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Off-Balance-Sheet Proposal for Private Companies Heads to Final Status

January 30, 2014

The FASB’s Private Company Council (PCC) agreed to amend U.S. GAAP to address complaints from private companies that the consolidated reporting requirements are too complex for some commonly used transactions. The PCC also decided it needs more information before continuing its work on a proposal to simplify the valuation of certain intangible assets. A proposed change to hedge accounting for some types of loans was dropped from the council’s agenda.

The FASB’s Private Company Council (PCC) on January 28, 2014, agreed to finalize an amendment to U.S. GAAP that private companies say will ease the accounting for a type of transaction often used by small businesses.

The decision means that private companies that meet certain conditions may opt out of the consolidated reporting requirements for “variable interest entities,” separate legal entities that private manufacturers often set up to house their factories or office buildings. The manufacturers then lease the facilities back from the owners, who are typically family members or business partners. The entities are used to lower tax bills or for estate planning.

The PCC agreed that a manufacturer wouldn’t have to report the liabilities of the separate entity on its balance sheet, a practice that private companies said was too complex and costly to calculate and one that investors and lenders said didn’t give them valuable information.

Private companies for years have argued that they don’t set up the arrangements to hide assets, a tactic that was abused by Enron. The energy company’s fraudulent accounting for its off-balance-sheet vehicles prompted a major revision to U.S. GAAP’s consolidated reporting guidance.

The proposal now heads to the FASB for a vote on whether to approve the proposed update as a permanent change to U.S. GAAP.

The decision confirmed the bulk of Proposed Accounting Standards Update (ASU) No. PCC-13-02, Consolidation (Topic 810) Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements, which was released in August and fine-tuned in November. Questions about the criteria to qualify for the break, however, cropped up before the PCC and the FASB could finish the project.

Under the proposal, a private company can opt out of the consolidated reporting requirements if the lessee and lessor are under common control; there is a leasing arrangement; and substantially all activity between the business and the separate entity is related to leasing.

A fourth condition—the obligations of the lessor entity, if any, are only collateralized by the assets leased by the private company lessee and not by the overall assets of the company—was the subject of much debate January 28 because private companies said it was overly broad and would force them to report transactions that should be exempt.

The PCC agreed to change the condition about “all activity between the business and separate entity is related to leasing” to “substantially all activity between the two entities is related to leasing activities of the lessor entity to the private company lessee.” The PCC also wants to clarify that a guarantee can qualify as a leasing-related activity.

The fourth criterion was changed to “the leased asset sufficiently collateralizes the debt of the lessor company.”

“Combined instruments” hedge accounting proposal dropped

In a separate discussion, the PCC decided not to proceed with a proposal that would provide a second option to ease accounting for private companies that can’t secure fixed-rate loans and engage in “plain vanilla” interest rate swaps to get fixed-rate debt.

The PCC had approved—and the FASB on January 16 published—a simplification that would give private companies an easier form of hedge accounting when accounting for the swaps, which are considered derivatives.

The January 16 option, released via ASU No. 2014-03, Derivatives and Hedging (Topic 815), Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps—Simplified Hedge Accounting Approach, a consensus of the Private Company Council, allows the arrangements to qualify for hedge accounting that treats the swap and the loan as separate financial instruments. The company would also be able to measure the swap at the price it paid and not its current market value, which is more difficult to calculate.

A second proposal, dubbed the “combined instruments” approach, would have let private companies that met certain criteria avoid the requirement in Topic 815, Derivatives and Hedging, to report the fair value of the swap assets and liabilities on their balance sheets.

Critics said the proposal lacked conceptual merit and would create too many differences in the accounting for private companies versus public companies.

Others noted that Dodd-Frank Act restrictions on financial swaps will reduce the number of private companies that could qualify for relief.

“The population’s a lot less, and you’ve made other relief related to the simplified hedge accounting. So I think you’re going to have to judge, is the change in doing this toward a narrow population worth it?” FASB Chairman Russell Golden said.

PCC members decided it wasn’t, and the project was dropped from the council’s agenda.

Intangible assets proposal needs more work

Finally, the PCC asked the FASB’s research staff to continue working on a proposal that would exempt private companies buying or merging with other companies from recording the value of intangible assets such as unpatented technology.

Released in July, Proposed ASU No. PCC-13-01A, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination, a proposal of the Private Company Council, would allow private companies to avoid what can sometimes be a complex calculation that requires the assistance of outside valuation specialists. It would require intangible asset recognition only for assets that are legally protected, such as trademarks and patents. The companies would not have to go through the costly process of valuing a brand name or technology that isn’t patented.

The PCC discussed three options: not recognizing intangible assets separately from goodwill; only recognizing intangible assets that can be sold or licensed independently from the business’s other assets; or not changing existing U.S. GAAP.

The PCC—and many FASB members sitting at the table—said they wanted to require recognition for “meaningful” intangible assets, such as non-compete arrangements and important customer relationships, but they were unsure how they could capture the information in an accounting standard.

“We’re not in a rush, and we need to be very, very careful about the wording,” PCC member Diane Rubin, retired partner of Novogradac & Co. LLP in San Francisco.