Lessors and discontinued operations subsequently retained.
EITF Abstracts, copyrighted by the FASB, is available in soft-cover and loose-leaf versions and may be obtained by contacting the FASB order department at 401 Merritt 7, P.O. Box 5116, Norwalk, Connecticut 06856-5116. Phone: (203) 847-0700.
ISSUE NO. 90-15
This issue, Impact of Nonsubstantive Lessors, Residual Value Guarantees, and Other Provisions in Leasing Transactions, considers whether a lessee should consolidate a special-purpose entity (SPE) lessor in a transaction structured to be an operating lease.
An SPE is established to engage in certain types of transactions (for example, leasing) on behalf of a sponsor (lessee). Although the sponsor is not related to the SPE through ownership, the sponsor often has virtually all the risks and rewards of the SPE-held assets. For example, a lessee may bear the entire risk of loss and liability from operation of the SPE's property. The SPE often is thinly capitalized, whereby majority equity owners make only a nominal capital investment. An SPE lessor's activities often include these real or personal property leasing transactions:
* Sale-leasebacks: the sale of property by the owner and a lease of the property back to the seller.
* Build-to-order leases: property constructed by the lessor according to the lessee's specifications.
* Buy-lease: the lessor's purchase from a third party of an existing asset meeting a lessee's specifications.
In a typical arrangement, a company (lessee) enters into a lease transaction and classifies it as an operating lease based on a literal reading of FASB Statement no. 13, Accounting for Leases, as amended. However, certain characteristics of that transaction raise questions about whether operating lease treatment (as opposed to a financing or consolidation) is appropriate. These characteristics include.
* The lessee's residual value guarantees.
* The lessee's participation in both risks and rewards associated with ownership of the leased property.
* Purchase options available to the lessee.
* An SPE lessor lacking economic substance.
* Property constructed to the lessee's specifications.
* Lease payments adjusted for final construction costs.
Accounting issue. Should a lease with these characteristics be accounted for as an operating lease?
Background. The Securities and Exchange Commission expressed concern over some leases that were recorded as operating leases but were in substance a financing of the leased asset. According to the SEC, accounting for these transactions as operating leases could be misleading to users of financial statements because the risks and rewards of ownership assumed by the lessee are not acknowledged under this accounting method. The SEC staff considered certain factors to determine whether these lease trasactions are, in substance, financings: construction risk; the special-purpose nature of the property; the use of a thinly capitalized SPE; and transfer of substantially all risks and rewards of ownership to the lessee.
Arguments. Accounting alternatives proposed included.
* Sale-leaseback accounting.
* Consolidating SPE lessors with the related lessee.
Some believe the lessee should account for these transactions as a sale-leaseback under FASB Statement no. 98, Accounting for Leases: Sale-Leaseback Transactions Involving Real Estate. Certain risks (for example, the rist of loss), assumed by the lessee before the beginning of the lease term may be similar to the risks of direct ownership of the property before a sale-leaseback. The EITF rejected this accounting treatment because Statement no. 98 applies only to transactions involving real property.
Others believe the lessee should consolidate the SPE. They think the real issue is whether consolidation is appropriate even though the lessee does not have an ownership interest in the SPE. Paragraph 29 of Statement no. 13 says if the lessee and lessor are related parties and the transaction terms are significantly affected by this relationship, then the lease should be accounted for in accordance with its substance rather than its legal form.
Leasing transactions with SPEs can, in substance, give the lessee indirect control of the SPE lessor. Often, the SPE's scope of business may be substantially restricted by the lessee, so control of the SPE rests more with the SPE than with the equity holders. If such indirect control exists, then the lessor is analogous to a subsidiary and should be consolidated by the lessee.
Consensus. The EITF concluded a lessee is required to consolidate an SPE lessor when all the following conditions exist:
* Substantially all the SPE's activities involve assets to be leased to a single lessee.
* The expected significant risks and substantially all the reward of the leased asset(s) and the obligation imposed by the SPE's underlying debt reside directly or indirectly with the lessee through such means as, for example.
a. The lease agreement.
b. A residual value guarantee through, for example, the assumption of the first dollar of loss provisions.
c. A guarantee of the SPE's debt.
d. An option granting the lessee a right to (1) purchase the leased asset at a fixed or defined price other than fair value determined at the date of exercise or (2) receive any of the lessor's sales proceeds over a stipulated amount.
* The SPE's owner(s) of record made no initial substantive residual equity capital investment that's at risk during the entire lease term.
If the SPE was established for both the construction and subsequent lease of an asset and the above conditions exist, consolidation by the lessee should begin at the lease's inception (that is, the date of the lease agreement or commitment, whichever is earlier) rather than at the beginning of the lease term.
When a lease contains the general characteristics described above but does not qualify for consolidation under the consensus, the lease may qualify for operating lease treatment. However, the EITF cautioned that lease classification should be determined based on the facts and circumstances in each case in relation to Statement no. 13 requirements, as amended.
A number of implementation questions arose from this issue. The SEC staff's positions on those questions are contained in the EITF Abstracts.
ISSUE NO. 90-16
Accounting Discontinued Operations Subsequently Retained addresses remeasurement and reclassification issues arising when a segment's anticipated discontinuance is reversed.
A company decides to dispose of a business segment and accrues a loss in accordance with Accounting Principles Board Opinion no. 30, Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. Following paragraph 15 of Opinion no. 30, the company assesses the segment's net realizable value and records a write-down of the related nonmonetary assets as part of an estimated loss on disposal. The company later decides to keep that business segment.
Accounting issues. The issues considered by the EITF were
1. Should the accrued loss on the segment's disposal, or a portion of that accrued loss, be reversed because of the subsequent decision to retain the segment?
2. Should the prior-period financial statements be restated or reclassified because of the later decision to retain the segment? If the financial statements should be reclassified, what amounts should be presented in continuing operations and what amounts should remain as discontinued operations?
Arguments. On the first issue, discussion centered on whether a write-down of nonmonetary assets (for example, fixed assets or identifiable intangibles) to net realizable value should be reversed. EITF Issue no. 84-28, Impairment of Long-Lived Assets, says, "...once written down, the assets are not subsequently written back up." This position is echoed in the FASB Discussion Memorandum, Accounting for the Impairment of Long-Lived Assets and Identifiable Intangibles, issued December 7, 1990.
Paragraph 21 of FASB Statement no. 12, Accounting for Certain Marketable Securities, provides additional support for nonreversal. If a noncurrent marketable security's cost basis was written down because an other-than-temporary decline occurred, "the new cost basis shall not be changed for subsequent recoveries in market value."
Those supporting reversal of the write-down believe the decision to retain the segment simply reflects a change in facts and circumstances, and the accounting should reflect those changes. The initial write-down was based on an estimate of the segment's net realizable value. The subsequent decision to retain the segment requires another estimate of the segment's value--not based on net realizable value, but on the value of future cash flows from operations. If the new estimate supports a higher value, the write-down should be reversed and accounted for as a change in estimate in accordance with APB Opinion no. 20, Accounting Changes.
Arguments on the second issue, reclassification of prior-period financial statements, centered on full vs. partial reclassification.
Those who favor full reclassification claim the prior-period financial statements shouldn't reflect the decision to discontinue operations, because the discontinuation never occurred. Therefore, all previously reported costs related to the contemplated segment disposal should be reclassified and included in income from continuing operations. Opponents believe full reclassification would result in noncomparable financial statements by including the loss on disposal--a loss that ultimately is not incurred--in income from continuing operations in one year and then reversing it in the next year.
Under the partial reclassification approach, only the results of operations of the segment in prior periods would be reclassified from discontinued operations to continuing operations. The estimated loss on disposal would remain as discontinued operations. The reporting period when the decision to discontinue operations is reversed would include results of operations of the segment in continuing operations. Reversal of the estimated loss on disposal would be presented in discontinued operations.
Consensuses. On issue 1, the EITF concluded only the loss on the disposal (which excluded any loss from operations of the segment in the prior period up to the measurement date) should be reversed in the period the company changes its mind and subsequently decides to retain the business segment. Components of the resersal may include an estimated loss from operations during the phaseout period, any write-down to net realizable value and estimated costs of disposal.
On issue 2, the EITF concluded the financial statements of the prior reporting period should not be restated. However, the results of operations of the business segment in that prior period (up to the measurement date) should be reclassified as continuing operations. The remaining estimated accrued loss on disposal should be classified as discontinued operations in those prior periods. In the period when the decision is made to retain the business segment, the remaining accrued loss on disposal should be reversed as part of discontinued operations, and the operations of the business segment in that period should be classified in continuing operations.
The SEC requires certain disclosures supplemental to those already required under Opinion no. 30 when this consensus is applied. The additional disclosures required when applying the consensus are contained in the EITF Abstracts that discusses Issue no. 90-16.
By MOSHES S. LEVITIN, CPA, senior technical manager, and LINDA A. VOLKERT, CPA, technical manager, of the American Institute of CPAs technical information division.
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|Publication:||Journal of Accountancy|
|Date:||Nov 1, 1991|
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