Financial Accounting and Reporting-CPA Practice Exam

Under GAAP, private companies may choose not to consolidate a lessor entity if which of the following criteria are met?

1. Both the lessee and lessor are independent

2. The lessee has a leasing arrangement with the lessor

3. The lessee absorbs all the risks

4. The lessor is an investment company

The correct answer is: The lessee has a leasing arrangement with the lessor

The reasoning behind selecting that option is based on the specific circumstances under which a lessor may not require consolidation with the lessee entity under Generally Accepted Accounting Principles (GAAP) for private companies. In this context, if the lessee has a leasing arrangement with the lessor, this can create a relationship that allows the lessor to maintain its ability to not consolidate the financials because the lessee operates as a separate entity that is not financially dependent on the lessor. When considering options like the independence of both entities or the absorption of all risks, those do not directly point to the criteria related to the existence of a leasing arrangement. Furthermore, while the status of the lessor as an investment company is relevant, it does not inherently satisfy the criteria for not consolidating based solely on the type of arrangement present between the lessee and lessor. The core principle here is that the leasing arrangement defines the nature of the business relationship, impacting consolidation decisions more than other factors.