FASB Updates ASC 842 Related-Party Lease Accounting Reporting Guidance

Last fall, the Financial Accounting Standards Board (FASB) recognized that implementing ASC 842 has been challenging for entities as it applies to leases under common control arrangements. Under ASC 842, entities determine whether a related-party arrangement between entities under common control is a lease, based on the legally enforceable terms and conditions.

On Monday, March 27, 2023 FASB passed ASU 2023-01 related to Common Control Arrangements which changes the way such arrangements are evaluated and accounted for in financial statements. Common control exists when the individual(s) making the decisions for the lessee and the lessor are under the control of one person or group. “Control” may be established through majority voting interest or indirectly by other means such as variable interest or contractual rights.

What Changed
The recent FASB guidance clarifies:

1. Private entities can look solely to written terms and conditions when considering legal enforceability in applying ASC 842 to arrangements between entities under common control.

ASC 842 requires entities to look at the “legally enforceable terms and conditions of the lease”. If the terms and conditions are not documented in writing, the new practical expedient would not apply. Therefore, when entities under common control have an unwritten agreement, a legal opinion may be needed in order to determine the legally enforceable terms.

To avoid needing a legal opinion as to enforceability of an unwritten lease when applying ASC 842 to common control leasing arrangements, document an agreement that is either month-to-month or cancelable by either party.

2. Leasehold improvements

Generally accepted accounting principles require that leasehold improvements be depreciated over the lesser of the economic life of the improvements or the remaining lease term. The changes related to leasehold improvements require leasehold improvements associated with related party leases between entities under common control to be amortized over the economic life of the improvements if the lessee controls the use of the leased asset. The guidance potentially allows for much longer depreciation periods for leasehold improvements under common control leasing arrangements.

Additionally, the clarifications provide guidance on how to account for the remaining book value of the leasehold improvements if the lessee gives up control of the underlying asset.

Next Steps
The update goes into effect for fiscal years beginning after December 15, 2023 with early application permitted. Overall, the new guidance will impact the financial reporting of entities that engage in common control leasing arrangements and changes may be needed in accounting processes and systems in order to comply with the new requirements. To review the details of the new guidance, the ASU is available at www.fasb.org, to view click here.

How KatzAbosch Can Help
Do you need help with ASC 842 implementation or have questions on how this new guidance may impact your business? Reach out your KatzAbosch advisor or contact us for more information.