By Jordan Miller, CPA, Senior Manager at Blue & Co.
The Financial Accounting Standards Board (FASB) recently issued Accounting Standards Update (ASU) 2023-01 to address challenges faced by private companies and not-for-profit entities when applying ASC 842 (the lease accounting standard) to related party arrangements under common control. For manufacturers—many of whom operate through complex, interrelated corporate structures—these updates offer clarity and flexibility in lease accounting, particularly for facilities, equipment, and other assets commonly leased between related entities.
Here’s a breakdown of what manufacturers need to know:
Key Updates in ASU 2023-01
The amendments address two main issues:
- Practical Expedient for Related Party Arrangements
Manufacturers can now elect to use the written terms and conditions of related party arrangements to:
- Determine whether the arrangement is a lease.
- Classify and account for the lease.
- Leasehold Improvements for Common Control Leases
The new rules clarify how to account for leasehold improvements, reducing diversity in practice and providing more economically faithful reporting.
Both updates are effective for fiscal years beginning after December 15, 2023, with early adoption permitted.
Issue 1: Using Written Terms for Common Control Arrangements
Why This Matters for Manufacturers:
Manufacturers often lease property or equipment (e.g., warehouses, machinery) between commonly controlled entities. Prior to this update, determining the legally enforceable terms of these arrangements was costly and often required formal legal opinions. The new practical expedient allows manufacturers to rely on written terms and conditions to identify and account for leases. Key takeaways include:
- Written terms must convey the practical right to control the asset in exchange for consideration.
- If no written agreement exists, entities must fall back on enforceable terms, which can be more complex to assess.
Action for Manufacturers:
Document all related party lease agreements in writing to ensure eligibility for this practical expedient. This can simplify compliance and reduce administrative burdens when applying ASC 842.
Issue 2: Accounting for Leasehold Improvements
Why This Matters for Manufacturers:
Manufacturers frequently make significant investments in leasehold improvements, such as retrofitting facilities or installing specialized equipment. Under current GAAP, these improvements are amortized over the shorter of the lease term or the improvement’s useful life. This can create challenges for common control leases, which often have short terms despite long-lived improvements. The new rules address this issue by allowing:
- Amortization of improvements over their useful life of the leasehold improvements (as long as the lessee controls the leased asset).
- Adjustments to equity if the lessee no longer controls the asset.
Example for Manufacturers:
If a manufacturer leases a facility under a one-year renewable lease but installs a new lighting system with a 10-year useful life, these leasehold improvements can now be amortized over 10 years rather than one, better aligning with economic reality.
How Does This Impact You?
For manufacturing companies, these updates provide:
- Simplified lease evaluation for common control arrangements, reducing compliance costs.
- More accurate financial reporting for long-term leasehold improvements, especially in situations with short-term leases.
The changes also improve transparency for stakeholders, such as investors and lenders, who rely on accurate financial statements to evaluate the economics of related party transactions.
Next Steps
- Review Related Party Leases: Ensure all arrangements are documented in writing to take advantage of the practical expedient.
- Reassess Leasehold Improvements: Work with your accounting team to evaluate the useful lives of leasehold improvements under the new rules.
- Plan for Transition: Understand how these changes impact your financial statements for fiscal years starting after December 15, 2023.
If you have questions about implementing these updates, the transition requirements, or how ASC 842 impacts your manufacturing business, reach out to your Blue & Co. advisor today.
