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Off-Balance Sheet Proposal for Private Companies Moves Forward

November 13, 2013

The FASB’s Private Company Council has forwarded to the FASB for final approval a proposal to exempt private companies from following variable interest entity guidance when determining whether to consolidate the reporting of separate entities that are technically part of their business operations. Private companies long have complained that the guidance is difficult to follow and not useful for the creditors and investors who read their financial statements.

The FASB’s Private Company Council on November 12, 2013, approved a proposal to exempt private companies from following guidance about off-balance sheet accounting they long have decried as too complex for common small business transactions.

The proposal now heads to the FASB, which has the final say on whether the exemption should be published as a final amendment to U.S. GAAP.

The November 12 decision approved the draft version of the guidance published in August as Proposed Accounting Standards Update (ASU) No. PCC-13-02,Consolidation (Topic 810) Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements (formerly FIN 46(R) and FAS 167).

If the FASB agrees to finalize the changes, private companies won’t have to follow variable interest entity guidance to determine to consolidate the reporting of a separate entity that is technically part of their company.The break would only apply to leasing arrangements.The changes cover some of the guidance for scope, recognition, measurement, and implementation in FASB ASC 810-10,Consolidation.

Private companies have over the years told the FASB that the variable interest entity guidance is their biggest accounting problem.They say they don’t set up the arrangements to hide assets off their balance sheets, a tactic that was abused in the Enron accounting scandal.

Instead, they often set up the arrangements for tax or estate planning purposes.Private manufacturing companies create separate legal entities to hold warehouses or factories.The manufacturing company then leases the warehouse or factory from that entity, which typically is owned by a family member or business partner, which is considered “common control.”

PCC member Thomas Groskopf, director and owner of Barnes, Dennig & Co. Ltd. in Cincinnati, said he planned to dissent from the proposal, calling it too broad.In his view, the amendment could lead to private companies structuring transactions to shield bad assets from their balance sheets.He had suggested that the proposal only apply to real estate transactions, but the council didn’t take action on this idea.

“We’ve written a pretty liberal exception that a lot of people can do a lot of things through,” Groskopf said.

Several businesses, auditors, and individuals who responded to the August proposal called on the FASB and the PCC to provide more guidance on what “common control” means.U.S. GAAP provides no definition, but businesses and auditors typically refer to observations from the SEC that are in a memo for EITF Issue No. 02-5, “Definition of ‘Common Control’ in Relation to FASB Statement No. 141.”The EITF issue was never finalized, and the SEC observations, which stem from a speech, aren’t authoritative GAAP.

The EITF memo summarizes the SEC position that common control exists between separate entities only in certain situations, such as when an individual or enterprise holds more than 50% of the voting ownership interest of each entity, or immediate family members hold more than 50% of the voting ownership interest of each entity.Immediate family members are considered a married couple and their children, but not the grandchildren.

Many separate entities are set up in grandchildren’s names.The entities can be set up with relatives from an extended family, or with a spouse, or partner in an unmarried couple.The PCC didn’t intend to exclude the relationships from the proposed accounting break, but it stopped short of trying to define “common control.”

“Trying to more tightly define this term would just be a ditch we’d be going into and really difficult to solve,” FASB member Daryl Buck said. “It’s just opening a can of worms.”

Instead, the FASB’s research staff plans to write in the standard’s basis for conclusions that the PCC didn’t intend for “common control” to apply only to a narrow set of relationships.