FASB Topic 842 changes help simplify common control lease accounting
The Financial Accounting Standards Board (FASB) has recently issued Accounting Standards Update (ASU) 2023-01 to amend certain provisions in its lease accounting guidance and help simplify accounting for common control leases.
The amendments are intended to address two separate issues that may arise in common control lease accounting. They are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is also permitted.
Here is what your organization should know about these changes:
Requirements of the new lease accounting standard
The new lease accounting standard, Topic 842, requires you to determine whether your arrangements — including those with related parties or entities under common control — are or contain a lease as defined within Topic 842. For arrangements that fall within the scope of the lease accounting standard, you must account for the lease based on the legally enforceable terms and conditions of the arrangement.
While certain arrangements clearly define the legally enforceable terms and conditions, others may not be as direct.
This is particularly true when the arrangement is between related parties or entities under common control, and especially if the arrangement is in a verbal or otherwise unwritten form. Because of this, many entities have wrestled with the determination of legally enforceable terms in these arrangements as part of their adoption of Topic 842.
ASU 2023-01 practical expedient
ASU 2023-01 simplifies the analysis of the legally enforceable terms and conditions for arrangements between entities under common control. It allows you to elect a practical expedient to use the written terms and conditions as the legally enforceable terms and conditions.
When applying the practical expedient, you would not need to look beyond the paper to evaluate whether other factors indicate that other terms and conditions exist. If no written terms and conditions exist, you would still need to evaluate and determine what is legally enforceable, including unwritten terms and other factors.
The practical expedient is available only to entities that are not public business entities, not-for-profit bond obligors or employee benefit plans that file financial statements with the Securities and Exchange Commission. It can also be applied by an entity on an arrangement-by-arrangement basis.
You’re permitted to document existing unwritten terms and conditions of an arrangement under common control prior to when your financial statements are available to be issued in accordance with the ASU.
If you haven’t issued financial statements under Topic 842 yet, you can adopt the practical expedient in the same period you adopt Topic 842 and follow the same transition guidance.
For entities that have already adopted Topic 842, the practical expedient can be adopted:
- Prospectively, to leases that commence on or after the date of adoption of the ASU
- Retrospectively, to the beginning of the earliest period presented for arrangements that existed at the original Topic 842 adoption date
Leasehold improvements accounting
Topic 842, like the predecessor guidance in Topic 840, requires a lessee to amortize its leasehold improvements over the shorter of the remaining lease term or the useful life of the improvements.
Under the original guidance, if you have determined the legally enforceable lease term is short-term in nature — for example, a month-to-month lease or a one-year lease — it would be considered less than the useful life of improvements. Therefore, you would need to amortize the entire leasehold improvement balance over the shortened period.
ASU 2023-01 changes this guidance with respect to leasehold improvements associated with leases between entities under common control.
The ASU requires leasehold improvements in a common control lease to be amortized over the useful life of the leasehold improvements if the lessee controls the use of the underlying asset. Once the lessee no longer controls the underlying asset, the remaining unamortized balance would be accounted for as a transfer between entities under common control. It should be recorded as an adjustment through equity for for-profit entities or net assets for not-for-profit entities.
This accounting treatment is not limited to private companies and not-for-profit entities. It applies to all entities with leasehold improvements associated with leases between entities under common control.
In addition to the accounting change, lessees in such arrangements would be required to disclose information about leases in which the useful life of any leasehold improvements is being amortized over a period longer than the lease term.
If you haven’t issued financial statements under Topic 842 yet, you can adopt the ASU in the same period you adopt Topic 842 and follow the same transition guidance.
If you’ve already adopted Topic 842, the practical expedient can be adopted:
- Prospectively, to all new leasehold improvements recognized on or after the date of adoption of the ASU
- Prospectively, to all new and existing leasehold improvements recognized on or after the date of adoption of the ASU, with any remaining unamortized balance of existing leasehold improvements amortized over their remaining useful life determined at that date
- Retrospectively, to the beginning of the earliest period presented for arrangements that existed at the original Topic 842 adoption date, with a cumulative-effect adjustment through the opening balance of retained earnings
How Wipfli can help
While Topic 842 was originally issued in 2016, new amendments will continue to impact your lease accounting.
Wipfli can help you stay updated on important regulatory changes so that your organization can adapt quickly. If you have questions about implementing ASC 842 or how the recent amendment will impact your organization, contact us today.
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