The FASB is at it again. With the private-company adoption getting closer every day, the board just released some information on a highly debated topic: Related-Party Leases. The previous guidance on these transactions had been a little fuzzy, so this clarification is welcome.
Under the current GAAP framework, companies are required to determine the legal enforceability of the terms and conditions for related-party leases whether the agreement is in writing or not. Private-company stakeholders and practitioners have notified the FASB that this analysis is difficult in practice and is being applied with varying levels of diligence. As a result, the FASB has recently voted to issue a proposal to amend the required procedures for analyzing related-party transactions.
The FASB has tentatively decided to allow companies to elect a practical expedient to avoid determining the legal enforceability of written terms and conditions for leases between related parties.
Here is the tentative board decision in their own words:
For arrangements between entities under common control, the Board decided to amend Topic 842, Leases, to provide entities within the scope of paragraph 842-10-65-1(b) (that is, entities that are not public business entities, not-for-profit bond obligors, or employee benefit plans that file or furnish financial statements with or to the U.S. Securities and Exchange Commission) a practical expedient to use written terms and conditions for:
- Determining whether a lease exists and, if so,
- The classification and accounting for that lease.
An entity applying the practical expedient would not be required to determine whether those written terms and conditions are legally enforceable. If no written terms and conditions exist, an entity would apply Topic 842 on the basis of the legally enforceable terms of an arrangement. If an entity determines that a lease does not exist, other GAAP would apply. The Board also decided that the practical expedient could be applied on an arrangement-by-arrangement basis.
This practical expedient is not intended to provide a loophole for unwritten or implicit terms and conditions. As one FASB board member stated, “If no written terms and conditions exist, an entity would apply the existing topic 842 requirements to any verbal or implicit terms and conditions. That is, entities would use legally enforceable oral and implicit terms to determine if a lease exists, and, if so, to classify and account for the lease. If an entity concluded that a lease did not exist, other GAAP would apply.”
Based on comments from the board members during the meeting, the board’s official release of this practical expedient is likely to include language addressing the ability for companies to retroactively document these arrangements as of the transition date to ASC 842.
What does this mean for accountants in practice? The takeaway is that getting lease agreements in writing between related parties has immense benefits. If the deal is on paper, then there will be no need to do an analysis of legal enforceability. Of course, this update is not quite finalized but is likely to be issued in the fourth quarter of 2022 with a 45-day comment period. Keep your fingers crossed that this one sticks.