Chapter 13 — Other Key Provisions
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).
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.
13.3 Income Taxes
A lease’s classification for accounting purposes does not affect its
classification for tax purposes. Thus, an entity needs 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. Entities therefore
will need to establish a process (or leverage its existing processes) to account for
these differences.
Under ASC 842, the lessee recognizes in its
statement of financial position an ROU asset and a
lease liability for most operating leases
(including those related to synthetic lease
arrangements). For income tax purposes, however,
the lessor is still treated as the owner of the
property, resulting in temporary differences with
respect to each individual item and the need to
record and track the deferred taxes on each
temporary difference separately.
For example, if there is no
tax basis in the ROU asset, a taxable temporary difference may arise. Similarly, if
there is no tax basis in the lease liability, a deductible temporary difference may
arise. The taxable and deductible temporary differences are separate and give rise
to separate and distinct deferred tax amounts that generally should not be netted in
the income tax disclosures. Entities should carefully consider the disclosure
requirements in both ASC 740-10-50-2 and ASC 740-10-50-6.
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 Deloitte’s Roadmap Income Taxes
for additional 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
agreement’s term. 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.