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).
This change in guidance may significantly affect lessees and lessors that enter into related-party leasing arrangements. Paragraph BC374 of ASU 2016-02 explains the FASB’s rationale for changing the accounting for related-party leasing arrangements and states, in part:
In previous GAAP, entities were required to account for leases with related parties on the basis of the economic substance of the arrangement, which may be difficult when there are no legally enforceable terms and conditions of the arrangement. Examples of difficulties include related party leases that are month to month and related party leases that have payment amounts dependent on cash availability. In these situations, it is difficult and costly for preparers to apply the recognition and measurement requirements. Even when applied, the resulting information often is not useful to users of financial statements.
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.”
- “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.”
Connecting the Dots
Issuance of ASU 2023-01 on Leases Between
Related Parties Under Common Control
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 not-for-profit entities 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 not-for-profit entities 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 17.3.1.10 for a detailed
discussion of ASU 2023-01 on leasing arrangements
between entities under common control, including
the transition requirements.