FASB Amends ASC 842: New Lease Standards for Non-Public Entities
ARTICLE | April 07, 2023
Nicholas C. Courville, CPA, Audit Partner at Heard, McElroy & Vestal
The Financial Accounting Standards Board (FASB) recently issued Accounting Standards Update (ASU) 2023-01, which provides new guidance for non-public entities regarding lease accounting standards under Accounting Standards Codification (ASC) Topic 842, Leases. The update addresses related party leases and aims to reduce complexity and improve consistency in financial reporting.
ASC Topic 842 was initially released in February 2016 to increase transparency and comparability in financial reporting related to leasing activities. The most significant change by ASC 842 was the requirement for lessees to capitalize all leases longer than 12 months, recognizing a right-of-use asset and a lease liability on the balance sheet.
While ASC 842 has already been effective for public entities, non-public entities had to adopt the new lease standard for periods beginning after December 15, 2021. Unfortunately, the original guidance under ASC 842 did not provide substantial clarity on related party leases, leading non-public entities to face challenges in adopting the standard. ASU 2023-01 addresses this issue and provides additional guidance for non-public entities.
Key Provisions of ASU 2023-01
Terms and Conditions to be considered
Under the amended ASC 842, private companies and not-for-profit organizations that are not conduit bond obligors are provided with a practical expedient to use the written terms and conditions of a common control arrangement to determine whether a lease exists and, if so, the classification of and accounting for that lease. This practical expedient is aimed at reducing the challenges faced by private companies in determining the enforceable terms and conditions of a common control arrangement, which often requires obtaining a formal legal opinion. The practical expedient is available for each arrangement separately and does not apply when there are no written terms and conditions for the lease between entities under common control.
Accounting for Leasehold Improvements
ASU 2023-01 also addresses the treatment of leasehold improvements under common control leases. Under ASC 842, leasehold improvements are amortized over the shorter of the remaining lease term or the useful life of the improvements. This requirement has led to challenges in cases where the lease term is shorter than the economic life of the improvements, as it may not accurately represent the economics of the arrangement.
The new standard requires that leasehold improvements associated with common control leases be amortized over the useful life of the improvements, as long as the lessee controls the use of the leased asset. However, if the lessor obtained the right to control the use of the underlying asset through a lease with a third-party, the amortization period of the leasehold improvements may not exceed the term of the third-party lease.
Effective Date and Transition Requirements
ASU 2023-01 will be effective for fiscal periods beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for financial statements not yet made available for issuance.
The changes introduced by the ASU are expected to significantly impact non-public entities that engage in common control leasing arrangements. The practical expedient for determining terms and conditions is expected to reduce implementation and application costs for these organizations. At the same time, the amended leasehold improvement accounting guidance will help entities better represent the economics of their transactions.
Non-public entities should review their existing leasing arrangements and update their accounting processes and systems accordingly. Early adoption of the amendments is permitted, allowing organizations to prepare for the changes before the effective date.
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