Proposed Amendments to Guidance on Common-Control Lease Arrangements

The Financial Accounting Standards Board issued a proposed accounting standards update (ASU) that would change some provisions of ASC 842 applicable to arrangements between related parties under common control. Comments on the proposed ASU are due by mid-January. The proposed amendments apply to the following key issues.

Practical expedient to assess the written terms and conditions of common-control arrangements

Feedback from private companies stated that the ASC 842 requirement obligating entities to determine whether a related-party arrangement between common-control entities is a lease on the basis of the legally enforceable terms and conditions of the arrangement creates unnecessary cost and complexity for financial statement preparers at times, even requiring legal counsel. The concept of legal enforceability applies regardless of whether the rights or obligations are included in the written contract.

In response, the FASB voted unanimously to give private companies and non-profit entities (that are not conduit bond obligors) a “shortcut” to use the written terms and conditions of an arrangement between entities under common control to determine whether a lease exists and the subsequent accounting (including classification) of the lease.

The practical expedient can be applied on an individual arrangement basis, and an entity would not be required to consider legal enforceability of written terms and conditions so long as those written terms and conditions between entities under common control exist. Otherwise, the entity would not be allowed to utilize the practical expedient and would be required to apply ASC 842 in a manner consistent with how it applies to other arrangements.

The application of the practical expedient is limited only to private companies and nonprofits that are not conduit bond obligors because this issue has not been of concern for public companies that have already adopted ASC 842.

Accounting for leasehold improvements in common-control arrangements

The requirement for a lessee to amortize leasehold improvements that it owns over the shorter of the useful life of those improvements or the lease term has been met with criticism from stakeholders stating that leasehold improvements associated with leases between common-control entities are economically different from those between entities that are not.

In lease arrangements between entities not under common control, leasehold improvements made by the lessee can either be for their own benefit or the benefit of the lessor. Leasehold improvements made under leases between common-control entities are expected to benefit the parties under the common-control arrangement.

To be more specific, private company stakeholders have stated that applying the amortization requirements of ASC 842 to leases between entities under common control would be inconsistent with the underlying economics of the arrangement because, the lessee will continue to control the use of the underlying asset after the lease term or, another party in the common-control group may benefit from the leasehold improvements after the lessee no longer controls the use of the underlying asset.

In response, FASB has voted to require a lessee in a common-control arrangement to amortize leasehold improvements that it owns over the economic life of those improvements, regardless of the lease term, if it continues to control the use of the underlying asset through a lease.

In select situations where a lessee obtains control of an underlying asset through a lease with an unrelated party not under common control and leases the asset to an entity under common control, the sublessee must amortize the leasehold improvements over a period that does not exceed the term of the lease between the lessee/intermediate lessor and the unrelated party. Further, a lessee that no longer controls the use of the underlying asset will account for the transfer of the asset as an adjustment to equity (i.e., as with a transfer of assets between entities under common control).

The leasehold improvements amendment applies to all entities despite only receiving feedback from private companies on the first issue. It is believed that all entities are currently applying multiple methods to account for leasehold improvements in leases between common-control entities. By requiring both private and public entities to follow the leasehold improvement rules, it will provide much-needed consistency.

Assistance with transition

Practical expedient

Entities that fail to adopt ASC 842 before the effective date of a final ASU would apply the transition requirements from ASU 2016-02. Entities that have adopted ASC 842 before the effected date of the final ASU would have the option to apply the amendments in one of the following ways:

• Prospectively to arrangements that begin or are modified on or after when the entity first applies the ASU.
• Retrospectively to the beginning period in which an entity applied ASC 842 for arrangements that existed as of the adoption date of the final ASU.

Leasehold improvements

Entities that fail to adopt ASC 842 before the effective date of a final ASU would apply the transition requirements from ASU 2016-02.

However, entities that elect to retrospectively apply ASU 2016-02 would be allowed to apply its amendments prospectively by using either of the following approaches.

Entities that have adopted ASC 842 before the effective date of a final ASU would have the option to use one of these adoption methods:

• Prospectively to all new leasehold improvements recognized on or after the date the entity first applies the amendments in the final ASU.
• Prospectively to all new and existing leasehold improvements recognized on or after the date that the entity first applies the amendments in the final ASU, with any remaining balance of improvements amortized over their remaining economic life determined as of that date.
• Retrospectively to the beginning of the period in which an entity applied ASC 842 for leasehold improvements that exist as of the date of adoption of a final ASU, with any leasehold improvements that otherwise would not have been amortized recognized through a cumulative-effect adjustment to opening retained earnings at the beginning of the fiscal year of adoption.

Transitioning to new lease accounting standards

The transition to the new lease accounting standards has been a monumental task and it is easy to become overwhelmed with all of the rules and requirements on top of any amendments that are made.

By now your business should be at least in the early stages of a transition to these new standards to ensure compliance. Our audit practice has been assisting clients with the transition to the new standard and continues to follow any developments.

We’ve taken it a step further to facilitate a smooth transition by partnering with LeaseCrunch to expedite the transition process and alleviate some of the stress that comes with such a massive procedural change. Through the early stages of partnership, we have seen faster implementation, less time spent on acclimation and training, greater accuracy, and a reduced total cost of ownership.