Technical Line: Private companies in common control leasing

No. 2014-06
10 April 2014
Technical Line
FASB — final guidance
Private companies in common
control leasing arrangements may
be eligible for relief from VIE model
In this issue:
Overview ....................................... 1
Key considerations ........................ 2
Evaluating common control ......... 2
Identifying a leasing arrangement . 3
Evaluating whether activities
relate to the leasing activities ... 3
Evaluating a guarantee or
collateralization of a leasing
entity’s obligations ................. 4
Illustrations ................................. 4
Disclosures ................................. 6
Elimination of implicit variable
interest guidance applicable
to all entities .......................... 6
Effective date and transition.......... 6
What you need to know
• Private companies can now choose to be exempt from evaluating lessors in common
leasing arrangements for consolidation under the variable interest entities (VIE)
guidance, if they meet certain criteria.
• Because the term “common control” is not defined, evaluating whether a private
company can apply the alternative may require significant judgment.
• Private companies that elect the alternative still need to apply other consolidation
guidance and other US GAAP (e.g., lease accounting) to these arrangements and make
certain disclosures.
Overview
The Financial Accounting Standards Board (FASB or Board) issued final guidance 1 that allows
private companies to choose to be exempt from applying the Variable Interest Model to lessors
in common control leasing arrangements that meet certain criteria. The FASB’s goal is to allow
private companies to simplify their accounting for these arrangements, while continuing to
provide relevant information to users of private company financial statements.
The guidance, which was developed by the Private Company Council (PCC), requires private
companies to make an accounting policy election and apply the accounting to all current and
future leasing arrangements that meet the criteria. A private company that elects this
alternative would need to make certain disclosures about any qualifying arrangements. It also
would continue to apply other consolidation guidance in ASC 810 2 and other applicable
US GAAP to the arrangements, such as ASC 460 3 and ASC 840. 4
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The PCC developed this alternative in response to concerns raised by private company
financial statement users and preparers that, in some cases, applying the Variable Interest
Model led private companies to consolidate lessors in common control leasing arrangements.
These stakeholders said private companies design common control arrangements primarily
for tax, estate-planning or legal liability purposes, not to structure off-balance sheet debt, and
consolidation doesn’t provide useful information. They noted that financial statement users
generally focus on a private company’s cash flows and financial position on a standalone
basis. In some cases, users were requesting consolidation schedules to reverse the effects of
consolidating the lessor in these arrangements.
Key considerations
Like the other alternatives developed by the PCC, Accounting Standards Update (ASU) 2014-07
applies to companies that don’t meet the FASB’s broad new definition of a public business
entity.5 It doesn’t apply to not-for-profit entities and employee benefit plans.
Under the ASU, a private company can choose to apply the alternative when all of the
following criteria are met:
•
The private company (the reporting entity) and the lessor are under common control.
•
The private company has a lease arrangement with the lessor.
•
Substantially all activities between the private company and the lessor are related to the
leasing activities (including supporting leasing activities) between those two entities.
•
If the private company explicitly guarantees or provides collateral for any obligation of
the lessor related to the asset leased by the private company, the principal amount of the
obligation at inception of such a guarantee or collateral arrangement does not exceed the
value of the asset leased by the private company from the lessor.
How we see it
Private companies that elect this alternative may still be required to record the leased
assets on their books under other US GAAP.
For example, under ASC 840’s guidance on lessee involvement in asset construction, a
private company could be considered the owner of an asset during construction if it
provides debt guarantees or assumes obligations to fund construction cost overruns,
among other things. This could result in a private company recording the asset on its books.
If the private company is considered the asset owner, it must also apply the sale-leaseback
provisions of ASC 840-40 (and ASC 360-20 for real estate assets) to evaluate when the
asset should be derecognized. This guidance might lead to counterintuitive results, such as
the lessee’s continued recognition of the asset in the case of a failed sale-leaseback.
Evaluating common control
To apply the alternative, a private company must be under “common control” with the lessor.
This term is not defined in the Accounting Standards Codification. Current practice is to
consider the guidance from the Securities and Exchange Commission staff discussed by the
Emerging Issues Task Force (EITF) in the abstract on EITF Issue 02-5 6 (the EITF didn’t reach a
consensus on this issue.7 Specifically, the abstract on EITF Issue 02-5 indicates that common
control exists only in the following situations:
•
An individual or entity holds more than 50% of the voting ownership interest of each entity.
2 | Technical Line Private companies in common control leasing arrangements may be eligible for relief from VIE model 10 April 2014
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•
Immediate family members hold more than 50% of the voting ownership interest of each
entity (with no evidence that those family members will vote their shares in any way other
than in concert). Immediate family members include a married couple and their children
but not the married couple’s grandchildren. Entities might be owned in varying
combinations among living siblings and their children. Those situations would require
careful consideration of the substance of the ownership and voting relationships.
•
A group of shareholders holds more than 50% of the voting ownership interest of each
entity, and contemporaneous written evidence of an agreement to vote a majority of the
entities’ shares in concert exists.
For purposes of applying the private company alternative, however, the FASB said in the
Basis for Conclusions in ASU 2014-07 that it used the term more broadly than what is
considered common control in current practice. In particular, the FASB said an entity owned
by a grandparent and an entity owned by a grandchild could qualify as being under common
control, depending on the facts and circumstances.
How we see it
Because the Codification does not currently define common control, evaluating whether a
private company could apply the alternative may require significant judgment.
The FASB said
‘common control’
has a broader
meaning for this
guidance than in
practice today.
Identifying a leasing arrangement
While the new guidance does not define “leasing arrangement,” ASC 840-10-15 provides a
model for determining whether an arrangement contains a lease. Refer to Chapter 1 of our
Financial Reporting Developments publication, Lease accounting, for additional guidance on
evaluating whether an arrangement is or contains a lease within the scope of ASC 840.
Evaluating whether activities relate to the leasing activities
Private companies may engage in the following activities that meet the criterion of being related
to the leasing activities (including supporting leasing activities) between the two entities:
•
Guaranteeing or providing collateral to the lender of a lessor for indebtedness that is
secured by the asset leased by the private company
•
Being an obligor in a joint and several liability arrangement for indebtedness of the lessor
that is secured by the asset leased by the private company
•
Maintaining, paying property taxes owed on the asset and negotiating the financing for
the asset leased by the private company
•
Paying income taxes of the lessor, when the only asset the lessor owns is the asset leased
by the private company or by both the private company and an unrelated party
•
Entering into a purchase commitment for the acquisition of or the support of the asset
leased by the private company
A private company engaging in the following activities would not meet this criterion:
•
Paying income taxes owed on an asset of the lessor that the private company is not leasing
•
Entering into a commitment to purchase products produced by the lessor or to sell
products to the lessor
3 | Technical Line Private companies in common control leasing arrangements may be eligible for relief from VIE model 10 April 2014
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Evaluating a guarantee or collateralization of a leasing entity’s obligations
The FASB added the fourth criterion limiting private company guarantees and collateral to
mitigate the risk that leasing arrangements could be used to structure off-balance sheet debt.
Without this anti-abuse provision, the FASB was concerned a private company could, for
example, avoid applying the Variable Interest Model when it provided guarantees or collateral
to a highly leveraged lessor with which it had a leasing arrangement on an insignificant asset.
Illustrations
The following illustrations, which are derived from the ASU, 8 show how the guidance would
apply in different situations.
Illustrations: Applying the guidance to common control leasing arrangements
Example 1 — General
A private company leases a manufacturing facility from a lessor with which it is under
common control. The common owner has guaranteed the lessor’s mortgage on the facility.
Assets of the private company are pledged as collateral on the mortgage.
The lessor does not own any other assets. The private company pays the property taxes on
the facility it leases and maintains it. The value of the facility exceeds the principal amount
of the mortgage at the inception of the collateral arrangement with the private company.
Analysis
The private company meets the criteria to apply the alternative. The private company and
the lessor have a lease arrangement and are under common control. Substantially all the
activities between them relate to their leasing arrangement. Further, the value of the
facility exceeds the principal amount of the lessor’s mortgage at the inception of its
collateral arrangement with the private company.
Example 2 — Leased asset value declines below principal balance of obligation
Assume the same facts as Example 1, except that in two years, the value of the
manufacturing facility declines below the principal amount of the mortgage.
Analysis
The private company continues to meet the criteria to apply the alternative because the
value of the facility exceeded the principal amount of the mortgage at the inception of the
collateral arrangement. Subsequent changes in the value of the leased asset do not affect
this conclusion.
Example 3 — Principal balance of refinanced obligation exceeds value of leased asset
Assume the same facts as Example 1, except that in two years, the mortgage is refinanced,
and the principal balance now exceeds the value of the facility. A condition of the new
mortgage is that the private company provides additional collateral.
Analysis
The private company no longer meets the criteria to apply the alternative because the
value of the facility is less than the principal amount of the mortgage at the inception of the
new collateral arrangement.
When the criteria are no longer met, a private company must evaluate the lessor for
consolidation by first applying the Variable Interest Model. This does not necessarily mean
that the private company would need to consolidate the lessor.
4 | Technical Line Private companies in common control leasing arrangements may be eligible for relief from VIE model 10 April 2014
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Example 4 — Excess capacity of leased asset leased to other parties
Assume the same facts as Example 1, except that the facility has 10 floors and the private
company leases only three of them. The remaining seven floors are leased to unrelated
parties. Assets of the private company continue to be pledged as collateral on the
mortgage that financed the purchase of the entire facility (i.e., all 10 floors).
Analysis
The private company meets the criteria to apply the alternative. In particular, substantially
all of the activities between the private company and the lessor relate to the lease of the
facility to the private company, even though the lessor is leasing excess capacity (i.e.,
seven floors) of the facility to unrelated parties. The arrangement also meets the fourth
criterion because the value of the facility exceeded the principal amount of the mortgage at
the inception of the collateral arrangement.
Example 5 — Lessor buys a separate asset and leases it to other parties
Assume the same facts as Example 1, except that the lessor obtains an additional
mortgage to finance the acquisition of a new manufacturing facility, which is leased only to
unrelated parties. The value of the new facility is significant to the lessor, and assets of the
private company are pledged as collateral on the additional mortgage.
Analysis
The private company fails to meet the criteria to apply the alternative because it is
engaging in substantial activities with the lessor outside of leasing activities by providing a
guarantee on an asset that it is not leasing.
Example 6 — Lessor operates a separate asset that is not part of the collateral
arrangement
Assume the same facts as Example 1, except that the lessor also owns and operates a
separate manufacturing facility. There is no mortgage related to the separate facility, and
the private company does not provide any guarantees or collateral related to that facility.
Analysis
The private company meets the criteria to apply the alternative because there are no
activities between it and the lessor that relate to the separate facility.
Example 7 — Private company purchases products produced by the lessor
Assume the same facts as in Example 6, except that the private company has a commitment
to purchase a significant amount of products manufactured by the separate facility.
Analysis
The private company fails to meet the criteria to apply the alternative because, by
purchasing products manufactured by the separate facility, it is engaging in substantial
activities with the lessor outside of leasing activities.
5 | Technical Line Private companies in common control leasing arrangements may be eligible for relief from VIE model 10 April 2014
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Disclosures
A private company that elects the alternative would not have to make the VIE disclosures but
must make the following new disclosures about the arrangement:
•
The amount and key terms of the lessor’s recognized liabilities (e.g., debt, environmental
liabilities, asset retirement obligations) that expose the private company to providing
financial support to the lessor
•
A qualitative description of circumstances (e.g., certain commitments and contingencies)
not recognized in the financial statements of the lessor that expose the private company
to providing financial support to the lessor
When making these disclosures, a private company must consider exposures through implicit
guarantees. An implicit guarantee might involve expectations that the private company would
make funds available (1) to the lessor to prevent the common owner’s guarantee of the
lessor’s debt from being called on or (2) to the common owner to fund all or a portion of the
call on that guarantee. The determination of whether an implicit guarantee exists is based on
facts and circumstances, which include considering whether:
Companies will
need to make new
disclosures about
their exposure to
lessors’ obligations.
•
There is an economic incentive for the private company to act as a guarantor or to make
funds available.
•
The private company has made funds available in similar situations in the past.
•
The private company acting as a guarantor or making funds available would be
considered a conflict of interest or illegal.
Private companies must present these disclosures in combination with other disclosures about
the arrangement required by existing guidance (e.g., ASC 460, 840, 8509) by either providing
all of them in one place or by cross-referencing them in the notes to the financial statements.
Elimination of implicit variable interest guidance applicable to all entities
The Variable Interest Model requires a reporting entity to consider whether it has any
implicit variable interests in an entity (e.g., an implied guarantee related to certain obligations
of the entity).10 ASU 2014-07 removed a brief paragraph and an example from the VIE
guidance in ASC 810 that suggested implicit variable interests commonly arise in leasing
arrangements among related parties. The FASB was concerned that retaining this guidance
might cause confusion because it suggested that lessees could be required to apply the
Variable Interest Model when they would qualify for an exemption from applying it under the
private company alternative.
How we see it
We do not believe that the FASB intended the elimination of this guidance to have a
significant effect on current practice.
Effective date and transition
The guidance is effective for annual periods beginning after 15 December 2014 and for
interim periods within annual periods beginning after 15 December 2015. Early adoption is
permitted for any annual or interim period for which an entity’s financial statements have not
yet been made available for issuance.
Private companies that elect the alternative are required to apply it retrospectively.
6 | Technical Line Private companies in common control leasing arrangements may be eligible for relief from VIE model 10 April 2014
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If a private company deconsolidates an entity as a result of applying the alternative, the
transition provisions are similar to those provided in FAS 167. 11 That is, the private company
would initially measure any retained interest in that entity at its carrying amount upon
adoption. Carrying amount refers to the amount at which the private company would have
carried the interest in its financial statements if the alternative had been effective when it first
became involved with the entity. Any difference between this amount and the carrying
amount of the net assets of the deconsolidated entity would be recognized as a
cumulative-effect adjustment to retained earnings. The amount of this adjustment would be
disclosed separately.
In the period in which a private company adopts this alternative, it also would have to make
the disclosures required by ASC 250 12 about a change in accounting principles.
Next steps
Private companies should carefully consider whether they might become public business
entities before electing private company alternatives. Companies that become public
business entities would have to retrospectively apply public entity accounting and
reporting requirements.
Endnotes:
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ASU 2014-07, Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements.
ASC 810, Consolidation.
ASC 460, Guarantees.
ASC 840, Leases.
ASU 2013-12, Definition of a Public Business Entity.
EITF Issue No. 02-5, Definition of “Common Control” in Relation to FASB Statement No. 141.
See Appendix C of our Financial Reporting Developments (FRD) publication, Business combinations, for further
interpretive guidance on evaluating common control.
The examples are codified in ASC 810-10-55-205C through 55-205I.
ASC 850, Related-Party Disclosures.
See Chapter 5 of our FRD publication, Consolidation and the Variable Interest Model, for further interpretive
guidance on identifying implicit variable interests.
FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R) (Codified in ASC 810). See Chapter 15
of our FRD publication, Consolidation and the Variable Interest Model, for further interpretive guidance on these
transition provisions.
The ASU clarifies that these are the disclosures in ASC 250-10-50-1 through 50-3, except for the disclosure
required in paragraph ASC 250-10-50-1(b)(2).
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7 | Technical Line Private companies in common control leasing arrangements may be eligible for relief from VIE model 10 April 2014