The FASB on Sept. 21, 2022, voted by 4 to 3 to issue a proposal that would change the accounting rules for leasehold improvements in inter-company leases done by both public and private companies.
Leasehold improvements are typically associated with commercial property whereby, for example, a tenant paints, upgrades lighting, adds new carpet, or makes repairs to the space.
The proposal would amend Topic 842, Leases, to specify that leasehold improvements associated with leases between entities under common control be “amortized by the lessee over the useful life of the improvements (regardless of the lease term) as long as the lessee continues to use the underlying asset” and “accounted for as a transfer between entities under common control if, and when, the lessee ceases using the underlying asset.”
Chair Richard Jones, Vice Chair James Kroeker, and Board members Susan Cosper and Marsha Hunt favored the proposal; Board members Gary Buesser, Fred Cannon, and Christine Botosan, dissented.
“The way I look at this project is it’s ‘do we want to narrow acceptable practice, and do we want to send a clarification message to the private companies that are adopting this standard?’ recognizing the time is quickly ticking away on their adoption date,” Jones said. “And I’m particularly sensitive to this coming up, if we don’t address it, as another issue associated with private company adoption and another reason that some will think that a delay for the standard would be appropriate,” he said.
Dissenting board members, among other views, did not favor the changes for public companies, fearing it would do more harm than good.
“We haven’t heard any problems identified by public companies so this to me is a solution in search of a problem,” Buesser, an analyst on the board, said. “These private companies under common control can simply write-down the contract terms - solves all their problems.”
The decision stems from guidance in Topic 842 which requires companies to account for a lease that is under common control on the basis of the legally enforceable provisions. Problems arose for private companies because some do not have written documentation of an inter-company lease and therefore are confused about “what is legally enforceable,” according to the discussions. Affiliated with that came issues about how to handle the treatment of leasehold improvements when there is a verbal related-party transaction because the life of the related-party lease could substantially differ from the actual life of the underlying lease asset.
On the topic, the full board also agreed to propose a practical expedient only for private companies to simplify guidance for determining whether a lease exists for arrangements between entities under common control. A practical expedient is an accounting workaround with a simpler approach to arriving at the same answer as the initial rule.
The proposal would specify that entities would only consider the written terms and conditions when determining whether a lease exists and the classification and accounting for that lease, according to the discussions. Entities would not be required to determine whether those written terms and conditions are legally enforceable. Moreover, if no written terms and conditions exist an entity would apply Topic 842 to any verbal or implicit terms and conditions. If no lease exists, other rules would apply.
Companies will get 45 days to submit comments.
The decisions come at a time when private companies are in the process of adopting Topic 842, and about three years after public companies adopted the standard.
Topic 842 requires the full magnitude of long-term lease obligations to be recorded on the balance sheet. The issues in question surfaced during the FASB’s post-implementation review (PIR) of the standard, its process to determine whether the provisions worked as intended.
In a rare turn of events, the three dissenting board members – the financial statement user voices on the board – said they did not have enough information to vote to propose changes for public companies about leasehold improvements. Analysts Buesser and Cannon and academic Botosan expressed concerns that staff did not reach out to public companies on that topic and thus were uncertain about the knock-on implications of the changes.
“I feel like this is asking too much too fast; I just don’t feel I have enough information at this point in time - would leave this for a later date,” Cannon said. Similarly, Botosan said she “would not [like to] make a change to the guidance in this area,” in light of the uncertainty.
On the contrary, Jones, Kroeker, Cosper and Hunt - the financial statement preparer and auditor voices on the board - felt the changes for leasehold improvements would not pose issues for public companies as they would not face the issues in question that would be addressed.
“I don’t think it’s imposing any significant cost on public companies - depending on how we deal with transition they have systems to account for fixed assets. Those fixed asset systems as I understand it are typically where leasehold improvements go,” said Kroeker. “They know how to assign useful life to assets so I don’t think it imposes any particular cost and I think it does have a benefit to investors, a very clear one of saying ‘hey where there might be multiple acceptable practices today, we’re clarifying that this is the approach with respect to leasehold improvements,’” he said. “So, I’m satisfied I have all the information I need to make a decision to move toward an exposure draft. Therefore, I would apply it for all I would not make an expedient.”
Following the board’s decision, some in the accounting profession were quick to respond on the topic.
Specifically, Visual Lease, a New Jersey-based provider of lease accounting software company, said public companies would likely not be troubled by the issue on leasehold improvements.
“Public companies have their inter-related party agreements typically in writing,” Bill Harter, a key lease accounting practitioner at Visual Lease, said. “They’re not doing them or shorter terms; they’re not treating them as less than arms-length transactions for the most part,” he said. “It would be very unusual for a public company to really be impacted by this. This more has to do with where the economics between the two related parties do not reflect a true arms-length transaction –that’s where this has its biggest impact.”
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