On March 27, 2023, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2023-01, Leases (Topic 842): Common Control Arrangements. The ASU addresses two issues:
- The terms and conditions to be considered when classifying and accounting for leases between entities under common control; and
- Accounting for leasehold improvements in leases between entities under common control.
Issue 1: The terms and conditions to be considered when classifying and accounting for leases between entities under common control
Accounting Standards Codification (ASC) Topic 842 requires that if a lease between entities under common control is determined to exist, the lease must be classified and accounted for on the same basis as leases with unrelated parties, that is, on the basis of legally enforceable terms and conditions.
Private company stakeholders expressed concern that determining the legally enforceable terms and conditions of a common control arrangement would likely be costly and difficult. This ASU provides private companies, not-for-profit entities that are not conduit bond obligors, and employee benefit plans that file or furnish financial statements with or to the U.S. Securities and Exchange Commission with a practical expedient to use the written terms and conditions of a common control arrangement to determine whether a lease exists and, if one does, the classification and accounting for that lease.
This expedient is available on an arrangement-by-arrangement basis, but if an entity elects not to apply it (or if no written terms and conditions exist for another reason), the entity is required to evaluate the legal enforceability of the terms and conditions of the arrangement.
An entity that adopts the practical expedient at the same time it adopts ASC 842 must adopt the expedient using the same transition method used to adopt ASC 842. For all other entities, the expedient may be adopted either:
- Prospectively to all leases that commence on or after the date of adoption of the final ASU; or
- Retrospectively to the beginning of the earliest period presented in accordance with ASC 842 for all arrangements that exist at the date of adoption of the final ASU. The amendments are not applicable for arrangements no longer in place at the date of adoption of the final ASU.
Entities are permitted to document any existing unwritten terms and conditions of a common control arrangement before the date on which the first financial statements are available to be issued in accordance with the practical expedient.
Issue 2: Accounting for leasehold improvements in leases between entities under common control
Leasehold improvements generally are amortized over the shorter of the remaining lease term or the useful life of the improvements. Private company stakeholders expressed concern that this accounting may result in financial reporting that is not representationally faithful of the economics of the deal and may fail to recognize the transfer of value between the common control entities when the lessee no longer controls the use of the underlying asset.
This ASU requires that leasehold improvements in common control leases be:
- Amortized by the lessee over the useful life of the improvements to the common control group, with no consideration of the lease term as long as the lessee controls the use of the underlying asset.
- Accounted for as a transfer between entities under common control through an adjustment to equity if and when the lessee no longer controls the use of the underlying asset.
Leasehold improvements remain subject to the impairment guidance in ASC 360, Property, Plant, and Equipment.
An entity adopting the amendments at the same time it is adopting ASC 842 follows the transition method used to adopt ASC 842 or may elect to use any of the prospective transition methods listed below. For all other entities, the amendments may be adopted using one of the following:
- Prospectively to all new leasehold improvements recognized on or after the date that the entity first applies the amendments.
- Prospectively to all new leasehold improvements recognized on or after the date that the entity first applies the amendments. The unamortized balance of existing leasehold improvements would be amortized over their remaining useful lives to the common control group determined at that date.
- Retrospectively to the beginning of the period in which the entity first applied ASC 842 for leasehold improvements that exist at the time this ASU is adopted. Any leasehold improvements that otherwise would not have been amortized or impaired would be recognized through a cumulative-effect adjustment to the opening balance of retained earnings at the beginning of the first year of adoption of ASC 842.
The amendments for both issues in the ASU are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for financial statements that have not yet been made available for issuance.