt arrangements. As well, they believed most users of the private company lessee entity’s financial statements stated that the consolidation is not relevant to them because they focus on the cash flows and tangible worth of the standalone private company lessee entity, rather than on the consolidated cash flows and tangible worth of the lessee. And lastly, those users stated that when they received consolidated financial statements, they often requested a consolidating schedule to enable them to reverse the effects of consolidating the lessor entity.

ASU 2014-07 permits a private company lessee (the reporting entity) to elect an alternative not to apply VIE guidance to a lessor entity if:

(a) the private company lessee and the lessor entity are under common control,

(b) the private company lessee has a lease arrangement with the lessor entity,

(c) substantially all of the activities between the private company lessee and the lessor entity are related to leasing activities (including supporting leasing activities) between those two entities, and

(d) if the private company lessee explicitly guarantees or provides collateral for any obligation of the lessor entity related to the asset leased by the private company, then the principal amount of the obligation at inception of such guarantee or collateral arrangement does not exceed the value of the asset leased by the private company from the lessor entity.

An example of “supporting leasing activities” could include issuance of a guarantee and provision of collateral on the obligations of the lessor entity related to the asset(s) leased to the private company lessee.

Under ASU 2014-07, a private-company lessee would not be required to provide the VIE disclosures about the lessor entity. The private company lessee would disclose:

(1) the amount and key terms of liabilities recognized by the lessor entity which expose the private-company lessee to providing financial support to the lessor entity, and

(2) a qualitative description of circumstances, not recognized in the financial statements of the lessor entity, that expose the private company lessee to providing financial support to the lessor entity. Those disclosures could be combined in a single note or by including cross-references within the notes to financial statements.

In regard to the effective date, if elected, the ASU 2014-07 guidance should be applied retrospectively to all periods presented. This alternative is effective for annual periods beginning after December 15, 2014, and interim periods within annual periods, beginning after December 15, 2015. Early application is permitted, including application to any period for which the entity’s annual or interim financial statements have not yet been made available for issuance.

Winstead, Art_4x5Art Winstead is a native of Greensboro, NC—he graduated from Grimsley Senior High School, and attended the University of South Carolina, earning his B.S. in Business (with a concentration in Accounting and a minor in Political Science) at the University of North Carolina—Greensboro. Art is also a Certified Fraud Examiner (CFE), Certified Financial Forensic (CFF), and holds the designation of Chartered Global Management Accountant (CGMA). He is a member of AICPA and is a member of NCACPA’s Board of Directors. Art has served on the State Mobility and Regulatory Response Committees of the National Association of State Boards of Accountancy (NASBA) and currently serves on the Global Standards Committee.