Simplifying the Financial Reporting of Leasing Arrangements

The construction team at Smith and Howard often advises construction clients who have separate, but related, business entities used to buy vehicles, equipment or facilities that they then lease back to their parent company. Earlier in 2014, FASB issued guidance that applies to privately held companies using GAAP providing a way for some construction companies to realize a simpler way to handle the financial reporting of these type of lease/buy-back arrangements.

FASB guidance

Earlier this year, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-07, Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements. This guidance applies to privately held companies using Generally Accepted Accounting Principles (GAAP).

Under GAAP rules, borrowers generally must consolidate the financial reporting from entities in which they have controlling financial interests. The new FASB guidance allows private companies following GAAP to, in some circumstances, elect not to consolidate the financial reporting from such entities that lease property to them.

Industry examples

Here’s an example of a leasing arrangement that could be affected: A midsize concrete company with 30 trucks chooses to set up a leasing operation to monetize idle equipment. Historically, if this operation truly wasn’t an entirely separate company, which is frequently the case, GAAP rules would typically require that the operation be consolidated on the concrete business’s financial statements.

A variety of other similar applications may also qualify. For instance, an electrical contractor may also install telecommunications equipment under a separate company name. If these operations both work out of the same facility, chances are, one entity leases equipment, office space and vehicles from another. In this scenario, too, the parent company historically would have to consolidate the lessor entity on its financial statements.

Such “common control” leasing arrangements are used by construction businesses and other types of private companies to achieve legitimate tax, financial and legal objectives. But many users of these companies’ financial statements find financial-statement consolidation of lessors under common control to be irrelevant and even confusing.

So FASB issued the aforementioned guidance to permit certain private companies that follow GAAP to elect not to consolidate the financial reporting from so-called “variable interest entities” that lease property to them.

Opt-out opportunity

As you might expect, the details of ASU No. 2014-07 are complex from an accounting perspective. But, to sum it up generally, GAAP-compliant privately held contractors may now opt out of the consolidation requirement if:

• The contractor and the lessor are under common control,
• The contractor has a leasing arrangement with the lessor, and
• Substantially all of the activity between the contractor and the lessor is related to the leasing activities (including supporting leasing activities) between those two companies.

In addition, if the contractor explicitly guarantees or provides collateral for any obligation of the lessor related to the asset leased by the contractor, the principal amount of the obligation at inception can’t exceed the value of the asset leased by the contractor.

A simpler life

If your construction company has created a separate business entity under a common-control leasing arrangement, or is considering doing so, ask Smith and Howard for more information about this FASB guidance. Although the rules are complex, implementation could make your business life simpler.

For more information, call Debbie Torrance, Marvin Willis, David Lee or another member of our construction group at 404-874-6244.