As another year ends, accountants will once again be thinking about their year-end financial close process. A key aspect of this process is ensuring their organization has properly implemented the accounting guidance that became effective in 2022.
In our May accounting update insights article, we summarized the Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) effective for non-public entities in their December 31, 2022, financial statements. The ASUs effective in 2022 cover many topics including government assistance (PPP loans, ERC credits, PRF funds, or other programs), stock compensation valuation (potentially easing the valuation process), presentation of contributed nonfinancial assets (applicable to not-for-profit entities), and more.
Below is a listing of the ASUs effective for non-public business entities in 2022.
While the impact of these ASUs will vary from entity to entity, one new accounting standard that will have broad applicability is the new lease standard.
2022 is the year the new lease standard became effective for most entities. Public companies and not-for-profit entities with conduit debt were required to adopt the new lease standard earlier. The standard became effective for most other entities on January 1, 2022.
While the new lease standard doesn’t result in significant changes to the accounting for capital leases, which are now called finance leases, or to lessor accounting, the new lease standard does bring significant changes to the accounting for operating leases of a lessee. Operating leases of a lessee were previously not reflected in the lessee’s balance sheet. Instead, future commitments under operating leases were disclosed in the financial statement footnotes.
Under the new lease standard lessees are required to recognize lease liabilities reflecting the lease obligations in their balance sheet along with a related right-of-use asset. The impact of this change will vary from entity to entity, but as we have seen with the companies that have already adopted the standard, the new standard can result in material changes to an entity’s balance sheet.
One project recently added to FASB’s technical agenda is related to common control lease arrangements. Common control leases are common in private companies who often have an operating entity for the business operations and a leasing entity that leases space to the operating entity, both of which are under common control. In their deliberations, FASB noted they had received feedback about challenges faced by stakeholders in applying the new lease standard to common control lease arrangements.
FASB added the project to address two issues related to arrangements between entities under common control. The first issue is what terms and conditions an entity should consider for determining whether a lease exists and, if it determines a lease exists, the classification and accounting for that lease. The second issue is the accounting for leasehold improvements associated with leases between entities under common control.
The project advanced to the next stage on November 30, 2022, when FASB issued an exposure draft of ProposedAccounting Standards Update - Leases (Topic 842): Common Control Arrangements. FASB issues exposure drafts when it wants to solicit public comment on a proposed accounting standard. After the public comment period, FASB evaluates the feedback, determines if modifications are needed to the proposed accounting standard, and determines if a proposed accounting standard should be issued. The following is a summary of the proposals included in the exposure draft.
Issue 1: Terms and Conditions to be Considered in Evaluating Common Control Leases
The new lease standard requires entities to evaluate if a contract is or contains a lease. A contract is defined as an arrangement that creates enforceable rights and obligations. FASB received feedback from private company stakeholders that applying the new lease standard to common control arrangements was uniquely challenging, because the entire arrangement (lessor entity and lessee entity) is controlled by one party or a control group. This poses issues in determining the legally enforceable terms and conditions of those arrangements since the controlling party or control group typically can amend the terms and conditions of a common control arrangement at any time without approval by the lessor or lessee.
To address those difficulties, the exposure draft proposes a practical expedient allowing entities under common control to use the written terms and conditions in determining whether the arrangement is or contains a lease and, if a lease exists, in classifying and accounting for the lease. Following the written terms and conditions would be a simpler approach to evaluating common control arrangements than evaluating what is legally enforceable. The exposure draft also proposes allowing this practical expedient on an arrangement-by-arrangement basis, which would provide additional flexibility to entities to decide for each common control arrangement if following the written terms and conditions or evaluating the legally enforceable terms and conditions is best for that arrangement.
If no written terms or conditions exist, entities would need to evaluate the legally enforceable terms and conditions.
The exposure draft also proposes permitting entities to document any existing unwritten terms and conditions of an arrangement between entities under common control before the date on which the entity’s first interim or annual financial statements are available to be issued with the proposed amendments. This would allow entities who have not yet issued interim or annual financial statements under the new standard to put unwritten terms and conditions in writing and to follow the now written terms and conditions in evaluating their common control arrangements as part of preparing their financial statements under the new lease standard.
The proposed practical expedient would only apply to private companies and not-for-profit entities that are not conduit bond obligors.
Issue 2: Accounting for Leasehold Improvements in Common Control Leases
The new lease standard currently requires that leasehold improvements be amortized over the shorter of the remaining lease term or the useful life of the leasehold improvements. FASB received feedback from private companies that it is not unusual for common control leases to have short lease terms and for the lessee to invest in leasehold improvements with an economic life that far exceeds the term of the lease. This could result in the lessee fully amortizing leasehold improvements over a period shorter than the economic life of the improvements and financial reporting that does not represent the economics or common control nature of the improvements. Additionally, FASB noted that diversity in practice may exist in the accounting for these leasehold improvements.
To address those concerns, the exposure draft proposes requiring that leasehold improvements between entities under common control be amortized by the lessee over the economic life of the improvements as long as the lessee controls the use of the underlying asset.
The economic life would be used regardless of the lease term unless the lessor obtained the right to control the underlying asset through a lease with a party that is not under the same common control group. If the right to control the underlying asset was obtained through a lease with a party outside of the same common control group, the amortization period could not exceed the lease term associated with the lessor’s lease with the other party.
When the lessee no longer controls the use of the underlying asset, any remaining value of the leasehold improvement would be accounted for as a transfer between entities under common control through an adjustment to equity (or net assets for not-for-profit entities).
The proposed accounting for leasehold improvements associated with common control leases would apply to all entities.
Additional Updates Related to the Exposure Draft
The exposure draft includes a comment due date of January 16, 2023. We will continue to monitor the project and will provide an update and guidance if an ASU is issued to address these issues.
Our first accounting update for 2022 discussed two ASUs that the FASB had issued through May 2022 (ASU 2022-02—Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures and ASU 2022-01—Derivatives and Hedging (Topic 815): Fair Value Hedging—Portfolio Layer Method). Since then, FASB has issued two additional ASUs. As summarized below, ASU 2022-03 addresses how to account for equity securities that are subject to contractual sale restrictions and ASU 2022-04 requires enhanced disclosures of supplier finance program obligations.
|2022-04—Liabilities—Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations|
Summary: This ASU enhances the transparency of supplier finance programs by requiring disclosures related to the programs. A supplier finance program is an arrangement that allows a buyer to offer its suppliers access to payment in advance of the invoice due date. This access to early payment is generally provided by a third-party based on the invoices that the buy confirms are valid. These programs are becoming increasingly popular as they provide suppliers with cash flows more quickly than waiting for the invoice due date.
Disclosure requirements under the ASU include:
|Effective date all entities||Fiscal years beginning after December 15, 2022 (interim periods within those fiscal years, except the amendment on rollforward information, which is effective for fiscal years beginning after December 15, 2023)|
|2022-03—Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions|
Summary: This ASU provides clarification on the accounting for equity securities that contain contractual sale restrictions by clarifying that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. Additionally, the ASU clarifies that an entity cannot, as a separate unit of account, recognize and measure a contractual sale restriction.
This means that while an entity may have contractually agreed to restrict the sale of an investment for a period of time, that restriction doesn’t affect the principal (or most advantageous) market that would be available to sell the securities once the contractual sale restriction has passed. As such, the equity security should be valued based on the principal (or most advantageous) market on the measurement date without regard to the contractual sale restriction.
The ASU also requires certain disclosures related to equity securities with contractual sale restrictions.
Investment companies as defined under Topic 946, Financial Services – Investment Companies, should apply the amendments in the ASU to contractual sale restrictions executed or modified on or after the date of adoption. All other entities should apply the amendments prospectively.
|Effective date for PBEs||Fiscal years beginning after December 15, 2023 (interim periods within those fiscal years)|
|Effective date for non-PBEs, except for investment companies||Fiscal years beginning after December 15, 2024 (interim periods within those fiscal years)|
Do you know which accounting standards apply to your entity? Figuring out what affects your organization can be complicated.