By Jennifer Miloszewski, CPA, Director at Blue & Co.
Time is running out for privately-held companies to adopt the infamous new lease standard. Effective for year-end December 31, 2022, Accounting Standards Update (ASU) 2016-02, Leases, (codified as ASC 842), the standard requires lessees to recognize substantially all leases on their balance sheets as lease liabilities with a corresponding right-of-use (ROU) asset.
The lease standard also applies to related-party leases, and as currently written, provides a relatively difficult and exhaustive analysis to be done of such leases. This is due to concerns that they are not arm’s length transactions and/or may not be evidenced by a written lease agreement.
Specifically, ASC 842 requires related-party leases to be accounted for based on the arrangement’s legally enforceable terms and conditions.
However, on November 30, 2022, in response to concerns about applying ASC 842 to arrangements between entities under common control, the Financial Accounting Standards Board (FASB) issued an exposure draft that addresses the existence and classification of such lease arrangements.
The amendments in the exposure draft would allow certain non-public entities with common control leasing arrangements to elect a practical expedient that provides for the ability to:
- Rely on the written terms and conditions of the leasing arrangement to determine the existence of a lease and related classification as finance or operating.
- Amortize leasehold improvements that relate to property that is the subject of a common control leasing arrangement over their estimated economic life, even if the underlying lease term is less.
- Transfer assets no longer controlled by the lessee to the lessor entity, related through common control, by means of an equity adjustment.
The above practical expedient is available for leases that are in writing. Leases that are not in writing will need to follow the original guidance in ASC 842 and consider the legally enforceable terms and conditions.
The comment period on the exposure draft ends January 16, 2023, and the effective date will then be determined based on the feedback received during the comment period.
We strongly advise that entities that have lease arrangements with an entity under common control ensure that such arrangements are documented in a written agreement, or an amendment that is executed prior to December 31, 2022.
While an assessment of leasing arrangements will be necessary as of the January 1, 2022 implementation date – so perhaps prior to the execution of a written agreement – having such a written agreement in place by year-end will allow an entity to elect the aforementioned practical expedient, should the exposure draft be codified.
If you have questions on the exposure draft, how to get started with adopting the new lease standard, or what ASC 842 means for your business, please check out our Lease Standard resources, and/or contact a Blue & Co. advisor today.