Anyone who’s seen a consolidated financial statement knows how confusing they can be. Under Generally Accepted Accounting Principles (GAAP), dealerships that lease real estate or equipment from one or more owners may be subject to the consolidation requirements of variable interest entities (VIEs). The good news is that consolidation of leasing entities can now be a thing of the past for qualifying privately held dealerships that elect an alternative reporting method.
Why do private companies need a simpler method?
Financial statement users generally aren’t worried that private entities will use common-control leasing arrangements to hide questionable off-balance-sheet debt structures. They understand that dealerships establish separate leasing entities to achieve legitimate tax, financial and legal goals.
Private dealerships that submit consolidated financial statements to their lenders or manufacturers are often asked to provide consolidating schedules to reverse the effects of consolidating — or combining — the operations of common-control entities. Users are more interested in cash flow and tangible net worth of the stand-alone dealership than in the combined performance of a consolidated group presented under GAAP.
Who may opt out of consolidation?
In response to pressure from private business owners and their stakeholders to simplify GAAP, the Financial Accounting Standards Board (FASB) has granted private companies the option to elect not to consolidate financial reporting from VIEs that lease property to them, if all the following conditions are met:
- The dealership (the lessee) and the VIE (the lessor, or leasing entity) are under common control.
- Substantially all of the activity between the dealership and the VIE is related to the leasing activities between those two companies (including supporting leasing activities, such as issuance of a guarantee or providing collateral on the obligations related to the leased asset).
- The dealership explicitly guarantees or provides collateral for any obligation of the VIE related to the leased asset, and the principal amount of the obligation at inception doesn’t exceed the value of the leased asset.
If you elect to apply the alternative method to a leasing arrangement, you must apply it to all current and future leasing arrangements satisfying the above conditions.
Even with the simplified reporting option, footnote disclosures must list the amount and key terms of debt, asset retirement obligations and other liabilities that could result from your activities with the VIE. It’s also important to explain any commitments or contingencies that might cause your dealership to provide financial support to the VIE.
How soon can you use the alternative method?
The alternative method is effective for annual periods beginning after Dec. 15, 2014, and interim periods within annual periods beginning after Dec. 15, 2015. However, early application is permitted. If this option is chosen, it also must be applied retrospectively to all periods presented on the financial statements.
How does the alternative method create opportunities?
Complicated reporting requirements may have caused you to shy away from using a separate leasing entity to achieve tax and financial planning objectives or to limit your legal liability. In light of FASB’s simplified reporting option, you might want to reconsider the benefits of common-control leasing arrangements.
For example, a retiring dealer-owner may lease the dealership’s real estate to the operating business at a rental rate commensurate with comparable properties. This setup generates a steady income stream for the retiree — without burdening lower-net-worth, second-generation owners with property ownership and management obligations.
Leasing arrangements also help protect dealership operations from legal claims if someone is injured on the property. And they may safeguard the dealership’s operating assets from creditors if the leasing entity defaults on its debt or files for bankruptcy.
Where can you get more information?
Achieving the optimal benefits of leasing arrangements requires carefully drafted legal documents and thoughtful planning. Always consult with your professional advisors if you think leasing arrangements might work for you. The alternative reporting method for common-control leases may cause you to see these arrangements in a new, more user-friendly light.