Chapter 13 — Other Key Provisions

13.1 Overview

This chapter discusses other key provisions in ASC 842, including those related to the following topics:

Related-party leases (Section 13.2).
Income taxes (Section 13.3).
Master lease agreements (Section 13.4).

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.

13.3 Income Taxes

A lease’s classification for accounting purposes does not affect its classification for tax purposes. An entity will therefore continue to be required to determine the tax classification of a lease under the applicable tax laws. While the classification may be similar for either purpose, the differences between tax and accounting principles and guidance often result in book/tax differences. Thus, once an entity implements ASU 2016-02, it will need to establish a process (or leverage its existing processes) to account for these differences.

Connecting the Dots

Potential for Additional Deferred Tax Assets and Liabilities

ASC 842 does not significantly affect the accounting for income taxes under ASC 740. In a manner consistent with ASC 840, differences between accounting and tax guidance will result in book/tax differences. Because the lessee will recognize a new ROU asset and lease liability for operating leases as a result of adopting ASC 842, there may be more book/tax differences under ASC 842 than under ASC 840.

Because ASC 842 requires entities to reevaluate their leases, they may have the opportunity to reassess the tax treatment of such leases as well as their data collection and processes. Since the IRS considers a taxpayer’s tax treatment of leases to be a method of accounting, an entity may need to obtain IRS consent if it makes any changes to its existing methods.

Entities should also consider the potential state tax issues that may arise as a result of ASC 842, including how the classification of the ROU asset may affect the apportionment formula in the determination of state taxable income and how the significant increase in recorded lease assets could affect the determination of franchise tax payable.

Since the potential tax implications are many and varied, it is essential for a company’s tax department to be involved in the evaluation of the impact of ASC 842 as well as in discussions related to policy adoption and system modifications. See Appendix D for additional implementation considerations.

13.4 Master Lease Agreements

ASC 842-10

55-17 Under a master lease agreement, the lessee may gain control over the use of additional underlying assets during the term of the agreement. If the agreement specifies a minimum number of units or dollar value of equipment, the lessee obtaining control over the use of those additional underlying assets is not a lease modification. Rather, the entity (whether a lessee or a lessor) applies the guidance in paragraphs 842-10-15-28 through 15-42 when identifying the separate lease components and allocating the consideration in the contract to those components. Paragraph 842-10-55-22 explains that a master lease agreement may, therefore, result in multiple commencement dates.

55-18 If the master lease agreement permits the lessee to gain control over the use of additional underlying assets during the term of the agreement but does not commit the lessee to doing so, the lessee’s taking control over the use of an additional underlying asset should be accounted for as a lease modification in accordance with paragraphs 842-10-25-8 through 25-18.

55-22 There may be multiple commencement dates resulting from a master lease agreement. That is because a master lease agreement may cover a significant number of underlying assets, each of which are made available for use by the lessee on different dates. Although a master lease agreement may specify that the lessee must take a minimum number of units or dollar value of equipment, there will be multiple commencement dates unless all of the underlying assets subject to that minimum are made available for use by the lessee on the same date.

A master lease agreement may specify that the lessee will obtain control over the right to use multiple underlying assets (e.g., equipment) at various points during the term of the master lease agreement. In these cases, the lessee’s accounting depends on whether the master lease agreement commits the lessee to gaining control over the right to use a minimum quantity (units or dollar value) of assets.

13.4.1 Lessee Is Obligated or Committed to Use a Minimum Quantity

Under ASC 842-10-55-17, if the lessee is obligated or committed to the right to use a minimum quantity of assets, the entity should include the minimum quantity when separating lease components and allocating the consideration in the contract to the separate lease components (see Chapter 4). Because the minimum quantity is included in the initial separation of, and allocation to, the lease components, the lessee’s attainment of control of the right to use the underlying assets throughout the term of the master lease agreement does not result in a lease modification.

However, because the lessee may obtain control of the right to use the underlying assets at different points during the term of the master lease agreement, the separate lease components may have different lease commencement dates, as explained in ASC 842-10-55-22. For rights to use underlying assets that have yet to commence, the lessee should consider the disclosure requirements in ASC 842-20-50-3(b) (see Section 15.2.2) related to leases that have not yet commenced.

Example 13-1

On January 1, 20X1, Lessor C enters into a master lease agreement with Lessee P related to various pieces of equipment throughout a five-year term. Under the master lease agreement, P leases the following pieces of equipment from C for one-year lease terms commencing on the following dates:

March 26, 20X1: Equipment X.
June 7, 20X2: Equipment Y.
September 9, 20X3: Equipment Z.

The master lease agreement states that P is obligated to lease three pieces of equipment (i.e., Equipment X, Equipment Y, and Equipment Z) at some point during the five-year term of the master lease agreement.

In accordance with ASC 842-10-55-17, because P is obligated to use a minimum quantity of equipment, the entities (both C and P) must consider the minimum quantity of equipment (i.e., three pieces of equipment) when identifying the separate lease components and allocating the consideration in the contract. Because P obtains control of the right to use the equipment at different points during the master lease agreement, each lease component (i.e., for Equipment X, Equipment Y, and Equipment Z) has a different lease commencement date. Accordingly, P should consider the disclosure requirement in ASC 842-20-50-3(b) for leases that have not yet commenced. In addition, because each right of use is considered in the initial identification and separation of lease components, the fact that P obtains control of each right of use at different times does not result in a lease modification.

13.4.2 Lessee Is Not Obligated or Committed to Use a Minimum Quantity

Under ASC 842-10-55-18, if the lessee is not obligated or committed to the right to use a minimum quantity of assets, the lessee must account for the attainment of control of each additional right to use an underlying asset as a lease modification in accordance with ASC 842-10-25-8 through 25-18 (e.g., each additional right of use could be a lease modification accounted for as a separate contract in accordance with ASC 842-10-25-8). Because the lessee is not subject to a minimum commitment, the entity would not include the right to use any additional underlying assets in the initial separation of, and allocation to, the lease components in the contract. See Section 8.6 for additional information on accounting for lease modifications.

Example 13-2

Assume the same facts as in Example 13-1, except that under the master lease agreement, Lessee P is not obligated or committed to use a minimum quantity of equipment throughout the five-year term of the master lease agreement.

Because P is not obligated to use a minimum quantity of equipment, the entities (both P and Lessor C) should account for P’s obtaining control over the right to use each additional piece of equipment as a lease modification on the date on which control is obtained (e.g., each modification may be accounted for as a separate contract in accordance with ASC 842-10-25-8). In this example, the entities will account for the master lease agreement as follows:

First lease commences on March 26, 20X1, when P obtains control of Equipment X.
First modification on June 7, 20X2, when P obtains control of Equipment Y.
Second modification on September 9, 20X3, when P obtains control of Equipment Z.

See Section 8.6 for additional information on accounting for lease modifications.