Private Company Accounting Alternative For Variable Interest Entities
“Private Company GAAP Simplification: Here It Comes (Jan. 8, 2014)”, an accounting alternative to the consolidation of variable interest entities (VIE) for private companies was recently finalized. Accounting Standards Update 2014-07, “Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements” (ASU 2014-07) permits private companies to elect not to consolidate VIEs under common control leasing arrangements that meet certain conditions.
Are you a private company that is reluctantly consolidating a VIE that you lease real estate from? If so, we believe application of this new GAAP alternative may provide the accounting relief you have been seeking.
BACKGROUND
Many owners of private companies establish affiliated entities to own assets, most commonly real estate. This leverages tax, estate planning, and legal liability strategies. For example, the owners of a distribution company might establish a separate legal entity to own a warehouse, which in turn leases the warehouse back to the distribution company. Prior to ASU 2014-07, these arrangements often resulted in the distribution company consolidating the warehouse entity under US GAAP. However, banks and other users of the consolidated financial statements frequently requested supplemental consolidating financial statements, in order to understand the discrete financial performance of the operating company. Do you think you could benefit by adopting the new GAAP alternative for VIEs? If so, here is a step-by-step overview of important considerations before adopting this new standard.
UNDERSTAND THE PROVISIONS OF ASU 2014-07
The new GAAP alternative to consolidating VIEs may only be elected by private companies for qualified leasing arrangements. The leasing arrangement between the operating company and the VIE lessor must meet all of the following:
- The lessee and lessor are under common control, as defined.
- A lease arrangement exists between the lessor and lessee.
- Substantially all activities between the lessee and lessor are related to leasing activities.
- If the lessee explicitly guarantees the debt of the lessor or provides collateral (support) for any obligation of the lessor, then the value of the leased asset must exceed the principal amount of the debt at the later of (1) the inception of the support, (2) the most recent lessor refinancing, or (3) the new debt arrangement.
Generally, we believe many common control leasing arrangements will meet these criteria.
DETERMINE THIRD PARTIES’ ACKNOWLEDGEMENT
Adopting ASU 2014-07 is optional, so do your homework. Determine in advance that your lender or other users of your financial statements will accept financial statements that do not consolidate a VIE due to adopting ASU 2014-07. Consider if your debt agreement requires consolidated financial statements, or if debt covenants may need to be amended. Since ASU 2014-07 is part of US GAAP, financial statements that adopt ASU 2014-07 are still in accordance with US GAAP.
CAPITAL VERSUS OPERATING LEASE
Occasionally, a common control leasing arrangement would be accounted for as a capital lease as a consequence of adopting ASU 2014-07. This largely offsets the benefits of ASU 2014-07. Therefore, we recommend that you review the lease terms in advance of adoption.
TRANSITION AND IMPLEMENTATION
ASU 2014-07 is optional – it is an accounting policy election, eligible for private companies only. Once elected, it must be applied to all current and future common control leasing arrangements. While ASU 2014-07 is not effective until fiscal years beginning after December 15, 2014 and interim periods beginning after December 15, 2015, it permits early adoption. The ASU must be applied retrospectively to all financial periods presented. In the period that the ASU is adopted, disclosures applying to an accounting change must be provided. If a private company goes public in the future, it will lose the option to utilize the ASU 2014-07 alternative. At WS+B, we are experts at assessing the impact of compliance with accounting changes. We would be pleased to discuss with you how these and other current developments would affect your business and financial reporting.
Need More Information?
If you have any questions about the topic discussed, please contact your local WS+B advisor.
Bob Van Arnum, CPA, Partner
Practice Leader, Assurance and Accounting Services
[email protected]
609.520.1188
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