Many owners of private construction companies lease property from commonly-owned entities. Under GAAP accounting rules, this could result in situations where a business owner is required to consolidate the financial statements for the two companies. Now, new accounting rules provide cases in which owners may be allowed to opt out of these consolidation requirements. This may significantly streamline financial reporting for business owners.
The old rules
In the past, business owners may have been required to consolidate their financial statements for multiple businesses if one entity leased a building to another company and met certain conditions (most common being the guaranty of the related entity's mortgage). Because the lessor and lessee were under common control, a single individual could be liable for loan defaults and other shortfalls, so consolidation was intended to provide a more complete picture of both organizations' financial standing. This was the result of variable interest entity rules which stated that companies needed to consolidate finances if one company was forced to absorb the economic losses or benefits from another or if a company had the power to direct the economic performance of another entity.
"The GAAP alternative streamlines reporting."
Consolidated reporting is useful for large public entities, but for individuals who hold a single construction company and one real estate company, it resulted in a large amount of extraneous work. Combining the financial information from two entities in this way made it more difficult to judge the financial standing of either organization individually. The changes to the guidelines allow these smaller companies to report their financial information independently.
GAAP alternative
Under the new guidelines, companies that meet the following criteria may not be required to consolidate, according to the FASB:
- The private company lessee and the lessor are under common control,
- The private company lessee has a leasing arrangement with the lessor,
- Substantially all of the activity between the private company lessee and the lessor is related to the leasing activities (including supporting leasing activities) between those two companies, and
- If the private company 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.
If an entity that wholly owns two companies engaged in a lessee and lessor relationship meets all of these qualifications, they may be eligible to sidestep consolidation in their reporting.
Business owners should consult with a CPA to determine if their organizations are eligible for this alternative and should be aware that these rules go into effect for interim annual periods following Dec.15, 2015 and annual periods after Dec.15, 2014.
In addition to our assisting clients with implementing this FASB, our employees have consulted with numerous sureties, insurance underwriters, and other users of contractor financial statements about this topic. To learn more about how we may be able to help you, contact a member of the LaPorte Construction Industry Group.