The Financial Accounting Standards Board (FASB) issued proposed Accounting Standards Update (ASU), Leases (Topic 842): Common Control Arrangements.
The proposed ASU intends to improve the accounting guidance under Topic 842, Leases, for related party arrangements between entities under common control.
Comments are due January 16, 2023.
Key Provisions
The proposed amendments address areas identified by the FASB as part of its post-implementation review of ASU 2016-02, Leases (Topic 842), regarding concerns with applying Topic 842 to related party arrangements between entities under common control. Specially, those areas identified are:
- Which terms and conditions should be considered when determining whether a lease exists and, if so, the classification and accounting for the lease
- The accounting for leasehold improvements associated with leases between entities under common control
Terms and Conditions
Topic 842 requires entities to determine whether a related party arrangement between entities under common control is a lease and, if so, to classify and account for the lease on the same basis as an arrangement with an unrelated party—that is, on the basis of legally enforceable terms and conditions. This represents a change from the economic substance requirements in Topic 840, Leases.
The FASB received feedback stating the requirements under Topic 842 can be difficult to apply to common control arrangements. Specifically, determining the legally enforceable terms and conditions of those arrangements could necessitate obtaining a formal legal opinion, which can be challenging because of the common control nature of the arrangement.
Proposed Updates
The proposed amendments would provide a practical expedient for private companies to use the written terms and conditions of a common control arrangement to determine whether a lease exists and, if so, the classification of and accounting for that lease.
If no written terms and conditions exist, an entity cannot apply the practical expedient and would continue to use the legally enforceable terms and conditions to apply Topic 842.
This means that entities may want to consider putting common control arrangements in writing prior to year-end.
The practical expedient would be applied on an arrangement-by-arrangement basis.
Scope
The proposed practical expedient would be available to private companies and certain not-for-profit entities and employee benefit plans. The proposed practical expedient wouldn’t apply to the following entities:
- Public business entities
- Not-for-profits that have issued or are a conduit bond obligor for securities that are traded, listed, or quoted on an exchange or an over-the-counter market
- Employee benefit plans that file or furnish financial statements with or to the SEC
Accounting for Leasehold Improvements
Under Topic 842, lessees recognize leasehold improvements when they’re the owner of the improvements. Lessees are required to amortize leasehold improvements over the shorter of the remaining lease term and the useful life of the improvements. For short-term leases, this can result in the amortization of leasehold improvements over a short period.
The FASB received feedback noting the requirement to amortize leasehold improvements associated with common control leases over the shorter of the remaining lease term and the useful life of the improvements could result in financial reporting that doesn’t faithfully represent the economics of those arrangements, particularly for leases with short lease terms.
This accounting also fails to recognize the transfer of value between the entities under common control when the lessee no longer controls the use of the underlying asset.
Proposed Updates
The proposed amendments would require leasehold improvements associated with common control leases to be amortized by the lessee over the economic life of the leasehold improvements—regardless of the lease term—as long as the lessee controls the use of the underlying asset.
However, if the lessor obtained the right to control the underlying asset through a lease with another entity not within the same common control group, the amortization period can’t exceed the lease term associated with the lessor’s lease with the other entity.
If, and when, the lessee no longer controls the use of the underlying asset, the leasehold improvements would be accounted for as a transfer between entities under common control through an adjustment to equity—or net assets for not-for-profit entities.
The leasehold improvements would also be subject to the impairment guidance in Topic 360, Property, Plant, and Equipment.
Scope
The proposed amendments relating to the accounting for leasehold improvements would affect all lessees party to a lease between entities under common control in which the lessee is the owner of leasehold improvements. The proposed amendments would apply to all entities, including:
- Public business entities
- Private companies
- All not-for-profit entities
We’re Here to Help
For more information on how the proposed amendments could affect your business, contact your Moss Adams professional.