FASB Issues Guidance on Common Control Leases
April 24, 2023
The Financial Accounting Standards Board has issued Accounting Standards Update 2023-01 - Leases (Topic 842): Common Control Arrangements. The update provides a practical expedient for private companies and not-for-profit entities that are not conduit bond obligors when assessing the existence and classification of a lease in accordance with Accounting Standards Codification 842 when assessing leasing arrangements between entities under common control. The update also provides clarification on the accounting for leasehold improvements in common control situations. The specific provisions of the update are as follows:
Issue 1: Terms and Conditions to be Considered
Prior to the update, ASC 842 required that common control arrangements be assessed to determine if the arrangement is a lease, and to classify the lease on the basis of legally enforceable terms and conditions. The implementation of these provisions was determined to be difficult and costly in certain situations because determining the enforceable terms and conditions in common control arrangements could result in the need for a formal legal opinion. The update allows private companies and not-for-profit entities that are not conduit bond obligors to use the written terms and conditions of the common control arrangement to determine whether a lease exists and, if so, the classification of and accounting for that lease.
Issue 2: Accounting for Leasehold Improvements
Prior to the update, ASC 842 generally required that leasehold improvements have an amortization period consistent with the shorter of the remaining lease term and the useful life of the improvements. It was determined that this guidance could cause accounting that did not represent the underlying economics of the arrangement in certain situations, as well as diversity in practice within the application of the guidance. The update requires that leasehold improvements associated with common control leases generally be amortized by the lessee over the useful life of the improvements to the common control group unless the lessor in the arrangement obtained the right to control the underlying asset through a lease with an unrelated entity. In that case, the amortization period may not exceed the amortization period of the common control group. The update also requires leasehold improvements to be accounted for as a transfer between entities under common control through an adjustment to equity at the point in time that the lessee no longer controls the use of the underlying asset.
The amendments are effective for fiscal years beginning after December 31, 2023 including interim periods within those years with early adoption permitted.
Issue 1: Terms and Conditions to be Considered
Prior to the update, ASC 842 required that common control arrangements be assessed to determine if the arrangement is a lease, and to classify the lease on the basis of legally enforceable terms and conditions. The implementation of these provisions was determined to be difficult and costly in certain situations because determining the enforceable terms and conditions in common control arrangements could result in the need for a formal legal opinion. The update allows private companies and not-for-profit entities that are not conduit bond obligors to use the written terms and conditions of the common control arrangement to determine whether a lease exists and, if so, the classification of and accounting for that lease.
Issue 2: Accounting for Leasehold Improvements
Prior to the update, ASC 842 generally required that leasehold improvements have an amortization period consistent with the shorter of the remaining lease term and the useful life of the improvements. It was determined that this guidance could cause accounting that did not represent the underlying economics of the arrangement in certain situations, as well as diversity in practice within the application of the guidance. The update requires that leasehold improvements associated with common control leases generally be amortized by the lessee over the useful life of the improvements to the common control group unless the lessor in the arrangement obtained the right to control the underlying asset through a lease with an unrelated entity. In that case, the amortization period may not exceed the amortization period of the common control group. The update also requires leasehold improvements to be accounted for as a transfer between entities under common control through an adjustment to equity at the point in time that the lessee no longer controls the use of the underlying asset.
The amendments are effective for fiscal years beginning after December 31, 2023 including interim periods within those years with early adoption permitted.
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