The FASB issued ASU 2023-01, Leases (Topic 842): Common Control Arrangements, to address two issues related to accounting for arrangements between entities under common control: (1) the terms and conditions to be considered, and (2) leasehold improvements.
While “common control” is not defined in U.S. GAAP, the concept is used in other Codification topics, such as ASC 805, Business Combinations. To assess whether entities are under common control, practitioners should consider, among other things, the SEC’s staff’s observations documented in EITF Issue 02-5, “Definition of ‘Common Control’ in Relation to FASB Statement No. 141.” Those observations indicate, for example, that two entities are considered to be under common control when an individual, enterprise, immediate family member, or a shareholder group subject to a voting agreement controls more than 50 percent of the voting interest in both entities.
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The first issue applies only to entities that are not any one of the following:
Prior to the issuance of ASU 2023-01, ASC 842 required all leases between related parties, including entities under common control, to be accounted for based on their legally enforceable terms and conditions. The new guidance provides a practical expedient for arrangements between entities under common control that allows an in-scope entity to use the written terms and conditions of the arrangement to determine whether it contains a lease, rather than using the legally enforceable terms and conditions. Under this practical expedient, an entity should consider whether the written terms and conditions convey the practical, rather than enforceable, right to control the use of an identified asset. If the arrangement is or contains a lease, the entity must classify and account for that lease based on the written terms and conditions under the practical expedient. The practical expedient applies to both lessors and lessees, and can be elected on an arrangement-by-arrangement basis.
If the entities in the arrangement cease to be under common control, the accounting would depend on whether (1) the arrangement was a lease when the entities were under common control, and (2) the arrangement is a lease now that the entities are no longer under common control, as shown in the following table.
The second issue applies to all entities, both public and private entities, that are the lessee in a lease with a lessor under common control and have recognized leasehold improvements related to that lease.
Prior to the issuance of ASU 2023-01, ASC 842 required all lessees to amortize leasehold improvements over the shorter of their useful life or the remaining term of the lease. The new guidance requires amortizing leasehold improvements for leases between entities under common control over the useful life of those assets to the common control group, regardless of the lease term. There is an exception to this rule when the asset underlying the common control lease is itself leased by the lessor from a party outside the common control group (and is then subleased to the lessee), and that lease does not contain a bargain purchase option or transfer of ownership. In that case, the useful life of the leasehold improvements cannot exceed the term of the lessor’s lease. Impairment testing for those leasehold improvements also utilizes the useful life to the common control group.
Under the new guidance, when the lessee no longer controls the use of the asset underlying the common control lease, the leasehold improvements are accounted for as a transfer between entities under common control. That is, the lessee records a distribution to the common control lessor through an adjustment to equity.
If during the lease term the parties to a lease either cease or start to be under common control, any change to the amortization period of the associated leasehold improvements that result from applying the new guidance for Issue 2 is accounted for prospectively as a change in accounting estimate.
When the useful life of leasehold improvements accounted for under the common control guidance is greater than the term of the related lease, a lessee is required to disclose the following: