FASB to propose changes to related party leases guidance

Oct 06, 2022
Audit Lease accounting Financial reporting

Accounting Standards Codification Topic 842 (ASC 842), Leases, which is effective this year for non-public entities with calendar-year ends, contains limited guidance on accounting for leases with related parties. ASC 842 requires entities to determine whether related party arrangements are leases based on the legally enforceable terms and conditions of the arrangement. However, certain private company stakeholders have notified the Financial Accounting Standards Board (FASB) that determining the legally enforceable terms and conditions in related party arrangements is difficult in certain circumstances, in particular for arrangements between entities under common control.

In response to this feedback, the FASB recently voted to issue a proposal that would provide entities within the scope of ASC 842-10-65-1(b) (i.e., entities that are not public business entities, not-for-profit bond obligors or employee benefit plans that file or furnish financial statements with or to the U.S. Securities and Exchange Commission) a practical expedient to use written terms and conditions for determining whether a lease exists, and if so, the classification and accounting for that lease. Among other things, the FASB has tentatively decided that an entity that applies the practical expedient would not be required to determine whether the terms and conditions are legally enforceable. If no written terms and conditions exist, an entity would be required to apply ASC 842 on the basis of the legally enforceable terms of the arrangement.

The FASB is also expected to propose that all entities with leases between entities under common control, where there are leasehold improvements associated with such a lease, should account for the leasehold improvements by:

  • Amortizing the leasehold improvement over the economic life of the improvements as long as the lessee continues to use the underlying asset
  • If and when the lessee ceases use of the underlying asset, account for any remaining leasehold improvement as a transfer between entities under common control

Lessees would also be required to disclose information about leases for which the lease term exceeds the economic life of the leasehold improvements.

The expected proposed accounting standards update (ASU) will include transition guidance that would allow implementation either:

  • Prospectively to any lease that commences on or after the date of adoption of a 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 a final ASU.

The FASB plans to issue the proposed ASU in the fourth quarter of 2022, with a 45-day comment period.

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