The FASB has issued ASU 2023-01 (Topic 842): Common Control Arrangements. This ASU is an outcome of concerns expressed by private company stakeholders about the application of ASC 842 for common control arrangements identified during the FASB’s post-implementation review process.

Topic 842 requires related party arrangements between entities under common control to account for the lease similarly to unrelated parties. This includes analyzing the legally enforceable terms and conditions of the leasing arrangement, which can be difficult with common control leasing arrangements. To determine the legally enforceable terms, some private companies felt they would need to seek legal counsel to determine the terms and conditions even when the lease is in writing.

The ASU allows for private companies and not-for-profit entities that are not conduit bond obligors with common control leasing arrangements to elect a practical expedient in which the entity can elect to use the written terms and conditions of the common control leasing arrangement to determine whether a lease exists and the classification of that lease.

This practical expedient can be elected on an arrangement by arrangement basis and is only applicable to leases that are in writing. For any leases that are not in writing, entities should continue to analyze the legally enforceable terms and conditions. The entity is permitted to document any existing unwritten terms and conditions of the arrangements between common control entities before the financial statements are available to be issued.

Additionally, under Topic 842, leasehold improvements are required to be amortized over the shorter of the remaining lease term or the useful life of the leasehold improvements. Private company stakeholders noted that amortizing leasehold improvements associated with common control leases over a shorter period than the economic life of the leasehold improvements may result in financial reporting that does not faithfully represent the economics of those arrangements due to the propensity for common control leases to often be continually renewed over the duration of the common ownership arrangement. The guidance also does not address the recognition of the transfer of value between common control entities when the lessee no longer controls the underlying asset. These issues result in diversity in practice. All public and nonpublic entities with common control arrangements are required to apply the following:

1. Leasehold improvements obtained in connection with common control leasing arrangements must be amortized over the economic life of the leasehold improvements, regardless of the lease term as long as the lessee controls the underlying asset.
2. Transfers between common control entities for underlying assets that are no longer being controlled by the lessee should be transferred to the common control entity through an adjustment to equity.

This ASU is effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for both interim and annual financial statements that have not been made available for issuance. If an entity adopts the amendments in an interim period, it must adopt them as of the beginning of the fiscal year that includes the interim period.

For entities adopting the practical expedient in the ASU concurrently with ASC 842, the same transition requirements should be applied. For all other entities, they can elect to either apply prospectively to arrangements that commence or are modified on or after the date of the entity makes the election or retrospectively to the first period in which ASC 842 was first applied for arrangements that exist as of the date the practical expedient is elected.

For the application of accounting for leasehold improvements, the entity can elect to apply i) prospectively to all new leasehold improvements, ii) prospectively to all new and existing leasehold improvements with any remaining unamortized leasehold improvement balances amortized over the remaining economic life, or iii) retrospectively to the adoption date of ASC 842 with a cumulative-effect adjustment to the opening balance of retained earnings.

The full text of ASU 2023-01 can be found here.

Published: 3/28/2023

_{^{Readers should not act upon information presented without individual professional consultation.}}

_{^{Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.}}