Related Party Leases in Construction: Structuring for Compliance and Benefit
In the construction industry, related party leases can be common particularly for privately held companies who lease facilities from entities under common control. Under U.S. Generally Accepted Accounting Principles (GAAP), specifically Accounting Standards Codification (ASC) 842, related party leases under common control can be complex to determine appropriate treatment under GAAP. This is especially true when there are no written terms and conditions for the lease. Here’s a comprehensive look at how to account for related party leases under common control within GAAP.
Understanding Related Party Leases Under Common Control Within GAAP
ASC 842, introduced by the Financial Accounting Standards Board (FASB), significantly changed how leases are reported in financial statements. It requires lessees to recognize lease liabilities and right-of-use (ROU) assets on the balance sheet. This standard applies to both related-party and third-party leases.
What are GAAP Requirements for Related Party Leases Under Common Control?
The following outline key GAAP requirements for related party leases under common control:
Lease Classification: Determine whether the lease is an operating lease or a finance lease. For related party leases under common control, the classification should be consistent with how the arrangement would be treated regardless of the lessee’s relationship to the lessor.
Disclosure Requirements: Disclosure requirements for all related party leases, regardless of whether common control exists, are specified by FASB ASC 850, Related Party Disclosures. Additional requirements, above those for ASC 842, are required for related party leases and should be considered whenever such a relationship exists. The ultimate goal of disclosure is to ensure that there is enough information included in an entity’s financial statements in order to allow a respective reader of the company’s financial statements to understand the effect of various related party transactions which would include leases.
Best Practices When Accounting for Related Party Leases
Establish Lease Terms in Writing: It can be common for related party leases to not be formally documented depending on the entity’s situation. However, it can be advantageous to consider to formally document the terms and conditions of the lease to help document the length of the lease, lease cost, etc.
Common Disclosure Considerations: Some common requirements for disclosure of related party leases include the following:
- The nature of the related party lease and relationship (i.e., from an entity under common control)
- Term of the lease
- Payment amount as well as any escalation clauses
- Renewal options, if any, and whether they have been included as required under ASC 842
- Discount rate used in accordance with ASC 842
- Total lease expense for the periods presented
- Leasehold improvements to the property, their amortization period and balance as of the balance sheet date(s)
- Description of any other relevant terms such as restrictions, covenants, subleases, etc.
Windham Brannon Can Help
Related party leases in the construction industry, while offering strategic advantages, must be carefully structured and accounted for in accordance with GAAP requirements under ASC 842. As with any accounting standard that can require significant estimates, working closely with a team of trusted advisors can be paramount to a company’s success. Windham Brannon’s Construction Practice is ready to help you and your organization tackle your pain points with ASC 842 and accounting for related party leases – for questions or more information, contact your Windham Brannon advisor today, or contact Bobby Vercoe.
