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FASB Issues New Guidance on Certain Related Party Lease Accounting

September 26, 2023

Attention businesses...the Financial Accounting Standards Board (FASB) has updated the accounting for common control leases and leasehold improvements associated with those leases. Here’s what you need to know.

Are you up to speed on ASC 842 and your lease accounting requirements? The FASB has recently issued guidance on accounting for lease arrangements between entities under common control. The new guidance eliminates confusion about accounting for such leases. Here are the details.

Why was the Guidance Needed?

The FASB recognized that implementing ASC 842 has been challenging for entities with lease arrangements between parties under common control (a type of related party arrangement). In response, they recently approved ASU 2023-01, an amendment of ASC 842. While the new guidance provides welcome relief for many private entities, it also creates some challenges you should be aware of.

What Changed?

The following are the key changes affecting leasing arrangements between parties under common control:

  • Provides a written terms and conditions practical expedient (PE)

Essentially, this update clarifies when private entities can rely exclusively on written terms and conditions to determine if a lease exists in common control arrangements without considering legal enforceability.

  • Modifies the accounting for leasehold improvements (LHI)

What Are the Details?

Written Terms and Conditions PE

If a business elects the written terms and conditions PE, the written terms and conditions of the lease can be used to determine the following for a leasing arrangement between entities under common control:

  • Whether a lease exists
  • Classification and accounting for that lease

This PE can be applied on an arrangement-by-arrangement basis and, if elected, the legal enforceability of the arrangement does not need to be considered. However, if no written terms and conditions exist, the PE cannot be applied. The new guidance does provide a one-time exception to this rule: If no written terms and conditions exist at the time this PE is elected, any existing unwritten terms and conditions can be documented in writing before the date the financial statements are available to be issued.

Here are some things to consider when deciding whether to elect this PE:

  • Some businesses might consider structuring a lease as a month-to-month lease to enable use of the short-term lease exception and avoid recording the lease on the balance sheet. In order to use both this PE and the short-term lease exception, the written terms of the lease would need to be regularly maintained and exclude any renewal options controlled by the lessee.

Leasehold Improvements

LHI should be accounted for as follows:

  • Amortized over the useful life of the LHI to the common control group (regardless of the lease term) as long as the lessee controls the use of the underlying leased asset
  • If the lessee no longer controls the use of the underlying asset, any remaining LHI is accounted for as a transfer between entities under common control

LHI are those improvements made by the lessee when the lessee is determined to be the accounting owner. The following are factors to consider when evaluating who the accounting owner is:

  • What happens to the LHI at the end of the lease term?
  • Are the improvements unique/custom?
  • Which party is supervising construction?
  • Which party owns the improvements?
  • Which party bears all costs of the improvements?
  • How does the economic life of the LHI compare to the lease term?

What Can Your Business Do Now to Prepare?

Evaluate your business’s leases with entities under common control. Are the terms of those leases in writing? If not, consider whether putting the terms in writing and electing the PE provided by this new guidance would be advantageous to the business. If there are any LHI related to common control leases, be sure to amortize those LHI in accordance with this new guidance once it is adopted.

When is it Effective?

Early adoption is permitted, but it is effective for all businesses for fiscal years beginning after December 15, 2023.

How to Adopt?

Businesses can adopt the new rules either prospectively or retrospectively.

Questions? Need help assessing how this will impact your business? We can help.

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