Private companies often have separate entities that hold real estate and lease it to a commonly-owned operating entity. In some cases, the main operating entity is required to consolidate the affiliated real estate entity into its financial statements. Under the existing guidance, companies are required to consolidate an entity in which it has a controlling financial interest.
Commonly-owned real estate entities need to be evaluated to determine whether they are considered variable interest entities (VIEs) and meet the criteria for consolidation.
Essentially, a reporting entity needs to determine if it has both:
- The power to direct the activities that most significantly affect the economic performance of the VIE, and
- The obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE.
This has typically added complexity, cost, and some confusion to users of those financial statements. As a result, the Private Company Council received feedback from private company stakeholders and reached a consensus to provide an elective accounting alternative for private companies impacted by the existing consolidation guidance relating to VIEs.
In March 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-07, Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements. This new guidance will allow private companies to elect an alternative accounting method to not apply the VIE consolidation guidance when certain conditions are met:
- The private company lessee and 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 entities are related to leasing activities.
- If the private company lessee explicitly guarantees or provides collateral for any obligation of the lessor 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.
For private companies that are permitted to utilize the accounting alternative, the financial statements must be retrospectively adjusted to the earliest year presented. In addition, there are certain note disclosure requirements as a result of the change in accounting policy for the reporting entity. The accounting alternative is effective for annual periods beginning after December 15, 2014 and interim periods with annual periods beginning after December 15, 2015. However, early application is permitted, including any period for which the entity’s annual or interim financial statements have not yet been made available for issuance.
This new guidance could be beneficial to those private companies that have affiliated entities under common control that hold real estate. By providing relief from the consolidation requirements for certain private companies, the alternative treatment could reduce complexity and provide clarity to users of the financial statements. We recommend consulting with your accounting firm or business advisor to determine which approach is best for you.
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