Understanding FASB’s Proposed ASU on Common Control Lease Arrangements

In October 2023, the Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update (ASU) intended to clarify how entities apply lease accounting guidance when leases occur between entities under common control. This update stems from continuing concerns over how current standards — particularly Topic 842 under the Accounting Standards Codification — are applied when leases involve related parties that share common ownership or governance.

Background: Why This Matters

Lease accounting has been an area of significant focus for the profession in recent years. Topic 842, which modernized lease accounting and eliminated off-balance sheet treatment for many leases, applies equally to leases between unrelated parties and those between entities under common control. However, certain challenges surfaced when Topic 842 was implemented, especially for private companies and nonprofit organizations that frequently enter into leasing arrangements among related entities.

Under the original Topic 842 guidance, entities determine whether an arrangement contains a lease and how to account for it based on legally enforceable terms and conditions. But for common control arrangements — where entities are governed or owned by the same party — defining legally enforceable terms and interpreting their economic substance can be burdensome, subjective, and costly.

Key Changes Proposed in ASU 2023-01

The proposed ASU addresses two core issues that arise specifically in the context of common control lease arrangements:

1. Practical Expedient for Lease Identification and Classification

One of the most significant proposals provides a practical expedient to simplify how certain entities determine whether an arrangement is a lease and how it should be classified under Topic 842.

• Who may elect this? The proposed practical expedient is available to private companies and certain not-for-profit entities that are not conduit bond obligors.

• What does it allow? Instead of assessing whether lease terms and conditions are legally enforceable — which can require legal analysis — eligible entities could elect to use the written terms of the arrangement to determine whether a lease exists and how it should be classified and accounted for.

• Application: This practical expedient may be applied on a lease-by-lease basis, offering flexibility without changing the underlying economics of Topic 842.

This change acknowledges that common control arrangements often lack the negotiation and legal enforcement mechanisms found in third-party transactions, yet still require appropriate and transparent financial reporting.

2. Accounting for Leasehold Improvements

The proposed ASU also revises guidance on how leasehold improvements should be amortized when leases are between entities under common control:

• Previously, amortization of leasehold improvements was based on the shorter of the lease term or the useful life of the improvements.

• Under the proposed update, entities would amortize leasehold improvements over the estimated useful life of the improvements to the common control group, as long as the lessee controls the use of the leased asset.

This change aims to better reflect the economic reality of many common control arrangements, where leases may be short in duration but the associated leasehold improvements have value extending well beyond the formal lease term.

When the lessee no longer controls the use of the asset, any remaining unamortized balance would be recognized as an equity adjustment (for example, a transfer between common control entities).

Effective Date and Transition

FASB intends these amendments to be effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted, which can benefit entities still finalizing their transition to Topic 842.

Entities that have already adopted Topic 842 can choose to apply the new guidance either prospectively — focusing on new or modified arrangements — or retrospectively to the beginning of the period in which Topic 842 was initially adopted.

Why This Update Is Important

These proposals represent a thoughtful response to practical challenges faced by organizations with common control lease arrangements. Key benefits include:

• Reduced cost and complexity: The practical expedient eliminates the need for legal enforceability assessments in many situations, lowering implementation costs for private and nonprofit entities.

• Better economic representation: Amortizing leasehold improvements over their use to the common control group enhances the relevance and comparability of financial statements.

• Maintained transparency: The proposed guidance retains the core principles of Topic 842 while accommodating the unique nature of common control relationships.

By refining how lease accounting applies in these cases, the FASB aims to improve both the usability and accuracy of financial reporting for related-party leases. For many organizations — particularly those with complex internal structures — these updates provide clarity and reduce accounting friction.