The Financial Accounting Standards Board (FASB) regularly issues Accounting Standards Updates (ASUs) to make changes to the FASB Codification, the primary source of Accounting Principles Generally Accepted in the United States (GAAP). Below is an ASU that was recently issued, ASU 2022-04, Liabilities – Supplier Finance Programs (Subtopic 405-50) Disclosure of Supplier Finance Program Obligations. Also highlighted below is a possible FASB update to address concerns with applying ASC 842, Leases to leases between entities under common control.
ASU 2022-04, Liabilities – Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations
The FASB has issued ASU 2022-04, Liabilities – Supplier Finance Programs (Subtopic 405-50) Disclosure of Supplier Finance Program Obligations. This ASU includes new disclosure requirements for supplier finance programs, also known as structed payables, reverse factoring, and payables finance arrangements. Prior to this ASU, there were no GAAP disclosure requirements for these programs, and these obligations were often presented in total on the balance sheet with accounts payable or other liabilities depending on the terms of the arrangement and with little or no disclosure.
Supplier finance programs allow a buyer to offer its supplier the option to be paid by a third party in advance of an invoice date based on the invoices that have been confirmed as valid by the buyer. This type of program allows suppliers to use the credit of their buyers and often allows the supplier to finance working capital at a lower rate of interest compared to alternative financing sources.
The amendments in this ASU require disclosures of the program’s qualitative and quantitative information to ensure users of the financial statements understand the nature of the program, the activity during the period, period-over-period changes, and the potential magnitude that the program has on the financial statements as a whole.
Specifically, in each reporting period the buyer should disclose the following:
- Program terms such as:
- Payment timing and the basis used for its determination
- Guarantees or pledged assets provided for the committed payment to the finance provider or intermediary
- For the obligations that the buyer has confirmed as valid to the finance provider or intermediary:
- The unpaid amount by the buyer as of the end of the annual period (confirmed amount outstanding)
- A description of where on the balance sheet these obligations are presented
- A roll forward of the obligations during the period showing the amount of obligations confirmed and subsequently paid
The disclosure requirements only apply to buyers. The ASU did not require any disclosures for suppliers participating in supplier finance programs. Also, there were no changes in the ASU regarding the recognition, measurement, or financial presentation of obligations covered by supplier finance programs.
Effective Date and Transition
The amendments are effective for fiscal years beginning after Dec. 15, 2022, except for providing the disclosure of roll forward information which is effective for fiscal years beginning after Dec. 15, 2023. Early adoption is permitted. The amendments should be retrospectively applied to each period, except for roll forward information which is to be applied prospectively.
ASC 842, Leases: Possible Update on Related Party Leases Under Common Control
For most nonpublic entities, ASC 842, Leases is effective for fiscal years beginning after Dec. 15, 2021, meaning many of these entities are using the new guidance for the first time in their Dec. 31, 2022 calendar year-end financial statements. As nonpublic entities prepare to adopt ASC 842, questions continue to arise about the treatment of leases between related parties and associated leasehold improvements. Particularly for leases between parties under common control, written lease agreements may be outdated or a lease agreement may never have been in writing. Additionally, lessees may have invested in significant leasehold improvements associated with such leases.
Under the old lease standards in ASC 840, this issue did not have a significant impact on financial reporting. The leases were considered operating leases, and the lease payments were expensed. However, under ASC 842, operating leases create right-to-use assets and lease liabilities on the statement of financial position of the lessee, which requires additional focus on the accounting for leases between entities under common control.
Currently, ASC 842-10-55-12 states that, “Leases between related parties should be classified in accordance with the lease classification criteria applicable to all other leases on the basis of the legally enforceable terms and conditions of the lease.” Further, the Basis for Conclusions for Accounting Standards Update (ASU) 2016-02, Leases (Topic 842) explains that “the recognition and measurement requirements for all leases should be applied by lessees and lessors that are related parties on the basis of legally enforceable terms and conditions of the arrangement, acknowledging that some related party transactions are not documented and/or the terms and conditions are not arm’s length.”
ASC 842 shifts the focus on the treatment of related party leases from economic substance to legal enforceability. Under ASC 842, the lessee has no enforceable rights or obligations when both the lessee and the lessor have the right to terminate the lease without permission from the other party with no more than an insignificant penalty. With the shift to the importance of legal enforceability, entities may need assistance from legal counsel to determine the accounting for these leases. The FASB believed this shift would simplify the accounting; however, many preparers find the guidance to be unclear when applying the guidance to their related party leases.
Also under ASC 842, the amortization period for leasehold improvements cannot be longer than the lease term of the associated lease, unless the lease transfers ownership of the underlying assets. Therefore, without a legally enforceable lease, investments in leasehold improvements would not be capitalizable.
On Sept. 21, 2022, the FASB added a project to its technical agenda regarding arrangements between entities under common control in response to the continued questions on leases between entities under common control.
The objective of the project is to address two issues related to these types of arrangements:
What terms and conditions an entity should consider for:
- Determining whether a lease exists, and if so,
- The classification and accounting for that lease
Tentative Decisions: The FASB has tentatively decided to include a practical expedient as it relates to the existence, classification, and accounting of a lease between entities under common control which would be available for most nonpublic business entities. Under the practical expedient, an entity could use written terms and conditions in those considerations without determining whether they are legally enforceable. If no written terms and conditions exist, an entity would apply ASC 842 based solely on the legally enforceable terms of an arrangement. If no legally enforceable terms exist, other accounting principles would apply. Application of this practical expedient could be applied based on the terms of individual agreements.
Accounting for leasehold improvements associated with leases between entities under common control.
Tentative Decisions: The FASB has tentatively decided that for all entities with leases between entities under common control, the associated leasehold improvements should be accounted for as follows:
- Amortize the leasehold improvements over their economic life as long as the lessee continues to use the underlying asset. If the asset was obtained by the lessor through a lease with an entity that is not under common control, the economic life used for amortization by the lease should not exceed the lease term associated with the lessor’s lease with the entity not under common control.
- When the lessee ceases using the underlying asset, account for any remaining leasehold improvements as a transfer between entities under common control.
Disclosures would be required for leasehold improvements in which the economic life is longer than the associated lease term.
The tentative FASB decisions are not official changes to the Accounting Standards Codification and do not currently change the application of ASC 842. Therefore, the above tentative decisions are subject to change. The FASB directed staff in late Sept. 2022 to draft a proposed ASU including the above tentative decisions with a comment period of 45 days.
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