March 30, 2023
FASB Issues Welcome Amendments to Accounting for Common Control Leases
On March 27, 2023, the Financial Accounting Standards Board (FASB) issued clarifying lease accounting guidance for leases between related parties under common control. The amendments in ASU 2023-01, Leases (Topic 842) – Common Control Arrangements address the following:
- Provide a practical expedient for non-public companies and nonprofit organizations to use the terms and conditions of the lease agreement to determine when a lease exists and how to account for it when the lease agreement is between entities under common control, and
- Require capitalized leasehold improvements associated with leases between entities under common control to be amortized over the estimated useful life to the common control group, subject to certain limitations.
Written Terms and Conditions Practical Expedient
Before the practical expedient, entities were required to determine whether a related party arrangement was a lease and, if so, classify and account for the lease under the same terms and conditions as if it was a lease with an unrelated party. Entities had to determine which terms and conditions were legally enforceable, placing an unnecessary burden on these entities as the determination could require legal consultation.
Under the practical expedient, privately-held companies and nonprofit organizations with leases between related parties under common control can use the written terms and conditions of the agreement to:
- Determine whether a lease exists, and
- Determine the classification and accounting for that lease.
The practical expedient can be applied on an arrangement-by-arrangement basis.
If the lease terms and conditions are not written, the practical expedient cannot be applied. However, the entity can document existing unwritten terms and conditions of a common control arrangement before the date of the financial statements in accordance with the practical expedient.
Accounting for Leasehold Improvements
Before the update, a lessee amortized leasehold improvements for leases between entities under common control over the shorter of the remaining lease term or the useful life of the leasehold improvement. This methodology did not reliably represent the economics of the leasehold improvements, especially for common control leases with short terms.
Under the revised guidance, leasehold improvements are accounted for by all entities (public companies, private companies and nonprofit organizations) as follows:
- The lessee in a common control lease arrangement will amortize leasehold improvements over the economic life of the improvements as long as the lessee controls the use of the underlying asset. However, if the related party lessor obtained control of that asset from another lease with an unrelated party, the amortization period may not exceed the lessor’s lease term with the unrelated party.
- When the lessee can no longer control the use of the underlying asset, the transfer of control back to the related party lessor is accounted for through an adjustment to equity (net assets for nonprofit entities).
ASU 2023-01 is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. The guidance can be adopted prospectively or retrospectively to the beginning of the period in which the entity first applies Topic 842, Leases.