On March 20, 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-07, Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements (a consensus of the Private Company Council).
This update allows private company lessee (the reporting entity) to elect an alternative not to apply Variable Interest Entity (VIE) guidance to a lessor entity if the following conditions are met.
- The private company lessee and the lessor entity are under common control
- The private company lessee has a lease arrangement with the lessor entity
- Substantially all of the activities between the private company lessee and the lessor entity are related to leasing activities
- 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 lessee, 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 lessee from the lessor entity
Once the alternative is elected by the private company lessee, it applies to all current and future leasing arrangements meeting the above conditions. Under this alternative, the private company lessee would not be required to disclose the lessor entity based on VIE guidance, instead the private company lease would disclose:
- The amount and key terms of liabilities recognized by the lessor entity that expose the private company lessee to providing financial support to the lessor entity and
- A qualitative description of circumstances not recognized in the financial statements of the lessor entity that expose the lessee to providing financial support to the lessor entity.
These disclosures would presumably capture economic liabilities or commitments which both on a quantitative and qualitative basis could impact the private company lessee. In addition, the disclosures related to ASC Topic 460, Guarantees, ASC Topic 840, Leases and ASC Topic 850, Related Party Disclosures would still apply, when applicable. The required disclosures could be combined in a single note in the financial statements. This update should reduce the cost and complexity of applying VIE guidance for private companies.
Above guidance will be effective for annual periods beginning after December 15, 2014 and interim periods within annual periods beginning after December 15, 2015. Early adoption is permitted. Private companies can elect to apply this alternative to their 2013 financial statements that have not been made available for issuance. Therefore, you can early adopt this accounting alternative and avoid the preparation of consolidated financial statements.
Definition of a Private Company
The FASB decided that it should proactively determine which entities would be within the scope of the Private Company Accounting Alternatives. Their aim was to minimize the inconsistency and complexity of having multiple definitions of, or a diversity in practice of what constitutes a nonpublic entity and public entity within U.S. GAAP. Generally speaking, a private company is defined as an entity other than a public business entity, a not-for-profit entity, or an employee benefit plan. A public business entity is generally defined as a business entity, other than a not-for-profit entity or an employee benefit plan, which would be required by the SEC or similar regulatory or administrative body to file or furnish financial statements, or is a conduit bond obligor for securities that are traded or quoted on an exchange or an over-the-counter market.
Variable Interest Entity (VIE)
U.S. GAAP requires a reporting entity to consolidate a VIE when that reporting entity is considered to be the primary beneficiary of the VIE. An entity considered to be the primary beneficiary of the VIE has both (a) the power to direct activities of the VIE that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. This standard had the unintended consequence of forcing many private companies which leased property from an entity under common control to issue consolidated financial statements, or adopt a different financial reporting framework (tax basis), or accept a GAAP departure qualification in their audit report.
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