FASB’s New Lease Standard Must Not Break You
The development and implementation of Financial Accounting Standards Board (FASB), Accounting Standards Codification (ASC) 842, Leases, played out much like the plot of the 1985 classic, Rocky IV. After Rocky Balboa reclaimed his championship title from Clubber Lang, he planned to relax and spend time with his family. Unfortunately for Rocky (SPOILER ALERT), Ivan Drogo killed his friend, Apollo Creed, and the boxing gloves had to be laced up once again.
Subsequent to the adoption of FASB ASC 606, Revenue from Contracts with Customers, it seemed like the perfect time to relax and enjoy the fruits of our labor. Unfortunately for your friendly neighborhood auditor, ever lasting peace was just not meant to be. The FASB issued ASC 842, Leases, shortly thereafter.
Rocky and I learned a lot along during our respective journeys. Originally, I felt that the effort to recognizing right-of-use assets and lease liabilities on the balance sheet outweighed the benefit. Over time, I began to appreciate the nuances of the standard. That said, a couple significant issues persisted with respect to common control leases.
- Lease term and legal enforceability
- The amortization of leasehold improvements
The FASB met last month to discuss these pressing matters.
Issue 1. The FASB agreed to expose a practical expedient, which clarifies the accounting. The FASB agreed on Approach 1A, which amends ASC 842, Leases, to specify that an entity would consider only written terms and conditions in relation to leases. An entity would not be required to determine whether those written terms and conditions are legally enforceable. If approved, the practical expedient would reduce the cost and complexity, as there would no longer be a need to consider legal enforceability of common control agreements. It would, however, create the question of how to amortize leasehold improvements by a lessee for common control leases, which is covered in issue 2.
Issue 2. How should entities account for leasehold improvements with a life in excess of the lease for common control lease arrangements?
- Approach 1A – No change – Amortize over the shorter of the useful life of the asset or the remaining lease term.
- Approach 2B – Amortized by the lessee over the useful life of the improvements, regardless of the lease term, if the lessee continues to use the underlying assets, and then accounted for as a transfer between entities under common control if, and when, the lessee ceases using the underlying asset.
Much like the boxing match between Ivan and Rocky, the debate among FASB members was intense, with valid points made on each side. Being the accounting and auditing geek that I am, I was on the edge of my seat. The decision could have gone either way, but in a split decision, the FASB chose Approach 2B, which in my humble opinion, was the correct decision. In fact, this subject was the primary reason I did not like the new lease standard to start with, as it effectively changed the economics of the transaction. Approach 2B allows common control entities to amortize leasehold improvements over the life of the asset and upon the termination of the lease, transfer any residual value to the common control lessor.
An exposure draft is currently being developed by the FASB with an expected comment period of 45 days. More details and guidance are expected to follow soon. So to paraphrase Rocky,
“During the [development of Topic 842], I’ve seen a lot of changing, in the way you feel about me, and in the way I feel about you. In here, there were two guys killing each other, but I guess that’s better than twenty million. I guess what I’m trying to say, is that if I can change, and you can change, everybody can change!”
This blog post was authored by Michael Westervelt. Thanks Mike!
- Carey M. Heyman, CPA
- Managing Principal of Industry - Real Estate
- CliftonLarsonAllen LLP
- Century City (Los Angeles)
Carey is the Managing Principal of the Real Estate Industry at CLA. He is a trusted advisor with close to 20 years of experience providing accounting, assurance, tax, and consulting services to real estate industry owners, operators, family offices, developers and syndicators. Carey has a strong track record of helping clients build and retain capital by leveraging tax- and cost-saving strategies and employing tax credits and incentives. He also consults with high net worth individuals, large family groups, and owners of closely-held businesses on all aspects of tax planning, estate planning, and retirement planning.
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