The new guidance specifically applies to leasing arrangements. Private companies commonly lease facilities from separate lessor entities owned by one of the company’s owners. The lessor entity usually is established for tax, estate planning or legal liability purposes—not to structure off-balance sheet debt arrangements. Typically, the lessor entity’s only asset is the leased facility, and the lease is the only contractual relationship between the lessee company and the lessor entity.
Existing GAAP guidance requires the lessee company to determine whether it holds a variable interest in the lessor entity (for example, a guarantee of the lessor’s debt). If it does, and the lessor is a VIE, the lessee company must assess whether it holds a controlling financial interest in the lessor under the VIE model. If the entities are under common control, the lessee generally must consolidate the financial reporting from the lessor.
The PCC found that, despite the cost and complexity of applying the GAAP VIE guidance in such a case, most users of private company financial statements consider the consolidation of the lessors under common control irrelevant. These users tend to focus on the cash flows and tangible worth of the stand-alone lessee entity, not the cash flows and tangible worth of the consolidated group presented under GAAP. Moreover, consolidation of the lessor distorts the lessee’s financial statements. As a result, users who receive consolidated financial statements often request a consolidating schedule that they can use to reverse the effects of consolidation.
New alternative for private companies
Under ASU 2014-07, a private company lessee can elect an alternative not to apply the GAAP VIE guidance to a lessor if:
- The private company lessee and the lessor entity are under common control,
- The private company has a leasing arrangement with the lessor, and
- Substantially all of the activity between the private company and the lessor is related to the leasing activities (including supporting leasing activities, such as issuance of a guarantee or providing collateral on the obligations related to the leased asset) between those two companies.
Electing the alternative would also free a private company from providing GAAP-compliant VIE disclosures about the lessor entity. The private company won’t be totally off the hook, though. It must disclose the following information:
- The amount and key terms of liabilities (for example, debt, environmental liabilities and asset retirement obligations) recognized by the lessor entity that expose the private company to providing financial support to the entity, and
- A qualitative description of circumstances not recognized in the lessor entity’s financial statements (for example, certain commitments or contingencies) that expose the private company to providing financial support to the entity.
A private company that elects the accounting alternative must apply it retrospectively to all periods presented on financial statements. The alternative will be effective for annual periods beginning after Dec. 15, 2014, and interim periods within annual periods beginning after Dec. 15, 2015. Early application is permitted for any period for which the company hasn’t yet issued financial statements.