On March 27, 2023, the Financial Accounting Standards Board (FASB) published narrowly drawn amendments to lease accounting rules that clarify issues that are relevant to rental agreements between businesses that have the same owner.
The provisions clarify that verbal leases must be put in writing in order to qualify for lease accounting rules and may assuage concerns some private companies had that they need to seek legal counsel to figure out if they have a lease. The rules around certain leasehold improvements have also changed for both public and private companies.
The changes aim to improve U.S. GAAP by removing differences in the way such agreements are reported. Companies will not incur significant costs to apply the guidance and the resulting information will better reflect the underlying economics of those transactions, the board said.
The provisions were issued as Accounting Standards Update (ASU) No. 2023-01, Leases(Topic 842) Common Control Arrangements, to clarify how related business entities that are controlled by the same owner are to approach: 1) determining whether a lease exists; and 2) accounting for leasehold improvements, i.e.upgrades such as painting, carpeting and other fixes that have been made to rented property.
The amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years, according to rule text.
Early adoption is permitted for both interim and annual financial statements that have not yet been made available for issuance. If a company adopts the amendments in an interim period, the company must adopt them as of the beginning of the fiscal year that includes that interim period.
ASU No.2023-01 is an amendment to Topic 842, Leases, which was issued in 2016 to require the full effect of companies' long-term lease obligations to be reported on the balance sheet. The standard took effect in 2019 for public companies; it took effect in 2022 for private companies, also running into this year's reporting period.
If a company decides to adopt the guidance this year concurrently with the adoption of Topic 842 the company would use the same transition approach as that standard, the text explains. If the rules are adopted in a subsequent period, then the company can do so either retrospectively or prospectively.
Leasehold Improvements & Practical Expedient
The amendments change a rule for public and private companies to require that leasehold improvement must be amortized over the useful life of those improvements to the common control group regardless of the lease term.
If and when that lessee no longer controls that underlying asset then the transfer of those improvements must be accounted for through equity or net asset. Those improvements remain subject to the impairment requirements of Topic 360, Property, Plant and Equipment Impairment Requirements, the ASU explains.
The provisions also provide an optional practical expedient to private companies that settles questions some raised about how to approach verbal leases and whether legal counsel is required to determine the terms and conditions of a lease. A practical expedient is an accounting workaround that allows a company to use a simpler route to get to the same final outcome.
The change clarifies that a private company electing the practical expedient must use the written terms and conditions of a common control arrangement to determine whether a lease exists and, if so, to classify and account for that lease.
The company is not required to determine whether written terms and conditions are enforceable when applying the practical expedient and may apply the practical expedient on an arrangement by-arrangement basis, according to rule text.
If the lease is verbal, the company must document the existing unwritten terms in order to apply lease accounting rules. The practical expedient is only applicable for written leases.
As always, please connect with us for additional guidance.