Accounting Standards Update: Leases (Topic 842): Common Control Arrangements
The Financial Accounting Standards Board has issued the first Accounting Standards Update (ASU) of 2023, ASU No. 2023-01, Leases (Topic 842): Common Control Arrangements. The full text of the ASU is available here.
ASU No. 2023-01 addresses two concerns related to leasing arrangements between entities under common control that have come up during the implementation of ASC 842, Leases.
- The ASU creates a practical expedient available for agreements between entities under common control where, when examining agreements, the written terms and conditions of the agreement can be used to determine whether a lease exists, and those written terms can be used to account for and classify the lease.
This is different than the original requirement of ASC 842 which requires entities to consider legally enforceable terms and conditions, often involving factors beyond just the written agreement itself. At times, legal enforceability can be a complex and judgmental determination.
The practical expedient may be applied on an arrangement-by-arrangement basis. The requirement to determine enforceable terms and conditions remains in place for all other leasing arrangements and the practical expedient can only be applied to written agreements, not verbal ones.
- The ASU requires that leasehold improvements associated with leases between entities under common control be amortized over their useful life as long as the lessee controls the use of the underlying asset through a lease.
This is a change from the original requirement (which still applies to all other leasing arrangements) that leasehold improvements are amortized over the shorter of the remaining lease term and useful life of the improvements. This change was enacted to address the fact that many leases between entities under common control have terms that are shorter in nature than the actual useful life of leasehold improvements and amortizing those improvements over the short lease term did not reflect their true value. If, and when, the lessee no longer controls the use of the underlying asset, a transfer will be recorded between the entities under common control as an adjustment to equity, or net assets for not-for-profit entities.
Both amendments only apply to arrangements between entities under common control. Not all related parties are entities under common control.
Effective Date and Transition
ASU No. 2023-01 is effective for fiscal years beginning after Dec. 15, 2023, including interim periods within those fiscal years but can be early adopted for financial statements that have not yet been made available for issuance.
The practical expedient (#1 above) is only available to entities that are nonpublic business entities and not-for-profit entities that are not conduit bond obligors. It can only be applied to arrangements that are between entities under common control.
If not adopted concurrently with the other requirements of ASC 842, entities can elect to apply the practical expedient in ASU No. 2023-01 either prospectively to arrangements that commence or are modified on or after the date the entity first applies the practical expedient or retrospectively to the beginning of the period in which the entity adopted ASC 842. However, the practical expedient may not be applied to any common control arrangements no longer in place upon the adoption of the practical expedient.
The practical expedient explicitly allows an entity to document any existing unwritten terms and conditions of a common control arrangement prior to the date financial statements are available to be used using the practical expedient, regardless of the transition method selected.
The amendment for leasehold improvements (#2 above) applies to all entities and affects all lessees that are party to a lease between entities under common control where there are leasehold improvements.
Entities adopting the amendment for leasehold improvements at the same time as the other requirements of ASC 842 may use either the same transition requirements otherwise used to apply ASC 842 or may use one of the prospective options, described below.
Entities adopting the amendment for leasehold improvements subsequent to the initial adoption of ASC 842 may select one of the following methods:
- Prospectively to all new leasehold improvements recognized on or after adoption
- Prospectively to all new and existing leasehold improvements at the date of adoption, with any remaining unamortized balance of existing improvements amortized over their remaining useful life
- Retrospectively to the beginning of the period in which the entity initially applied ASC 842, with any differences recognized through a cumulative-effect adjustment to the opening balance of retained earnings at the earliest period presented under ASC 842
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