Defining Issues | September 2022
Insight
The project would change how ASC 842 applies to common control lease arrangements and related leasehold improvements.
At a September 2022 meeting, the FASB added a new project to its technical agenda and reached tentative decisions about how (1) private entities should apply ASC 842 to common control lease arrangements; and (2) all entities should account for leasehold improvements in common control leases. We summarize the Board’s tentative decisions and what lies ahead below.
Applicability
- All private entities (i.e. private companies and private not-for-profit entities) with common control arrangements that may contain or be leases
- All entities (public or private) with leasehold improvements related to common control leases
Relevant dates
- On September 21, 2022, the FASB:
- added a project to its technical agenda on (1) applying ASC 842 to arrangements between entities under common control, and (2) accounting for leasehold improvements that relate to common control leases; and
- reached tentative decisions.
Project overview
Background
Under ASC 842, related party leases (including those between parties under common control) are classified, recognized and measured based on the legally enforceable terms and conditions of the arrangement, as opposed to the economic substance of the arrangement. However, identifying the enforceable rights and obligations in an arrangement between parties under common control may be difficult because of its related-party nature.
There are presently diverse views about the extent to which entities must look for legally enforceable rights and obligations outside of any written terms and conditions, or consider the legal enforceability of any written terms (e.g. whether legal counsel must be involved).
Objective
To clarify (1) whether, and if so when, private entities must look beyond the legally enforceable rights and obligations when applying ASC 842 to arrangements between entities under common control; and (2) how lessees (public or private entities) should account for leasehold improvements related to common control leases.
Project decisions
The following reflects the Board’s tentative decisions to date. As a next step, the FASB staff will draft a proposed ASU for Board vote by written ballot. If approved, the proposed ASU will be exposed for a 45-day public comment period.
Identifying terms and conditions (applicable to private entities only)
- If there are written terms and conditions between the entities under common control, they would be permitted (but not required) to not look beyond those written terms and conditions, or consider their legal enforceability, in applying ASC 842.
- If there are no written terms and conditions, those entities would then consider whether legally enforceable terms and conditions otherwise exist. If so, they would consider those terms and conditions in applying ASC 842.
Leasehold improvements (applicable to all entities)
- A lessee in a common control lease arrangement would amortize related leasehold improvements over their estimated economic life, regardless of the ASC 842 lease term.
- If the lessee ceases using the underlying asset before the end of the improvements’ economic life, it will treat those improvements as having been transferred to the lessor for accounting purposes.
- A lessee should disclose information about leasehold improvements with an economic life longer than their related ASC 842 lease term
Transition and effective date
- Entities would have the option to adopt any final amendments related to identifying terms and conditions either (1) retrospectively to the beginning of the earliest period of ASC 842 application for all arrangements existing at the amendments’ effective date (the amendments would not apply to arrangements no longer in place at that date); or (2) prospectively to arrangements that commence on or after the date the entity adopts the amendments. Entities may document any previously unwritten terms and conditions of an arrangement between entities under common control before they adopt the amendments.
- Entities would have the same two options to adopt any final amendments on leasehold improvements, along with a third option to prospectively amortize leasehold improvements that relate to leases that exist or commence on or after the entity’s adoption date over their remaining economic life.
- The effective date of any final amendments will be decided later.
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