By: Carl Kampel
Many private companies lease properties from other entities that are under common control. A common situation is one where an individual owns both an operating company and real estate entity. The real estate entity is frequently set up as a separate company for tax or estate-planning purposes and leases real estate (offices, manufacturing facilities, etc.) to the operating company. Under current generally accepted accounting principles in the United States (U.S. GAAP), the operating company may be required to consolidate the real estate entity if it has: (a) the power to direct the activities that most significantly affect the economic performance of the entity or (b) the obligation to absorb losses or right to receive benefits of the real estate entity that could be potentially significant. Effectively, consolidation could be required even though the operating company has no ownership interest in the real estate entity.
New guidance recently adopted by the Financial Accounting Standards Board (FASB) offers private companies an accounting alternative that would exempt them from the consolidation requirement for certain common control leasing arrangements when all of the following criteria are met: (a) the private company lessee and the lessor entity are under common control, (b) the private company lessee has a lease arrangement with the lessor entity, (c) substantially all of the activities between the private company lessee and the lessor entity are related to leasing activities (including supporting leasing activities) between those two entities and (d), 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, 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.
The accounting alternative is an accounting policy election that, when elected, should be applied by a private company lessee to all current and future lessor entities under common control that meet the criteria for applying this approach.
Under the alternative, a private company lessee would disclose: (1) 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 (2) a qualitative description of circumstances not recognized in the financial statements of the lessor entity that expose the private company lessee to providing financial support to the lessor entity.
If elected, the accounting alternative should be applied to all leasing arrangements meeting the above conditions. The alternative should be applied retrospectively to all periods presented and is effective for annual periods beginning after December 15, 2014 and interim periods within annual periods beginning after December 15, 2015. Early application is permitted for all financial statements that have not yet been made available for issuance. If a private company has not yet made its financial statements available for issuance for the most recent annual period, it may elect to apply the alternative accounting policy to those financial statements, which means many private companies will be able to apply this alternative in their 2013 financial statements.
Carl Kampel, a certified public accountant, is the director in charge of professional standards at Ellin & Tucker, an accounting and business consulting firm with offices in Baltimore, Frederick and Belcamp, Maryland and Washington, D.C. He is a member of the FASB Emerging Issues Task Force and past vice chair of the AICPA Financial Reporting Executive Committee. He is also a member of the Board of Directors of the Baltimore Chapter of Financial Executives International and the Maryland Association of CPAs.