The Substance of the Standard

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1 The Substance of the Standard Mayer Hoffman McCann P.C. An Independent CPA Firm TM A publication of the Professional Standards Group April 2014 Accounting Election for Common Control Leasing Arrangements On March 20, 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) Consolidations (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements (hereafter ASU or the standard). This standard is the third accounting alternative proposed by the Private Company Council (PCC) and endorsed by the FASB. It is an accounting alternative that permits a private company reporting entity to elect to not apply the variable interest entity (VIE) guidance to certain leasing arrangements. If elected, the guidance of this standard must be applied to all qualifying lease arrangements. The adoption of ASU may result in the deconsolidation of commonly controlled lessor entities Contents Qualifying Private Companies...1 Qualifying Leasing Arrangements...1 Applying other U.S. GAAP...5 Disclosure...6 Period of Adoption...7 Other Changes to ASC 810 Consolidation...8 Considerations...8 Implementation Steps...8 Appendix: Summary of Significant Changes roots TM our run deep In summary: ASU was issued in March 2014 and its provisions may be elected by entities that are not public business entities, not-for-profit entities or employee benefit plans. Through early adoption, qualifying entities may elect to not apply the VIE guidance to certain common control leasing arrangements under this standard for their December 31, 2013 financial statements (for calendar year companies) as long as those financial statements have not been made available for issuance prior to March 20, See the summary of Significant Changes for the key differences created by ASU that were previously consolidated under the VIE guidance, the removal of disclosures prescribed by the VIE guidance for consolidated and certain non-consolidated commonly controlled lessor entities, or the reduction in the documentation and procedures necessary to evaluate these types of entities under the VIE guidance. Qualifying Private Companies A reporting entity may elect to adopt the Standard if it is a private company. A private company is defined as an entity that is not: a) an employee benefit plan, b) a not-forprofit entity or c) a public business entity as defined by ASU Definition of a Public Business Entity (see MHM Messenger ). If a reporting entity that initially meets the criteria to be a private company and adopts ASU subsequently ceased to meet the definition of a private company it would be required to apply the VIE guidance prospectively to all leasing arrangements and lessor entities that had previously qualified under this standard. Qualifying Leasing Arrangements In order to qualify to not apply the VIE guidance to a leasing arrangement, the reporting entity and lessor entity must meet four criteria. Those criteria, shown on the next page, include that the entities be under common control, that they have a leasing arrangement, that substantially all the page 1

2 Leasing arrangement criteria (excerpt from ASU ): a. The private company lessee and the lessor legal entity are under common control. b. The private company lessee has a lease arrangement with the lessor legal entity. c. Substantially all activities between the private company lessee and the lessor legal entity are related to leasing activities between those entities. d. If the private company lessee explicitly guarantees or provides collateral for any obligation of the lessor legal entity related to the asset leased by the private company, then the principal amount of the obligation at inception of such guarantees or collateral arrangement does not exceed the value of the asset leased by the private company from the lessor legal entity. activity between them relates to the leasing arrangement and that any guarantees provided by the reporting entity be fully collateralized by the leased assets at the inception of the guarantee. As with the VIE guidance, in order to apply the guidance of ASU , the leasing arrangement must be with an entity. An entity is defined as any legal structure used to conduct activities or to hold assets. Some examples of entities that meet the definition include corporations, limited liability companies (LLCs), partnerships, trusts, as well as legal structures that are disregarded under tax regulations, such as single member LLCs. A reporting entity may not apply the standard to a leasing arrangement for an asset owned directly by an individual. Common Control Criterion a) requires that the reporting entity and the lessor entity are under common control. U.S. Generally Accepted Accounting Principles (U.S. GAAP) does not define common control. Control has been defined as the direct or indirect ability to direct management and policies through ownership, control or otherwise, or a controlling financial interest. Consistent with examples provided in ASC 805 Business Combinations, entities that share an ultimate parent (which has a controlling financial interest in both entities) would be considered under common control. However, in many instances, private companies may be owned by an individual or group of individuals and do not Controlling financial interest: A controlling financial interest is the basis used in U.S. GAAP to conclude whether a reporting entity should consolidate another entity. A reporting entity usually has a controlling financial interest in a corporation when it has greater than 50% of the voting rights of the equity of the corporation or when, through the VIE guidance, it determines that it has the power to direct the activities that most significantly impact a VIE s economic performance and it has an obligation to absorb losses of the VIE or right to receive benefits from the VIE that could potentially be significant to the VIE. have a parent that is an entity, or may be owned in legal structures that have many different levels of parent entities. In these circumstances it may not be evident whether two entities share the same ultimate parent. Since common control may occur in circumstances that are not easily interpreted under the guidance of a controlling financial interest, additional interpretation of common control is necessary. The Securities and Exchange Commission (SEC) issued guidance defining common control when its The SEC staff stated the following would indicate common control exists: An individual or enterprise holds more than 50 percent of the voting ownership interest of each entity. Immediate family members hold more than 50 percent of the voting ownership interest of each entity (with no evidence that those family members will vote their shares in any way other than in concert). Immediate family members include a married couple and their children, but not the married couple s grandchildren. Entities might be owned in varying combinations among living siblings and their children. Those situations would require careful consideration regarding the substance of the ownership and voting relationships. A group of shareholders holds more than 50 percent of the voting ownership interest of each entity, and contemporaneous written evidence of an agreement to vote a majority of the entities shares in concert exists. page 2

3 staff commented on Emerging Issues Task Force (EITF) Issue Number Definition of Common Control in Relation to FASB Statement No While the EITF did not reach consensus on Issue 02-05, the SEC staff comment (see box) is for use by SEC registrants (issuers) when applying the concept of common control. This guidance, while not authoritative for non-issuers, is often used as an interpretation of U.S. GAAP when preparing non-issuer financial statements. In the basis for conclusion to ASU , the FASB and PCC discussed considerations related to common control and their decision to not define common control. A primary reason given to not define common control was the wider implications within U.S. GAAP of creating a definition. This impact would be beyond the scope of the activities of the PCC and the goals of this standard. The discussion did indicate that the FASB and PCC would consider the concept of common control to be broader than the SEC definition. For instance, depending on facts and circumstances, two entities may be considered to be under common control if one is owned by a grandparent and one is owned by a grandchild, which does not fit the strict definition of the SEC. Taking into consideration the factors discussed above, the evaluation of whether the reporting entity and the lessor entity are under common control may require significant analysis, but some general guidelines can be developed. Generally, entities may be considered under common control if: one entity is a consolidated subsidiary of the other entity, they are required to be consolidated by a common parent entity under U.S. GAAP, an individual owns more than 50 percent of the voting interest, controls by contract or through general partnership, or is the primary beneficiary of both entities, or a group of owners or a combination of owners, of both entities would be expected to vote together in concert to achieve greater than 50 percent of the voting interest. Such groups may include family members, and unrelated individuals with a written agreement to vote their shares together. Under certain circumstances, other arrangements amongst individuals or entities may result in common control and would require careful consideration and analysis. Example Novel Environmental Plumbing, Inc. (NEP) is a manufacturer of specialty plumbing supplies and is preparing its financial statements (NEP is the reporting entity). It leases a facility from Land and Novel Development, LLC (LAND), a lessor entity. NEP is 100 percent owned by Jane Doe. Jane Doe has three adult children. While performing estate planning in 2002, she helped create LAND, which is owned one-third by each of her children. Assuming Jane and her children are not estranged or have a conflict that would preclude them from voting in concert, NEP and LAND would be considered to be under common control and would meet criterion a). Lease Arrangement The second criterion requires that the reporting entity and the lessor entity have a lease arrangement. A lease is defined in U.S. GAAP as an agreement conveying the right to use property, plant or equipment, usually for a stated period of time. A lease arrangement is not required to be called a lease by the parties to the arrangement. Any arrangement that meets the definition would contain a lease. The EITF addressed how to determine whether an arrangement contains a lease and provided a model for evaluating arrangements. This model requires an arrangement to meet the following conditions to be considered a lease: A lease includes only property, plant or equipment. Arrangements for inventory, exploration rights, and other intangibles (for instance trademarks) would not be leases under U.S. GAAP. Arrangements involving land or depreciable assets could meet the definition of a lease. A lease must be for specific property. The property should be explicitly or implicitly identified in the arrangement. This condition may not be met if the arrangement calls for the owner/seller to deliver specified quantities of goods or services, but has the right to provide those goods or services using property not specified in the arrangement. This condition is not violated by general warranty or substitution provision contained in an arrangement. An arrangement implicitly involves specific property if it is not economically feasible for the owner/seller page 3

4 to perform under the arrangement using alternative property. The arrangement provides the user the right to use the specific property if they control more than a minor amount of output or utility of the property while also: operating or directing the operation of the property, controlling physical access to the property, or facts and circumstances indicate that it is remote that other parties will take more than a minor output or other utility of the property during the term of the arrangement, and the price is not fixed per unit of output or the current market price per unit of output at the time of delivery of the output. It is usual for a lease to be a written agreement, however, amongst related party entities, there are occasionally leasing arrangements that are unwritten or that have continued on a month-to-month basis after expiration of the original lease term. All arrangements written or otherwise, which meet the definition of a lease would qualify under criterion b). Nature of Activities The third criterion is that substantially all the activities between the reporting entity and the lessor entity are related to the leasing arrangement. This criterion includes activities that are designed to support the leasing activity. Examples of qualifying activities include a guarantee or joint and several liability for the debt related to the leased property provided by the reporting entity to the lessor entity, payment of property taxes, maintenance or repairs by the reporting entity related to the leased property, and negotiating financing for the leased property by the reporting entity on behalf of the lessor entity. In addition, payment of income taxes of the lessor entity by the reporting entity is considered to support the leasing activity when the lessor entity leases property exclusively to the reporting entity or the property is leased by the reporting entity and an unrelated party. Activities between the reporting entity and the lessor entity that are not related to the leasing arrangement would result in a failure to comply with criterion c). Examples of activities that would not meet criterion c) include the following circumstances: The reporting entity provides a guarantee for a liability of, or enters into joint and several liabilities for, the lessor entity and that liability is for assets that are not leased by the reporting entity. This situation may occur when the lessor entity owns two buildings, only one of which the reporting entity leases, but for which the reporting entity guarantees liabilities for both buildings. The reporting entity purchases products or services from the lessor entity that do not qualify as a lease. The reporting entity sells products or services to the lessor entity that are not related to the lease arrangement. The reporting entity pays income taxes for a lessor entity and the lessor entity has income from unrelated third parties, unless that income is earned through a lease of part of the property that is also partially leased to the reporting entity. The reporting entity has a purchase commitment with the lessor entity, unless the commitment is in support of or for the acquisition of the leased asset. Example NEP leases three out of ten floors of the only building owned by the commonly controlled lessor entity, LAND. As part of the lease arrangement, NEP is responsible for paying for repairs, maintenance, insurance and property tax for the property. In addition, NEP prepares and pays the income taxes of LAND. The activities between NEP and LAND would be determined to be substantially all related to supporting the leasing activities between NEP and LAND because they relate to the building leased by NEP. In June 2015, LAND acquires a second building that is leased to an unrelated party. The unrelated party is responsible for paying for property taxes, maintenance and insurance on the building and NEP does not pay any amounts in support of the new building. If NEP continued to pay the income taxes of LAND the activities between NEP and LAND would no longer be considered to be substantially all related to the leasing activities between NEP and LAND. The violation of criterion c) occurs because NEP would pay for income taxes related to the building it does not lease. Likewise, if NEP were to issue a guarantee for the mortgage debt of the second building or pay for operating costs of the second building, such as insurance, the activities would no longer qualify under criterion c). page 4

5 Guarantees and Collateral The last criterion applies if the reporting entity enters into an arrangement that is similar to a guarantee, joint and severally liability or collateral arrangement in support of the obligations of the lessor entity. If the reporting entity enters into one of these arrangements, such as a guarantee of debt, the assets of the lessor entity (the leased assets) that serve as collateral for the debt are required to have a greater value than the principal amount of the debt that is being guaranteed by the reporting entity at the inception of the guarantee. ASU does not provide guidance for the determination of value for the leased asset. Depending on circumstances, indicators of the value of the leased asset that may be appropriate include the purchase price of the building when purchased at the time the guarantee or collateral arrangement is created, appraisals of the asset or the fair value of the asset under ASC 820 Fair Value Measurement. While an ongoing reassessment is not required for criterion d), it would be necessary to reassess when a new guarantee or collateral arrangement is entered into or when an existing arrangement is refinanced or restructured. If all four criteria are met by a leasing arrangement, then the lessor entity is not evaluated under the VIE guidance of ASC 810 Consolidation. Applying Other U.S. GAAP After determining an arrangement qualifies for treatment under ASU , the reporting entity is required to apply U.S. GAAP, other than VIE guidance, to the leasing arrangement and lessor entity. The most frequently applicable U.S. GAAP includes consolidation guidance, lease accounting, accounting for guarantees and joint and several liabilities and guidance on accounting for investments as described below. Consolidation U.S. GAAP includes consolidation guidance that is required to be evaluated if the VIE guidance is not applicable to the lessor entity. This includes the voting interest entity (VOE), control of partnerships and similar entities, and control by contract guidance. Under the VOE, guidance the usual circumstance for control of the lessor entity is when the reporting entity owns more than 50% of the voting interest in the lessor entity either directly or indirectly. However, this is modified in instances by other guidance when there is a general partner, or equivalent, that has rights and responsibilities that provide it control with less than 50% of the voting rights. In addition, it is modified when contractual rights cause the reporting entity to have control and thus consolidate an entity when it owns less than 50% of the voting rights or to not have control and not consolidate an entity when it owns more than 50% of the voting rights. Lease Accounting Lease accounting is a complex area of U.S. GAAP that can have several different effects on the accounting for various financial statement line-items and disclosures. If a reporting entity adopts ASU , and as a result of that adoption ceases to consolidate a commonly controlled lessor entity, the accounting for the lease arrangement which was previously eliminated in consolidation must be retrospectively applied to the reporting entity s financial statements. The following areas of lease accounting are some of the most common issues that may arise: Capital lease test The lease arrangement may be a capital lease because the arrangement violates one of the provisions that would require it to be accounted for as a capital lease. The four requirements that would cause capitalization of a leased asset and liability are that the lease 1) transfers ownership of the asset at the end of the lease term (see box), 2) contains a bargain purchase option, 3) has a lease term equal to or greater than 75% of the estimated economic life of the leased property, unless the lease term is in the last 25% of the total economic life of the asset and 4) has a present value of the minimum lease payments (see box) at the beginning of the term equal to or greater than 90% of the fair value of the property, unless the lease term is in the last 25% of the assets economic life. Lease term In order to determine the lease term for use in the capital lease test, amortization period for leasehold improvements and disclosures, it is often necessary to consider whether stated renewal options should be included in the lease term. Renewal options are included in the lease term when 1) there is a penalty on the lessee that would make the renewal reasonably assured, 2) the renewal option is within the period during which the lessee is guaranteeing the debt of the lessor entity, 3) the renewal occurs prior to a bargain purchase option or 4) the renewal is at the option of the lessor. page 5

6 Straight-line rent recognition If the lease arrangement is treated as an operating lease, it may be necessary to straight-line the rent payments resulting in the accrual of a deferred rent liability. Straight-line rent recognition is usually required when rent holidays are included in the rental agreement or when the agreement calls for escalations in minimum lease payments over the term of the lease. Minimum lease payments Minimum lease payments include required lease payments, bargain purchase options, residual value guarantee, and payments required if the lessee fails to renew a lease. They exclude executory costs such as insurance, maintenance and taxes. In some instances, a loan to the lessor or guarantee of the lessor s debt by the lessee may be an in-substance residual value guarantee, which must be included in the minimum lease payments for use in the capital lease test or straight-line rent recognition. Leasehold improvements Evaluation of leasehold improvements may be necessary to determine whether they are owned by the lessor or lessee. In addition, leasehold improvements are generally amortized over the lesser of the life of the asset or the term of the lease. Lessee involvement in asset construction If the lessee was involved in asset construction, it may be deemed the owner of the asset for accounting purposes. There are several forms of involvement described under ASC that can trigger the lessee to report the asset and a liability as if it had purchased the asset that is being leased, or account for the transaction as a saleleaseback. A few examples of this involvement include the maximum guarantee test, whereby at any time during the construction period the lessee is responsible for paying 90% or more of the total project costs incurred to date; certain investments, ownership, use or title to real estate related to the asset; direct payment of costs of the construction project; certain indemnities or guarantees provided by the lessee during construction; and entering into a lease that requires, or may require, lease payments be made prior to construction being completed. Guarantees The accounting for guarantees provided by one entity to another is addressed in ASC 460 Guarantees. If the reporting entity is guaranteeing the obligations of a commonly controlled entity, it is exempt from the requirements to record the fair value of the guarantee; however, additional disclosure is required in the event of a guarantee. Disclosure includes presenting information about the obligation and collateral, what could cause the reporting entity to make payments under the guarantee, and the current status of the risk of payment. Joint and several liabilities ASU Obligations resulting from Joint and Several Liability Arrangements for Which the Total Amount of Obligation is Fixed at the Reporting Date addresses how to account for joint and several liabilities, which would include co-borrowing arrangements where the reporting entity and lessor entity are joint borrowers on the debt of the lessor entity. Under certain circumstances, these arrangements may be treated in part, or in total, as the liability of the reporting entity or alternatively in a manner similar to a guarantee as described above. ASU is effective for fiscal periods ending after December 15, 2014 for non-public entities, early adoption is permitted. Investments If the reporting entity has an equity interest in the lessor entity, it may be required to account for that investment under the equity method or the cost method of accounting. The equity method of accounting is required when the reporting entity has significant influence, which is generally considered to be 20% of the voting interest in a corporation, but may be different than the 20% threshold depending on the facts and circumstances. Disclosure When ASU is elected, the disclosures that were previously required under VIE guidance for certain commonly controlled lessor entities no longer apply if the lessor entity meet the four criteria of ASU The PCC and FASB identified certain disclosures that are similar to the VIE disclosures that were considered useful for financial statement users and that had a low cost to the preparer of the financial statements. Therefore, these additional disclosures specific to lessor entities that are accounted for under this standard are required: page 6

7 Key terms of the liabilities of the lessor entity that expose the reporting entity to providing support to the lessor entity. For example, if the reporting entity is at risk for the debt of the lessor entity through a guarantee or otherwise, it should disclose the amount, interest rate, maturity, collateral, and guarantees related to the debt. Qualitative description of the circumstances not recognized in the financial statements of the lessor entity that may expose the reporting entity to provide support to the lessor entity. For example, if the lessor entity had ongoing litigation or a commitment that could expose it to a loss that was not a recognized liability in the lessor entity s financial statements, then the reporting entity would be required to disclose information about the litigation or commitment in its financial statements if the reporting entity could be exposed to providing support to the lessor entity as a result of the litigation or commitment. The disclosures above would be required when the reporting entity explicitly guarantees the debt or is contractually required to provide support. In addition to those explicit circumstances, ASU requires an evaluation of implicit guarantees provided to the lessor entity by the reporting entity that would also require the disclosures noted above. An implicit guarantee requires an evaluation of facts and circumstances, which includes considering if there is an economic incentive for, or history of, the reporting entity acting as a guarantor or providing funds to the lessor entity, and whether there are restrictions that would prevent the reporting entity from providing funds such as due to a conflict of interest, or a contractual, legal or regulatory requirement. In addition to the specific disclosures required under the standard, a reporting entity is required to complete disclosures required by any other applicable U.S. GAAP and should include these disclosures in a single footnote or cross reference all the relevant footnotes for a lessor entity. Other applicable U.S. GAAP that frequently requires additional disclosure includes ASC 460 Guarantees, ASC 840 Leases and ASC 850 Related Parties. Under this applicable U.S. GAAP, a reporting entity may need to disclose information such as the total amount of money that it could be required to pay under a guarantee, estimates of the value of the assets that are collateral for the lessor entity s debt obligation, amounts paid to, received from or owed to, or receivable from the lessor entity and detail information about the lease arrangement, such as contingent rent and the minimum lease payments for the next five years. There may be additional disclosures required depending on the U.S. GAAP applied and nature of the arrangement. Due to the unique nature of each leasing arrangement, careful consideration of disclosures required by each applicable area of U.S. GAAP is necessary in order to ensure completeness of the financial statements. Period of Adoption ASU is effective for annual periods beginning after December 15, 2014 and interim periods within annual periods beginning after December 15, However, early adoption is permitted so that a qualifying private company may adopt this standard for any financial statements that have not yet been made available for issuance as of March 20, Therefore, if a calendar year company has not yet issued its financial statements as of March 20, 2014 it may adopt this standard for its December 31, 2013 financial statements. In the period of adoption a reporting entity is required to reflect the effects of the adoption retrospectively to all periods presented in the financial statements. Since the reporting entity is required to apply the provisions of ASU to all qualifying leasing arrangements, in the year of adoption any leasing arrangement that may meet the four criteria requires evaluation. In addition, application of other appropriate U.S. GAAP to those qualifying leasing arrangements would need to be done for all periods presented, which may result in changes beyond the deconsolidation of a lessor entity. When the effect of adoption results in changes to retained earnings for periods earlier then the oldest period presented in the financial statements, a cumulative effect adjustment to retained earnings is required to be made. There are additional disclosure requirements for the year of adoption. These additional disclosures are the disclosures included in ASC 250 Accounting for Changes and Error Corrections paragraphs through 50-3, excluding paragraph 50-1(b)(2). These paragraphs require disclosure of: The nature and reason for the change in accounting principle and why it is preferable. The use of the retrospective method and a description of the information changed. page 7

8 The cumulative effect of the change on retained earnings or other equity accounts as of the beginning of the earliest period presented. Indirect effects of the change, including amounts that are recognized in the current period and per-share changes (if presented), including prior periods presented, if practicable. An example indirect effect would be increases in operating expenses due to additional lease expense recognized as a result of deconsolidation of a lessor entity, if those effects are material to the financial statements. Other Changes to ASC 810 Consolidation In addition to the accounting alternative for private companies, ASU removes Example 4 of ASC 810 from U.S. GAAP. Example 4 provided an example of an implicit variable interest between a reporting entity and a related party lessor entity. The removal of the example is not expected to significantly impact the accounting for VIEs. Considerations before Electing to Adopt When making any accounting election, the decision on the accounting principle to use should be carefully considered. The decision to elect to apply the provisions of ASU is no different. Some considerations that may be necessary include expectations of financial statement users, expected cost savings from adoption, impacts on covenants and contracts, and the future plans of the reporting entity. The more common concerns to evaluate include: Do the owners, lenders, bonding companies or other users of the financial statements expect to have the lessor entity consolidated with the reporting entity under the VIE guidance? If the adoption of the standard results in deconsolidation, does the application of other U.S. GAAP after deconsolidation result in preferable and/or cost beneficial presentation as compared to the prior consolidation? Does the election of the standard impact the computation or compliance with financial covenants, or compliance with non-financial covenants? Does the Company have plans that will cause it to no longer qualify as a private company or for the leasing arrangement to no longer meet the four criteria in ASU ? When evaluating covenant compliance with non-financial covenants, it is important to note that the financial statements prepared using the election permitted in ASU result in financial statements that are in compliance with U.S. GAAP, as long as the reporting entity is a qualified private company and all qualifying lease arrangements are accounted for correctly under the provisions of this standard. If a reporting entity ceases to qualify to apply the standard, or a leasing arrangement changes such that it no longer meets the four criteria, the change is accounted for on a prospective basis. However, when this change results in the reporting entity consolidating the commonly controlled lessor entity, that consolidation may be a change in reporting entity that requires the consolidation to be presented retrospectively. Additionally, if a private company is acquired by a registrant or registers with the SEC, it may be required by the regulator, or acquirer, to restate prior financial statements as if it the reporting entity had not made the election to apply this accounting alternative. If restatement were required by the SEC, or the acquirer, it may be necessary to re-audit prior periods. Implementation Steps Every implementation of ASU will be unique, but the following steps can be used to assist in designing an implementation plan: Step 1: Ensure the entity qualifies to make the election in ASU The entity is only eligible to adopt the provisions of ASU if it does not meet the definition of a public business entity provided by ASU (see MHM Messenger ). Additionally, the option is not available to not-for-profit entities or employee benefit plans. Step 2: Identify all leasing arrangements to be evaluated for the election When elected, the provisions of ASU must be applied to all qualifying leasing arrangements. Leasing arrangements that may require evaluation are not limited to those arrangements with entities that were previously determined to be VIE s and are consolidated or disclosed in the reporting entities financial statements under the VIE guidance. Rather, all potentially qualifying leasing arrangements should be evaluated. For example, an arrangement with a lessor entity where the lessor entity was previously determined to not be a VIE could require evaluation under ASU page 8

9 Step 3: Evaluate other applicable U.S. GAAP for qualifying leasing arrangements When the accounting alternative is elected and applied to a leasing arrangement, the application and evaluation of the VIE model to the commonly controlled lessor entity is no longer required. However, any other U.S. GAAP applicable to the lessor entity or the lease arrangement must be evaluated. Step 4: Ensure the transition requirements are applied properly Upon adoption and election to apply the accounting alternative, the full retrospective approach is required. The full retrospective approach requires that all periods presented in the financial statements to be restated to reflect the application of the accounting alternative to the respective period s financial statements. The application of ASU , and other applicable U.S. GAAP, to qualifying arrangements may result in a cumulative effect adjustment to beginning retained earnings for the earliest period presented. Step 5: Ensure financial statement presentation and disclosures are appropriate ASU introduces additional disclosure requirements for entities electing its provisions. In addition, any disclosure requirements for other applicable U.S. GAAP must be applied to transactions accounted for using the election. This includes disclosures related to accounting for other applicable consolidation guidance, leases, guarantees, joint and several liabilities, related parties and investments. Any information about a qualifying leasing arrangement should be included in a single note to the financial statements or all the notes addressing the leasing arrangement should be cross-referenced to each other. In the year of adoption, the disclosure requirements of ASC 250 Accounting Changes and Error Corrections must be included in the financial statements (ASC through 50-3, except for (b)(2)). For More Information If you have any specific questions or concerns regarding the application of VIE guidance to commonly controlled leasing arrangements, please contact James Comito or Hal Hunt of MHM s Professional Standards Group or your MHM service professional. You can reach James at jcomito@cbiz.com or or Hal at hhunt@cbiz.com or page 9

10 Substance of the Standard Appendix: Accounting Election for Common Control Leasing Arrangements Summary of Significant Changes Consolidation of a commonly controlled lessor entity Disclosure of a commonly controlled lessor entity Without the election of ASU With the election of ASU A reporting entity evaluates whether it consolidates a lessor entity that is a variable interest entity (VIE) because it has the power to direct the activities that most significantly impact the economic performance of the lessor entity and is exposed to losses or residual benefits that may be significant to the lessor entity. If the lessor entity is not consolidated under the VIE guidance, then other applicable U.S. GAAP is applied to the leasing arrangement and lessor entity. A reporting entity evaluates whether it must disclose information about the lessor entity under the VIE guidance because the lessor entity is a VIE and the reporting entity is required to consolidate or has a variable interest in the lessor entity. If the lessor entity is not consolidated under the VIE guidance then other applicable U.S. GAAP is applied to the leasing arrangement and lessor entity. A reporting entity that is a private company does not evaluate a lessor entity under the VIE guidance when the lease arrangement meets the four criteria of ASU If deconsolidation occurs as a result of electing the standard, the reporting entity deconsolidates the lessor entity and applies other applicable U.S. GAAP retrospectively. The four criteria that must be met are that the entities be under common control, that they have a leasing arrangement, that substantially all the activity between them relates to the leasing arrangement and that any guarantees provided by the reporting entity to the lessor entity are fully collateralized by the leased assets at the inception of the guarantee. A reporting entity does not make the required disclosures under the VIE guidance if the leasing arrangement meets the four criteria of ASU , but it is required to make additional disclosures related to the qualifying lessor entity, including information about liabilities of the lessor entity that the reporting entity is potentially exposed to and circumstances that could expose the reporting entity to support the lessor entity, as well as disclosures required by other applicable U.S. GAAP. page 10