Alternative to GAAP for Private Companies
Who Is Affected?
Some private companies lease property from entities owned by one or more of the same shareholders. For example, it's common in family businesses for first-generation owners with high net worth to invest in real estate and subsequently lease it back to second-generation owners. This arrangement gives the company's owners the opportunity -- but not the obligation -- to invest in real estate.
It also creates a stream of cash flow for owners nearing retirement without burdening younger owners. And it establishes a separate entity for liability purposes. So, the assets of the operating business may be protected from creditors if the lessor files for bankruptcy or from legal claims if someone is injured on the property.
GAAP requires companies to consolidate financial reporting for any entities in which they have controlling financial interests. Consolidating the financial results of commonly controlled lessees and lessors can be complicated for financial statement preparers and confusing for financial statement users, however.
What has changed?
Under the alternate method, the private company that leases the property (the lessee) must disclose the amount and key terms of the liabilities reported by the lessor that expose the lessee to providing financial support to the lessor (such as providing a guarantee or collateral for a loan on the lessor's books). A lessee's footnotes also must disclose a qualitative description of any circumstances that could require it to provide financial support to the lessor.
Who is eligible?
ASU 2014-07 provides a private company with the option not to apply VIE guidance to a lessor when:
- The lessee and the lessor are under common control;
- The lessee has a leasing arrangement with the lessor.
- Substantially all of the activity between the lessee and the lessor is related to the leasing activities (including supporting leasing activities) between those two companies.
- The 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 does not exceed the value of the asset leased by the private company from the lessor.
Companies that elect the alternate method must use it for all qualifying lease arrangements and apply it retrospectively for all periods presented. The alternative does not apply to public companies, not-for-profits and employee benefit plans.
Although the amendment is effective for annual periods beginning after December 15, 2014 -- and interim periods within annual periods beginning after December 15, 2015.
The Big Picture
This simplified reporting option could make common control leasing arrangements more attractive to private company investors as an alternate form of personal investment or an estate planning tool. Lenders and other stakeholders will also appreciate simpler financial statements that reserve discussions of these arrangements for the footnotes, rather than consolidating financial results.
ASU 2014-07 is about more than reporting common control lease arrangements, however. It's also symbolic of FASB's growing appreciation of the divergent needs of private companies compared to public entities. FASB's Private Company Decision-Making Framework focuses on user-relevance and cost-benefit considerations for private companies.
After soliciting feedback from private companies and their constituents, FASB has allowed certain exceptions to GAAP's most complex requirements for private companies. Two ASUs were also issued in January that offer exceptions for private firms that report goodwill and simple interest rate swaps.
For more information about our Private Company Services, contact Leisa Gill at firstname.lastname@example.org.