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
1
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.