1. The following table provides a summary of the amendments to the Accounting Standards Codification for applying Topic 842 to common control arrangements. The amendments are organized by issue.

2. The Accounting Standards Codification is amended as described in paragraphs 3–13. In some cases, to put the change in context, not only are the amended paragraphs shown but also the preceding and following paragraphs. Terms from the Master Glossary are in bold type. Added text is underlined, and deleted text is

struck out

.

BC1. The following summarizes the Board’s considerations in reaching the conclusions in this Update. It includes reasons for accepting certain approaches and rejecting others. Individual Board members gave greater weight to some factors than to others.

BC2. On February 25, 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842), to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing transactions.

BC3. As part of the Board’s post-implementation review of Topic 842, the Board and staff continue to assist stakeholders by responding to technical accounting inquiries and proactively seeking feedback on potential implementation issues that have arisen as entities began implementing Topic 842. Since the issuance of Update 2016-02, the Board has issued seven Updates to assist stakeholders with implementation issues and two Updates deferring the effective date for private companies and certain not-for-profit organizations. The staff continues to perform outreach with stakeholders to determine whether the standard is accomplishing its stated objective and evaluate the benefits being provided to investors and other allocators of capital and continuing costs related to Topic 842.

BC4. The amendments in this Update respond to the following issues related to applying Topic 842 to related party arrangements between entities under common control (hereinafter referred to as common control arrangements) brought to the Board’s attention primarily through interactions with private company stakeholders:

BC5. The Board issued proposed Accounting Standards Update, Leases (Topic 842): Common Control Arrangements, on November 30, 2022, and received 29 comment letters in response to the amendments in that proposed Update. The Board considered respondents’ comments in reaching the conclusions in this Update, as discussed further below.

BC6. The objective of financial reporting is to provide information that is useful to present and potential investors, creditors, donors, and other capital market participants in making rational investment, credit, and similar resource allocation decisions. However, the benefits of providing information for that purpose should justify the related costs. Present and potential investors, creditors, donors, and other users of financial information benefit from improvements in financial reporting, while the costs to implement new guidance are borne primarily by present investors. The Board’s assessment of the costs and benefits of issuing new guidance is unavoidably more qualitative than quantitative because there is no method to objectively measure the costs to implement new guidance or to quantify the value of improved information in financial statements.

BC7. For Issue 1, the Board concluded that providing the practical expedient in this Update to entities that are not (a) public business entities, (b) not-for-profit bond obligors, or (c) employee benefit plans that file or furnish financial statements with or to the SEC will reduce the cost of implementation and ongoing application of Topic 842 for those entities while reducing diversity in practice when applying lease accounting requirements to common control arrangements. Additionally, the Board expects that using the written terms and conditions of a common control arrangement will often result in financial reporting for those arrangements that is consistent with financial reporting that uses enforceable terms and conditions, thereby not compromising the decision usefulness of information provided to investors and other allocators of capital.

BC8. For Issue 2, the Board concluded that the amendments in this Update improve current GAAP by clarifying the accounting for leasehold improvements associated with common control leases, thereby reducing diversity in practice. Additionally, the Board decided that the amendments result in financial information for investors and other allocators of capital that better reflects the economics of those transactions. The Board does not anticipate that entities will incur significant costs as a result of applying the amendments in this Update.

BC9. The amendments in this Update address issues with applying Topic 842 to common control arrangements. The Board decided not to include other related party arrangements within the scope of the amendments primarily because stakeholders’ feedback, including the feedback received in comment letters, indicated that issues with applying Topic 842 were most frequently associated with common control arrangements (see paragraphs BC13 and BC14). Additionally, that feedback indicated that common control arrangements in particular pose unique challenges.

BC10. Some comment letter respondents requested that the Board define common control or provide additional guidance for determining whether entities are under common control. Consistent with deliberations in previous projects addressing common control arrangements, the Board decided not to define common control in this Update. The Board noted that common control exists in other areas of GAAP (for example, to determine the measurement basis for assets transferred between entities under common control under Topic 805, Business Combinations). For purposes of applying the amendments in this Update, the Board believes that it would be appropriate for entities to reference, among other things, the SEC staff’s observations ¹ documented in EITF Issue No. 02-5, “Definition of ‘Common Control’ in Relation to FASB Statement No. 141,” to determine common control.

BC11. Consistent with its observations in paragraph BC19 of Accounting Standards Update No. 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities, the Board continues to believe that the term common control should be broader for private companies and most not-for-profit entities than what the SEC staff observed in Issue 02-5. For example, an entity owned by a grandparent and an entity owned by a grandchild could, on the basis of facts and circumstances, be considered entities under common control for the purposes of applying the amendments in this Update.

BC12. Topic 842 requires that entities determine whether a related party arrangement, including one between entities under common control, is a lease on the basis of the legally enforceable terms and conditions of the arrangement. That requirement is consistent with the requirements for an arrangement between unrelated parties. The classification and accounting under Topic 842 for all leases—both leases between related parties and leases between unrelated parties—also are based on the enforceable terms and conditions. Under Topic 840, if those terms and conditions were affected by the related party nature of the arrangement, an entity was required to classify and account for that arrangement on the basis of its economic substance as opposed to its legal form.

BC13. Many private company stakeholders stated that determining the enforceable terms and conditions in common control arrangements often presents unique challenges, even when the terms and conditions are written. Moreover, those stakeholders noted that a common owner or owners typically can amend the terms and conditions of an arrangement at any time. Similarly, a common owner or owners typically can choose not to enforce the terms and conditions of an arrangement. In other words, the arrangements are generally controlled entirely by one party or control group and, thus, pose unique issues when considering enforceability.

BC14. Private company stakeholders consistently indicated that common control arrangements often are unwritten or lack sufficient detail (for example, the agreements may not explicitly specify whether lessee-controlled renewal options exist). Additionally, those stakeholders stated that the terms and conditions of the arrangements often are not negotiated at arm’s length and not aligned with other related transactions or agreements. In those cases, private company stakeholders were concerned that determining the enforceable terms and conditions could necessitate obtaining a formal legal opinion, which is challenging and costly because of the common control nature of the arrangement (even for written arrangements).

BC15. The Board acknowledged that the related party requirements in Topic 842 were intended to address stakeholders’ concerns about the complexities and diversity in practice associated with applying the economic substance requirements in Topic 840. Notwithstanding, the Board concluded on the basis of feedback from stakeholders and additional analysis that determining whether terms and conditions of arrangements between entities under common control are enforceable may be overly challenging when applying Topic 842, particularly in situations in which those terms and conditions are unwritten. Furthermore, the Board learned through outreach that in situations in which an entity identifies oral or implicit terms and conditions for purposes of applying Topic 842, practitioners often require that those terms and conditions be written to satisfy audit requirements.

BC16. To respond to stakeholders’ concerns, the Board provided a practical expedient to entities that are not (a) public business entities, (b) not-for-profit bond obligors, or (c) employee benefit plans that file or furnish financial statements with or to the SEC. An entity electing the practical expedient will use the written terms and conditions of a common control arrangement to determine whether a lease exists and, if so, to classify and account for that lease. An entity is not required to determine whether written terms and conditions are enforceable when applying the practical expedient and may apply the practical expedient on an arrangement-by-arrangement basis. If no written terms and conditions exist, the Board decided that an entity cannot apply the practical expedient and must use enforceable rights and obligations to apply Topic 842, consistent with the requirements for arrangements between related parties not under common control. Additionally, the Board observed that, similar to legacy requirements and practice, if an entity determines that an arrangement is not a lease, the entity should apply other applicable GAAP to account for both the arrangement and any improvements made by a customer to a supplier’s asset.

BC17. The Board noted that entities that have common control arrangements are subject to Topic 850, Related Party Disclosures. The disclosures required by Topic 850 are intended to provide investors and other allocators of capital with sufficient information to analyze those arrangements. Those disclosure requirements were developed to address the fact that arrangements between related parties often are not consummated at arm’s length and, therefore, may not reflect the economic substance of those arrangements. The Board concluded that applying the practical expedient, coupled with the Topic 850 disclosure requirements, should provide investors and allocators of capital with sufficient information to analyze an entity’s common control arrangements.

BC18. The Board concluded that the option to use written terms and conditions for common control arrangements instead of the enforceable terms and conditions is a practical expedient. The Private Company Decision-Making Framework: A Guide for Evaluating Financial Accounting and Reporting for Private Companies, describes a practical expedient as “a more cost-effective way of achieving the same or a similar accounting or reporting objective.” If the information provided by existing GAAP is deemed relevant to the users of private company financial statements, then a practical expedient should be used to lower the cost and complexity of applying the guidance. Because the Board expects that applying Topic 842 to common control arrangements on the basis of written terms and conditions is generally consistent with public business entity practice, it concluded that a practical expedient was warranted.

BC19. More than a majority of comment letter respondents supported the practical expedient. Many of those respondents stated that the practical expedient (a) is operable and (b) will not compromise the decision usefulness of financial information provided to investors.

BC20. The Board considered whether the practical expedient should be available for all entities but decided to limit the practical expedient to entities that are not (a) public business entities, (b) not-for-profit bond obligors, or (c) employee benefit plans that file or furnish financial statements with or to the SEC. The Board reasoned that the entities in (a) through (c) have fully adopted Topic 842 and have raised no significant concerns since the issuance of Update 2016-02 in February 2016 about applying related party requirements in Topic 842 to common control arrangements. Moreover, the Board noted that feedback indicated that public business entities are generally concluding that the written terms and conditions of a common control arrangement are the legally enforceable terms and conditions in accordance with paragraph 842-10-55-12. Therefore, the Board expects that using written terms and conditions in accordance with the practical expedient will generally be consistent with the accounting for similar arrangements by public business entities.

BC21. Some respondents broadly supporting the practical expedient recommended that the Board describe the specific terms and conditions that must be included in the written arrangement to apply the practical expedient. The Board considered that feedback but determined that providing additional guidance was unnecessary given the specificity of the existing requirements in Topic 842 for (a) determining whether a lease exists and, if so, (b) classifying and accounting for that lease. The Board further observed that applying the practical expedient does not eliminate the need for an entity to apply relevant guidance in Topic 842 to account for the lease. For example, an entity is still required to determine whether an arrangement contains lease and nonlease components.

BC22. Other respondents requested clarification on the form required for documenting the written terms of an agreement to apply the practical expedient. The Board observed that entities have latitude to use reasonable judgment when deciding how the terms and conditions of an arrangement are conveyed in writing and, therefore, did not prescribe a specific form or approach.

BC23. The Board decided that the practical expedient may be applied on an arrangement-by-arrangement basis, primarily because it expects that entities will apply Topic 842 to common control arrangements on the basis of written terms and conditions. Notwithstanding, the Board reasoned that if entities wish to identify and account for enforceable unwritten terms and conditions for certain arrangements and not elect the practical expedient, they should be allowed to do so. Almost all comment letter respondents supported allowing entities to apply the practical expedient on an arrangement-by-arrangement basis.

BC24. Leasehold improvements, although not defined in the Master Glossary, generally constitute improvements made by a lessee to the underlying asset (the leased asset) for which the lessee is determined to be the accounting owner. In addition, those improvements are recognized as leasehold improvements on a lessee’s balance sheet only when an arrangement is determined to be a lease (under either Topic 842 or Topic 840). Topic 842 generally requires that leasehold improvements have an amortization period consistent with the shorter of the remaining lease term and the useful life of the improvements. That requirement is largely consistent with legacy guidance. Private company stakeholders stated that it is not uncommon for private company common control leases to have short lease terms (for example, one year), even in situations in which the commonly controlled lessee makes significant leasehold improvements with an estimated useful life that far exceeds the lease term. Those stakeholders were concerned that amortizing leasehold improvements over a period shorter than that estimated useful life of the improvements may result in financial reporting that does not faithfully represent the economics or the common control nature of those improvements because:

BC25. The Board observed that multiple methods of accounting for leasehold improvements in leases with entities under common control are acceptable under current GAAP. Those methods include, but are not limited to:

BC26. Comment letter respondents had differing views about the extent of diversity in practice for leasehold improvements in common control leases. Many respondents to the proposed Update stated that the amendments would clarify the accounting for those improvements and reduce diversity or the potential for diversity in practice. Other comment letter respondents stated that they have not observed diversity in practice among principally public entities that have adopted Topic 842.

BC27. The Board noted that leasehold improvements associated with common control leases are economically different from those associated with third-party and other related-party leases. The Board observed that leasehold improvements associated with common control leases generally are made at the direction of a common owner or owners. The Board further observed that in common control leases, those improvements are expected to benefit all common control parties through (a) the lessee’s use of those improvements or (b) a transfer to the common control lessor or another entity within the common control group with the leased asset. The Board noted that this is not the case for leasehold improvements associated with leases between entities not under common control. Outreach and feedback from respondents to the proposed Update supported the Board’s observations about the economics of leasehold improvements associated with common control leases.

BC28. To clarify the accounting for leasehold improvements associated with common control leases, better reflect the economics of those transactions, and reduce diversity in practice, the Board decided to require that those leasehold improvements be:

BC29. The Board noted that common control leases are not prevalent for public companies and, therefore, it did not expect to receive formal feedback on Issue 2 from that stakeholder group. Furthermore, for the more limited set of public companies that engage in common control leases, the Board expects that leasehold improvements associated with those leases will not be a significant issue. Notwithstanding the limited expected effect for the vast majority of public companies, the Board received feedback from (a) auditors (including those that audit the majority of public companies), (b) professional societies that include public company members, and (c) regulators of public companies and obtained sufficient information to conclude that additional outreach was unnecessary. While the effect of the amendments in this Update is not expected to be significant for public companies, the Board concluded that the amendments better reflect the economics of leasehold improvements associated with common control leases and will reduce diversity in practice; therefore, the amendments are applicable for all entities (that is, including public business entities).

BC30. In the proposed Update, the Board decided that leasehold improvements associated with common control leases should be amortized over the economic life of those improvements. The Board observed that using economic life as opposed to useful life would be appropriate for leasehold improvements associated with common control leases because economic life is not limited to entity-specific (that is, lessee-specific) assumptions about how an entity intends to use an asset.

BC31. Many comment letter respondents recommended that the Board replace amortizing leasehold improvements over their economic life with amortizing those improvements over the useful life to the common control group. Those respondents noted that using economic life could be challenging because impairment guidance in Topic 360, Property, Plant, and Equipment, specifically requires that an entity consider the useful life. Additionally, amortizing leasehold improvements over the economic life would have required commonly controlled lessees to consider factors that are outside the control of the common control group. The Board agreed with those respondents and concluded that leasehold improvements associated with common control leases should be amortized by the lessee over the useful life of those improvements to the common control group (regardless of lease term) as long as the lessee controls the right to use the underlying asset through a lease.

BC32. The Board also concluded that the amortization period for leasehold improvements associated with common control leases is limited to the period in which the common control group can direct the use of the underlying asset. Therefore, if the lessor under common control obtains the right to control the use of the underlying asset through a lease with another entity not within the same common control group, the amortization period is limited to the lease term associated with that other lease, unless that other lease transfers ownership of the underlying asset to the lessor or the lessor is reasonably certain to exercise an option to purchase the underlying asset, in which case the lessee should amortize the leasehold improvements over the useful life to the common control group.

BC33. The Board observed that entities may need to obtain information from the lessor or common owner or owners to determine the useful life of leasehold improvements to the common control group. The Board observed that commonly controlled lessees will be able to readily obtain the necessary information from the commonly controlled lessor and the common owner or owners to comply with the requirements.

BC34. The Board expects that leasehold improvements associated with common control leases often may benefit another party within the common control group if, and when, the lessee no longer controls the use of the underlying asset. Therefore, the Board decided that the unamortized cost of the leasehold improvements on that date should be accounted for as a transfer between entities under common control through equity (net assets for a not-for-profit entity). The Board concluded that this accounting faithfully represents the economics of leasehold improvements associated with common control leases and is consistent with how entities currently account for transfers of other similar assets to entities within the same common control group. The Board also concluded that this accounting appropriately reflects the derecognition of those improvements at the date of transfer.

BC35. The Board decided against providing specific requirements for situations in which a lessee does not expect to transfer leasehold improvements associated with a common control lease to another entity within the common control group if, and when, the lessee no longer controls the use of the underlying asset. The Board noted that the useful life of leasehold improvements to the common control group would include that expectation.

BC36. The Board concluded that an entity with leasehold improvements associated with common control leases is required to apply the impairment requirements in Topic 360, particularly paragraph 360-10-40-4. That paragraph requires that a long-lived asset (asset group) be tested for recoverability while the asset is held and used and an entity should consider estimates of future undiscounted cash flows based on the asset’s remaining useful life, assuming that a transfer will not occur. Paragraph 360-10-40-4 also requires that an entity recognize an impairment when the asset is transferred if the carrying amount of the asset exceeds its fair value at the transfer date. The Board concluded that this impairment guidance is appropriate for leasehold improvements associated with leases between entities under common control that may be transferred to another party within the common control group. Moreover, the Board observed that applying this impairment guidance effectively prohibits a lessee under common control from transferring leasehold improvements at an amount that would be immediately impaired by the receiving entity.

BC37. The Board decided that lessees that have leasehold improvements associated with common control leases in situations in which the useful life to the common control group is longer than the lease term must make specific disclosures to enhance the transparency of those arrangements. The purpose of those required disclosures is to assist users of financial statements in analyzing those circumstances. Most comment letter respondents stated that the additional disclosures should provide investors and other allocators of capital with decision-useful information.

BC38. Most respondents who did not support the proposed amendments expressed a concern that commonly controlled lessees could establish leases with short lease terms and avoid recognizing a lease liability while benefiting from recognizing leasehold improvements on the balance sheet and amortizing those improvements over a longer period. Some respondents suggested that the Board require that commonly controlled lessees impute a lease for a period equal to the useful life of the leasehold improvements and recognize a corresponding lease liability and right-of-use asset. Other respondents suggested that the Board require that commonly controlled lessees fully amortize leasehold improvements over the shorter of the lease term and the useful life of those improvements to incentivize the common control parties to document a longer lease term. Many of those respondents questioned whether an inconsistency between the amortization period and the lease term used for recognizing lease liabilities would result in information that is decision useful.

BC39. The Board agreed that situations may exist for which the amortization period for leasehold improvements associated with common control leases is longer than the lease term. The Board concluded that the amendments in this Update (including the disclosure requirements) better reflect the economics of leasehold improvements associated with common control leases and clarify the accounting for those improvements. Furthermore, the Board rejected requiring that commonly controlled lessees impute a lease liability in situations in which no lease and corresponding obligation exist. The Board noted that the recognition of an imputed lease liability would similarly require that an entity recognize a right-of-use asset that also does not exist. The Board further noted that requiring accounting that fails to reflect the economics of transfers of value between entities under common control to incentivize those entities to alter business arrangements is inconsistent with the objective of general purpose financial reporting.

BC40. The Board acknowledged that for improvements made by a lessee to an underlying asset to be recognized as leasehold improvements, the lessee must be determined to be the accounting owner of the improvements. The Board further acknowledged that no separate GAAP exists for making that determination. The Board observed that practice has developed various approaches for determining the accounting owner of improvements made to an underlying asset. The Board decided not to develop requirements for determining the owner of improvements made to an underlying asset as part of the amendments in this Update and noted that this determination is not unique to the application of Topic 842 or to common control leases.

BC41. The amendments in this Update for both Issue 1 and Issue 2 are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for both interim and annual financial statements that have not yet been made available for issuance. If an entity adopts the amendments in an interim period, it must adopt them as of the beginning of the fiscal year that includes that interim period.

BC42. For Issue 1, the Board noted that many entities within the scope of the practical expedient will be adopting the expedient concurrently with the adoption of Topic 842. For entities that have adopted Topic 842, the Board observed that those entities are already applying Topic 842 on the basis of enforceable terms and conditions, which can be readily documented in writing. Therefore, the Board concluded that a delayed effective date and staggered interim reporting requirements for private entities were unnecessary.

BC43. For Issue 2, the Board concluded that additional time or staggered effective dates for annual and interim reporting periods were not warranted for any entities. Although some comment letter respondents suggested delayed effective dates for entities within the scope of Issue 1, the Board expects that those entities will adopt the amendments for Issue 2 concurrently with adopting Topic 842 to avoid applying the requirements in a future reporting period. For entities that have adopted Topic 842, the Board concluded that requiring all calendar-year-end entities to apply the amendments for Issue 2 on January 1, 2024 (at the earliest) provides sufficient time to understand and obtain the information necessary to apply the amendments.

BC44. The Board decided that entities adopting the practical expedient in this Update concurrently with the adoption of Topic 842 are required to follow the same transition requirements used to apply Topic 842.

BC45. The Board decided that all other entities are required to apply the practical expedient in this Update either:

BC46. The Board also decided to provide specific transition guidance for:

BC47. Regardless of an entity’s transition approach, the Board also concluded that an entity is permitted to document any existing unwritten terms and conditions of an arrangement between entities under common control before the date on which the entity’s first interim (if applicable) or annual financial statements are available to be issued in accordance with the amendments in this Update.

BC48. Some comment letter respondents questioned whether the entity-wide election of the Topic 842 transition practical expedients in paragraph 842-10-65-1(f) or (g) would limit an entity’s ability to utilize the practical expedient in this Update. Therefore, the Board clarified that an entity is not required to apply those Topic 842 transition practical expedients to common control arrangements for which the practical expedient is being applied.

BC49. The Board decided that entities adopting the amendments in this Update concurrently with the adoption of Topic 842 may follow the same transition requirements used to apply Topic 842 or may use either of the prospective approaches described below to avoid retrospectively accounting for leasehold improvements.

BC50. The Board decided that all other entities are required to apply the amendments in this Update using one of the following methods:

The amendments to the FASB Accounting Standards Codification® in this Accounting Standards Update require improvements to the GAAP Financial Reporting Taxonomy and SEC Reporting Taxonomy (collectively referred to as the “GAAP Taxonomy”). Those improvements, which will be incorporated into the proposed 2024 GAAP Taxonomy, are available through GAAP Taxonomy Improvements provided at www.fasb.org, and finalized as part of the annual release process.