The Financial Accounting Standards Board (FASB) has issued a proposed Accounting Standards Update (ASU), Leases (Topic 842) – Common Control Arrangements, (proposed ASU), to address private company stakeholder concerns about applying ASU No. 2016-02, Leases (Topic 842), to related party arrangements between entities under common control, which has resulted in diversity in practice. The proposed ASU is out for comment until January 16, 2023.
The first issue addressed in the proposed ASU relates to the terms and conditions of a lease arrangement. 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. Through the post-implementation review process, it was highlighted that these requirements are difficult to apply to common control arrangements for private companies as it was often difficult to determine the legally enforceable terms and conditions. The proposed ASU would provide a practical expedient for private companies and not-for-profit entities that are not conduit bond obligors to use the written terms and conditions for a common control arrangement to determine whether a lease exists, and if so, the classification and accounting for that lease. The expedient could be used on an arrangement-by-arrangement basis. If no written terms and conditions exist, an entity would not be able to apply the expedient and would continue to use the legally enforceable terms and conditions to apply Topic 842. The expedient would not be available to public business entities, not-for-profit conduit bond obligors or employee benefit plans that file or furnish financial statements with or to the SEC.
The second topic addressed in the proposed ASU relates to accounting for leasehold improvements. Topic 842 requires that leasehold improvements recognized by a lessee be amortized over the shorter of the remaining lease term or the useful life of the improvements. Through the post-implementation review process, it was highlighted by private company stakeholders that amortizing the leasehold improvements associated with leases between entities under common control over a shorter period of time than the economic life of the improvements did not necessarily represent the economics of the arrangement, in particular when the lease is short-term. It was also noted that such accounting fails to recognize the transfer of value between entities under common control when the lessee no longer controls the use of the underlying asset. The proposed ASU would require that leasehold improvements associated with leases between entities under common control be amortized over the economic life of the leasehold improvements, regardless of the lease term but as long as the underlying asset is controlled by the lessee through a lease. When the lessee no longer controls use of the underlying asset, the transaction 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 proposed ASU would also clarify that the leasehold improvements would be subject to impairment guidance in Topic 360, Property, Plant, and Equipment.
The proposed ASU also sets out the transition requirements and explains that an effective date will be determined once the feedback from the consultation has been considered.
