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9.8 Amounts previously recognized in business combinations
Publication date: 31 Jan 2023
us Leases guide
ASC 842-10-65-1 provides guidance for reporting entities that have previously recognized an asset or a liability related to favorable or unfavorable terms of an operating lease under the business combination guidance in ASC 805.
If an entity has previously recognized an asset or a liability in accordance with Topic 805 on business combinations relating to favorable or unfavorable terms of an operating lease acquired as part of a business combination, the entity shall do all of the following:
1. Derecognize that asset and liability (except for those arising from leases that are classified as operating leases in accordance with Topic 842 for which the entity is a lessor).
2. Adjust the carrying amount of the right-of-use asset by a corresponding amount if the entity is a lessee.
3. Make a corresponding adjustment to equity if assets or liabilities arise from leases that are classified as sales-type leases or direct financing leases in accordance with Topic 842 for which the entity is a lessor. Also see (w).
9.8.1 Transition for certain leasehold improvements
Under ASC 840, leasehold improvements that are installed significantly after lease inception or acquired in a business combination can have an amortization period greater than the lease term used for accounting purposes. This is because the lessee must use the shorter of the useful life of the assets, or a term that includes required lease periods and renewals that are deemed to be reasonably assured at the date that the leasehold improvements are purchased for amortization purposes, while the lease term for accounting purposes is not updated in these cases. However, ASC 842 does not permit this treatment. Instead it includes the following guidance:
Amortization of Leasehold Improvements
ASC 842-20-35-12: Leasehold improvements shall be amortized over the shorter of the useful life of those leasehold improvements and the remaining lease term, unless the lease transfers ownership of the underlying asset to the lessee or the lessee is reasonably certain to exercise an option to purchase the underlying asset, in which case the lessee shall amortize the leasehold improvements to the end of their useful life.
ASC 842-20-30-13: Leasehold improvements acquired in a business combination or an acquisition by a not-for-profit entity shall be amortized over the shorter of the useful life of the assets and the remaining lease term at the date of acquisition.
ASC 842 does not have specific transition provisions for leasehold improvements. Therefore, questions have arisen about whether the amortization period of these leasehold improvements should be shortened to conform to the lease term used for accounting purposes upon adoption of ASC 842. We believe that unless hindsight is elected, the amortization period for the leasehold improvements should not be changed. However, based on informal discussions with the FASB staff, a lessee could alternatively adjust the amortization to conform with the lease term either on a prospective basis or as a cumulative catch-up adjustment through equity.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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