EITF ABSTRACTS. Title: Application of Issue No and FASB Interpretation No. 23 to Entities That Enter into Leases with Governmental Entities

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1 EITF ABSTRACTS Issue No Title: Application of Issue No and FASB Interpretation No. 23 to Entities That Enter into Leases with Governmental Entities Date Discussed: September 23, 1999 References: ISSUE FASB Statement No. 13, Accounting for Leases FASB Statement No. 98, Accounting for Leases: Sale-Leaseback Transactions Involving Real Estate, Sales-Type Leases of Real Estate, Definition of the Lease Term, and Initial Direct Costs of Direct Financing Leases FASB Interpretation No. 23, Leases of Certain Property Owned by a Governmental Unit or Authority FASB Interpretation No. 45, Guarantor s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others FASB Interpretation No. 46, Consolidation of Variable Interest Entities FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities FASB Staff Position FIN46-6, "Effective Date of FASB Interpretation No. 46 AICPA Audit and Accounting Guide, Audits of Investment Companies 1. Governmental entities typically fund major real property improvements, such as airports and transit or port facilities, through the issuance of tax-exempt bonds that will be repaid from rental payments under a lease agreement with the lessee of the improvements. The lessee typically is the general contractor during the construction period for the improvement, seeking reimbursement from the bond trustee as funds are spent to complete the project. The lessee's involvement during the construction period may take various forms, such as guaranteeing the construction debt or providing construction financing directly or indirectly. While each arrangement will differ in form and in the degree to which the lessee is required to be involved, a guarantee of the underlying financing would require the lessee to be considered the owner of the project

2 under Issue No , "The Effect of Lessee Involvement in Asset Construction," because a lessee providing a guarantee to parties other than the lessor (except for environmental risks) is an automatic indication of ownership under that Issue. There also may be other forms of lessee involvement during the construction period, such as a datecertain lease provision, that cause the lessee to fail the 90 percent "maximum guarantee" test in Issue 97-10, thereby causing the lessee to be deemed the owner of the construction project for financial reporting purposes. Finally, other aspects of the arrangement between the governmental lessor and the lessee could be automatic indicators under Issue that the lessee should be considered for accounting purposes to be the owner of the project during the construction period. 2. If the lessee was considered the owner of the construction project based on Issue 97-10, application of Statement 98 when construction is completed would result in the transaction being treated as a financing transaction (that is, the property and related "financing" would remain on the lessee's balance sheet) if the lessee has guaranteed the underlying financing (which is a form of continuing involvement prohibited by Statement 98). Other aspects of the arrangement also may cause the transaction to be accounted for as a financing or by the deposit method under Statement 98. If the transaction is accounted for as a financing or by the deposit method, the leasing literature is not applicable. However, Statement 13 and Interpretation 23 contain criteria whereby certain leases with governmental entities are accounted for as operating leases without regard to the classification criteria in paragraph 7 of Statement The issue is whether projects involving the construction of government-owned properties that involve a lease of the completed improvements that would be classified as an operating lease under Interpretation 23 should be excluded from the scope of Issue

3 EITF DISCUSSION 4. The Task Force reached a consensus that the construction of government-owned properties subject to a future lease of the completed improvements should be included in the scope of Issue Accordingly, if the lessee is deemed to have substantially all of the construction period risks as defined in Issue 97-10, the lessee should be considered the owner of the property for accounting purposes, with the subsequent sale-leaseback accounted for pursuant to Statement 98. [Note: See STATUS section.] 5. This consensus applies to construction projects committed to after September 23, 1999, and also to those projects that were committed to on or before September 23, 1999, if construction does not commence by March 31, A construction project is considered committed to if all construction-related contracts have been executed including (a) debt and equity financing agreements, (b) construction agency agreements, and (c) other related lease agreements, such that the owner-lessor and other entities providing financing have a binding commitment to the project and the lessee has agreed to its involvement (as developer, general contractor, or construction manager/agent or in other capacities) in the project during the construction period. 6. The SEC Observer indicated that if airlines or other registrants affected by this Issue had been appropriately applying the guidance in Issue prior to this consensus, they would be precluded from changing that prior accounting and adopting the consensus in Issue in a later period. STATUS 7. Interpretation 45, which was issued in November 2002, requires a guarantor to recognize, at inception of the guarantee, a liability for the obligation undertaken in

4 issuing the guarantee. The Interpretation also elaborates on the disclosures to be made by a guarantor. 8. Interpretation 46 and Interpretation 46(R) address consolidation by business enterprises of variable interest entities, which include many special-purpose entities used in leasing transactions. Interpretation 46 and Interpretation 46(R) require a variable interest entity to be consolidated by an enterprise if that enterprise will absorb a majority of the entity s expected losses or is entitled to receive a majority of the entity s expected residual returns or both. Interpretation 46(R) does not require an enterprise to consolidate a governmental organization and generally does not require an enterprise to consolidate a financing entity established by a governmental organization. 9. Interpretation 46 was issued in January The consolidation requirements of Interpretation 46 apply immediately to variable interest entities created after January 31, The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. 10. FSP FIN46-6 deferred the effective date for applying the provisions of Interpretation 46 for: a. Interests held by a public entity in variable interest entities created before February 1, 2003, if the public entity has not issued financial statements reporting that interest in accordance with Interpretation 46. The application of Interpretation 46 to those interests is deferred until the end of the first period ending after December 15, b. Nonregistered investment companies accounting for their investments in accordance with the specialized accounting guidance in the investment company Guide.

5 11. Interpretation 46(R) was issued on December 24, 2003, and replaced Interpretation 46. An enterprise with an interest in an entity to which the provisions of Interpretation 46 were not applied as of December 24, 2003, must apply the effective date and transitions provisions in Interpretation 46(R) to that entity. Application by public companies of Interpretation 46 or Interpretation 46(R) to entities commonly referred to as special-purpose entities is required no later than as of the end of the first reporting period that ends after December 15, Public enterprises must apply Interpretation 46(R) to all entities no later than the end of the first reporting period that ends after March 15, 2004 (public enterprises other than small business issuers) or December 15, 2004 (small business issuers). Nonpublic enterprises must apply Interpretation 46(R) to entities created after December 31, 2003, immediately and to all other entities by the beginning of the first annual period beginning after December 15, An enterprise that has applied Interpretation 46 to an entity prior to the effective date of Interpretation 46(R) shall either continue to apply Interpretation 46 until the effective date of Interpretation 46(R) or apply Interpretation 46(R) at an earlier date. 12. No further EITF discussion is planned.

EITF ABSTRACTS. Title: Accounting by a Real Estate Investment Trust for an Investment in a Service Corporation

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