A Closer Look at ASU 2023-01 Leases: Common Control Arrangements

Financial Accounting Standards Board (FASB) kicked off 2023 by issuing ASU 2023-01 Leases (Topic 842): Common Control Arrangements. This new guidance is intended to ease the application of lease accounting for entities under common control, providing clarity on key issues that emerged following the introduction of ASC 842, Leases.

Common control arrangements are quite prevalent, especially among private companies and non-profit entities. These setups usually involve multiple entities controlled by a single party - often unwritten and subject to change at the controller's discretion. The flexible nature of these arrangements posed significant challenges under the original lease accounting standard, ASC 842.

ASU 2023-01, effective for fiscal years beginning after December 15, 2023, addresses these challenges, focusing on two main areas: the consideration of terms and conditions, and the accounting for leasehold improvements.

Terms and Conditions

The ASU introduces a practical expedient for non-public entities. Rather than grappling with legally enforceable terms that may not exist in a written format or are subject to change, entities can now use the written terms and conditions of their common control arrangement to establish whether a lease exists and how to classify and account for it. This practical expedient can be applied on an arrangement-by-arrangement basis, which grants entities the flexibility to navigate their unique circumstances.

However, it's important to note that if no written terms and conditions exist, entities are still required to use the enforceable rights and obligations to determine whether a lease exists under ASC 842. Therefore, it is prudent for entities to document their common control arrangements wherever possible.

Leasehold Improvements

The second significant update concerns the life of leasehold improvements. Under ASC 842, leasehold improvements had to be amortized over the remaining lease term or the improvement's useful life, whichever was shorter. This often led to an inaccurate reflection of the economic reality, especially in common control leases where the lease term is often shorter than the economic life of the improvements.

In response, FASB has revised this guidance. Now, leasehold improvements associated with common control leases must be amortized over the useful life of the improvements to the common control group, provided the lessee controls the use of the underlying asset. If control is lost, the remaining balance of leasehold improvements is accounted for as a transfer between entities under common control through an adjustment to equity.

Notably, the ASU also requires lessees to disclose certain information when the useful life of leasehold improvements exceeds the related lease term. These disclosures include the unamortized balance of the improvements, the remaining useful life, and the remaining lease term.

While ASU 2023-01 represents a welcome relief for entities under common control, it also emphasizes the need for careful documentation and tracking of lease arrangements and related improvements. Entities should establish processes to monitor changes and ensure compliance with the new guidance.

As with any new standard, entities must understand its implications and take the necessary steps to ensure compliance. ASU 2023-01 provides much-needed clarity and eases the application of lease accounting for entities under common control.