There have been many challenges in implementing the new ASC 842 Lease standard (Topic 842). One of those challenges has been the treatment of a lease with a related party under "common control."

On November 30, 2022, the Financial Accounting Standards Board (FASB) issued a Proposed Accounting Standards Update (ASU) regarding these common control lease arrangements. The FASB is gathering feedback regarding the proposed ASU through January 15, 2023 before finalizing their decision. The proposed changes are:

Issue 1: Terms and Conditions

Topic 842 as currently written requires entities to account for a related party lease based on legally enforceable terms and conditions (i.e., a documented, current, written lease agreement). That represents a change from the economic substance requirements in Topic 840, where a lease agreement could be considered significant even if it was not in writing or had previously expired but is still being honored. Stakeholders have indicated that Topic 842 treatment could require them to obtain a formal legal opinion in certain cases because they did not have a written agreement, or there had been no amendments or updates to old lease agreements. Given the common control nature of the arrangement, this could be considered challenging, unnecessary, and costly (even if the agreement was already in writing).

Proposal: Provides a practical expedient for a private company to use the written terms and conditions of a common control arrangement to determine:

1. Whether a lease exists and, if so,
2. The classification of and accounting for that lease.

The practical expedient may be applied on an arrangement-by-arrangement basis. If no written terms and conditions exist, an entity cannot apply the practical expedient and would continue to use the legally enforceable terms and conditions to apply Topic 842.

Issue 2: Accounting for Leasehold Improvements

Topic 842 as currently written 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, an approach that is generally consistent with legacy guidance. Lessees recognize leasehold improvements when they are the owner of those improvements. Private company stakeholders noted that amortizing leasehold improvements associated with a lease between related parties over a period shorter than the economic life of the improvements may result in financial reporting that does not faithfully represent the economic reality of those arrangements, particularly for leases with short lease terms.

Proposal: Requires that leasehold improvements associated with leases between entities under common control be:

1. Amortized by the lessee over the economic life of the leasehold improvements (regardless of the lease term) as long as the lessee controls the use of the underlying asset (the leased asset) through a lease.
2. Accounted for as a transfer between related parties through an adjustment to equity if, and when, the lessee no longer controls the use of the underlying asset.

The implementation of this proposed ASU would vary depending on whether or not the private company has already adopted ASC 842.

Please reach out to your accountant to discuss how this proposed ASU regarding common control lease arrangements might impact you and your financial statements for the current year.