13.2 Related-Party Leases

ASC 842-10

55-12 Leases between related parties should be classified in accordance with the lease classification criteria applicable to all other leases on the basis of the legally enforceable terms and conditions of the lease. In the separate financial statements of the related parties, the classification and accounting for the leases should be the same as for leases between unrelated parties.

Pending Content (Transition Guidance: ASC 842-10-65-7)

55-12 Except for leases between entities under common control accounted for in accordance with the practical expedient in paragraph 842-10-15-3A, leases between related parties should be classified in accordance with the lease classification criteria applicable to all other leases on the basis of the legally enforceable terms and conditions of the lease. Additionally, except for leases between entities under common control accounted for in accordance with paragraph 842-10-15-3A, the classification and accounting for the leases should be the same as for leases between unrelated parties in the separate financial statements of the related parties.

Related parties often enter into lease arrangements for tax structuring or other reasons. Under ASC 842, an entity should classify a lease with a related party on the basis of the legally enforceable terms and conditions of the contract rather than the substance of the arrangement (see Section 8.3.5.2 for additional discussion of a lessee’s classification of related-party leases). That is, a lease between related parties should be accounted for in a manner similar to a lease between unrelated parties.

Changing Lanes

Form Over Substance

Unlike ASC 842, ASC 840 required entities to consider the substance of the contract when classifying and accounting for a related-party lease. Specifically, the guidance in ASC 840-10-25 stated:

Except as noted in the following sentence, leases between related parties (see paragraph 840-10-55-27) shall be classified in accordance with the lease classification criteria in paragraphs 840-10-25-1, 840-10-25-31, and 840-10-25-41 through 25-44. Insofar as the separate financial statements of the related parties are concerned, the classification and accounting shall be the same as for similar leases between unrelated parties, except in circumstances in which it is clear that the terms of the transaction have been significantly affected by the fact that the lessee and lessor are related. In such circumstances the classification and accounting shall be modified as necessary to recognize economic substance rather than legal form. [Emphasis added]

On the other hand, before the adoption of ASU 2023-01, ASC 842-10-55-12 indicates that “[l]eases between related parties should be classified in accordance with the lease classification criteria applicable to all other leases on the basis of the legally enforceable terms and conditions of the lease. In the separate financial statements of the related parties, the classification and accounting for the leases should be the same as for leases between unrelated parties” (emphasis added).

In March 2023, the FASB issued ASU 2023-01, which amends certain provisions of ASC 842 that apply to arrangements between related parties under common control. ASU 2023-01 allows non-PBEs, as well as NFPs that are not conduit bond obligors, to elect, as an accounting policy, to use the written terms and conditions of a common-control arrangement when determining whether a lease exists and the subsequent accounting for the lease, including lease classification, on an arrangement-by-arrangement basis. Therefore, if they elect this option, non-PBEs, as well as NFPs that are not conduit bond obligors, may not be required to consider the legal enforceability of such written terms and conditions, as described above.

ASU 2023-01 also amends the accounting for leasehold improvements in common-control arrangements for all entities.

See Section E.3.1.11 for a detailed discussion of ASU 2023-01 on leasing arrangements between entities under common control, including the transition requirements.

In addition to accounting for related-party leasing arrangements under ASC 842, lessees and lessors must disclose the information required by ASC 850 for all such arrangements. ASC 850-10-50-1 indicates that such disclosures should include the following:

“The nature of the relationship(s) involved.”
“A description of the transactions . . . for each of the periods for which income statements are presented” and “other information deemed necessary to an understanding of the effects of the transactions on the financial statements.”
“The dollar amounts of [the] transactions . . . and the effects of any change in the method of establishing the terms from that used in the preceding period.”
“Amounts due from or to related parties as of the date of each balance sheet presented and . . . the terms and manner of settlement.”
”The information required by paragraph 740-10-50-17.”

13.2.1 Practical Expedient Related to Accounting for Common-Control Leases on the Basis of Written Terms and Conditions

ASC 842 requires entities to determine whether a related-party arrangement between entities under common control is a lease on the basis of the legally enforceable terms and conditions of the arrangement. The accounting for a lease depends on the enforceable rights and obligations of each party as a result of the contract. This principle applies irrespective of whether such rights or obligations are included in the contract or explicitly or implicitly provided outside of the contract (i.e., there may be enforceable rights or obligations that extend beyond the written lease contract).

As part of the FASB’s postimplementation review of ASC 842, private companies asserted that this requirement creates unnecessary cost and complexity for financial statement preparers, since the terms and conditions of such common-control lease arrangements may lack sufficient details, may be uneconomic, or may be changed without approval, given that one party in the common-control group generally controls the arrangement. Therefore, stakeholders have indicated that it is challenging to determine the legally enforceable terms and conditions of these arrangements and that legal counsel may need to be involved in making this determination, thereby incurring additional cost.

In response to that feedback, ASU 2023-01 provides an optional practical expedient under which non-PBEs, as well as NFPs that are not conduit bond obligors, can use the written terms and conditions of an arrangement between entities under common control to determine (1) whether a lease exists and (2) the subsequent accounting for (and classification of) the lease. This practical expedient can be applied on an arrangement-by-arrangement basis, and an entity is not required to consider the legal enforceability of such written terms and conditions. However, if no written terms and conditions of an arrangement between entities under common control exist, an entity is not allowed to elect the practical expedient and is required to apply ASC 842 in a manner consistent with how it is applied to other arrangements. Although the FASB considered whether this practical expedient should be available to all entities, it ultimately decided to limit its application to private companies and NFPs that are not conduit bond obligors because public registrants have already adopted ASC 842 without raising concerns related to arrangements between related parties under common control.

13.2.2 Accounting for Leasehold Improvements for Leases Between Parties Under Common Control

Under ASC 842-20-35-12, a lessee is generally required to amortize leasehold improvements that it owns over the shorter of the useful life of those improvements or the lease term.

As part of the FASB’s postimplementation review of ASC 842, some stakeholders stated that leasehold improvements associated with leases between entities under common control economically differ from those associated with leases between entities not under common control. In lease arrangements between entities not under common control, leasehold improvements made by the lessee can be either for the lessee’s own benefit or for the benefit of the lessor. However, leasehold improvements made under leases between entities under common control are expected to benefit the parties under the common-control arrangement. Therefore, private-company stakeholders have noted that, in a lease arrangement between entities under common control, the amortization requirements of ASC 842 are inconsistent with the underlying economics of the arrangement, since (1) the lessee may continue to control the use of the underlying asset after the lease term and (2) another party in the common-control group may benefit from the leasehold improvements after the lessee no longer controls the use of the underlying asset.

In response to that feedback, ASU 2023-01 requires a lessee in a common-control lease arrangement to amortize leasehold improvements that it owns over the improvements’ useful life1 to the common-control group, regardless of the lease term, if the lessee continues to control the use of the underlying asset through a lease.

In situations in which a lessee obtains control of an underlying asset through a lease with an unrelated party not under common control and subsequently subleases the asset to an entity under common control, the sublessee would generally amortize the leasehold improvements over a period that does not exceed the term of the lease between the lessee/intermediate lessor and the unrelated party. However, if the lease between the lessee/intermediate lessor and the unrelated party contains an option to purchase the underlying asset and the lessee/intermediate lessor is reasonably certain to exercise that option, the leasehold improvements should be amortized over the useful life to the common-control group.

Further, a lessee that no longer controls the use of the underlying asset will account for the transfer of the underlying asset as an adjustment to equity (i.e., as with a transfer of assets between entities under common control).

Footnotes

This represents a change from the proposed ASU, which stated that leasehold improvements associated with common-control leases should be amortized over the economic life of the leasehold improvements rather than their useful life. The FASB made the change primarily because (1) the amortization period should be limited to the period in which the common-control group can direct the use of the underlying asset, (2) amortizing the leasehold improvements over the useful life to the common-control group would be consistent with the period used by a lessee when applying the impairment guidance in ASC 360, and (3) it could be challenging for a lessee to determine the economic life of a leasehold improvement since it may be required to consider factors outside the common-control group in such circumstances.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.