Chapter 10 — Sale-and-Leaseback Transactions

10.3 Determining Whether the Transfer of an Asset Is a Sale

The sale-and-leaseback accounting guidance in ASC 842-40 is aligned with ASC 606 in that both focus on the notion of control transfer. In other words, the seller-lessee and buyer-lessor must determine whether the seller-lessee transfers to the buyer-lessor control of the underlying asset. If so, the transfer of the asset is a sale and both parties may apply successful sale-and-leaseback accounting. If not, the transaction is economically a financing arrangement for both parties and must be accounted for as such.

The decision tree below illustrates how the seller-lessee and buyer-lessor would perform the control transfer assessment.

Changing Lanes

Transfer of Control Is a Simpler Concept for All Asset Types

ASC 842-40 is simpler than ASC 840-40 with respect to using the transfer of control of an underlying asset in a transaction to determine when a sale has occurred and sale-and-leaseback accounting may be applied. The sale-and-leaseback accounting guidance in ASC 840 differed depending on the type of asset and is, by design, very onerous for real estate assets. Specifically, under ASC 840-40, a seller-lessee of real estate was required to perform a comprehensive and complex assessment of the continuing-involvement provisions of the legacy real estate sales guidance in ASC 360-20.

Going forward, and in a manner consistent with ASC 606, transferring control of — and thus selling — real estate is treated no differently than transferring control of any other type of asset. In other words, while there is an intentionally high hurdle under ASC 360-20 with respect to demonstrating that real estate has been sold for accounting purposes (and thus that a sale-and-leaseback has occurred) and control has been transferred, ASC 606 (and thus ASC 842-40) establishes no such hurdle.

As a result, we think that seller-lessees will find that the sale-and-leaseback accounting guidance in ASC 842-40 is easier to apply to real estate than the accounting requirements in ASC 840-40.

Connecting the Dots

Seller-Lessee and Buyer-Lessor May Reach Different Conclusions

As noted in Section 10.2.1, the buyer-lessor in a transaction involving the transfer and lease of an underlying asset is subject to the sale-and-leaseback accounting guidance in ASC 842-40. That is, the buyer-lessor must assess whether it obtains control of the underlying asset before leasing it back to the seller-lessee.

However, although the accounting requirements are symmetrical, there is no requirement in ASC 842-40 for the seller-lessee and buyer-lessor to reach symmetrical conclusions about whether a sale has occurred. Accordingly, it may be reasonable for the seller-lessee and buyer-lessor to reach different conclusions about whether control of the underlying asset is transferred from the seller-lessee to the buyer-lessor. This could be the case when the two entities’ judgments about the following are different:

Lease classification assumptions (e.g., the economic life and fair value of the asset; the discount rate to be used), when one entity concludes that the lease is a finance lease or a sales-type lease and the other does not.
Control indicators in ASC 606-10-25-30, when one entity concludes that control has been transferred to the buyer-lessor and the other does not (see the next section).

This could also be the case when the buyer-lessor has adopted ASU 2021-05 (see Section 17.3.1.8) and is required to classify certain leases with significant variable lease payments that do not depend on an index or rate as an operating lease on the lease commencement date.

10.3.1 Transfer of Control in Accordance With ASC 606

ASC 842-40

25-1 An entity shall apply the following requirements in Topic 606 on revenue from contracts with customers when determining whether the transfer of an asset shall be accounted for as a sale of the asset:

Paragraphs 606-10-25-1 through 25-8 on the existence of a contract
Paragraph 606-10-25-30 on when an entity satisfies a performance obligation by transferring control of an asset.

The FASB decided that for an entity to apply the sale-and-leaseback accounting guidance in ASC 842-40, it is necessary for control of the asset to be transferred in accordance with ASC 606. Under ASC 606, the notion of control transfer governs the determination of when to recognize revenue. That is, an entity recognizes revenue when it transfers control of a good or service to a customer. For more information about the control transfer notion in ASC 606, see Deloitte’s Roadmap Revenue Recognition.

When appropriate, the FASB has tried to make its use of the control transfer notion consistent with that in ASC 606. For example, like ASC 842-40, the guidance in ASC 610-20 on sales of nonfinancial assets to noncustomers relies on the concepts in ASC 606 related to determining when control of a nonfinancial asset is transferred. (See Chapter 17 of Deloitte’s Roadmap Revenue Recognition for further discussion.) In addition, when developing ASC 842, the FASB changed the lessor model to make it more consistent with the control transfer concepts in ASC 606. (See Chapter 9 for further discussion of the lessor accounting model in its entirety.) Accordingly, having developed a robust control transfer framework related to determining when a sale occurs, the FASB acknowledges in paragraph BC350 of ASU 2016-02 that it was appropriate to use that same framework to determine when to apply sale-and-leaseback accounting.

10.3.1.1 Identifying the Contract

Step 1 of the revenue model requires that a contract exist. This requirement is necessary to establish that there is a valid transaction with economic substance and that it is thus appropriate to proceed with applying the rest of the model in ASC 606 and recognize revenue. The same can be said for the requirements in ASC 842-40-25-1(a); if a contract does not exist for accounting purposes, it would be inappropriate to conclude that the seller-lessee has transferred control of — and sold — an asset to the buyer-lessor.

Generally, when a contract has legally enforceable rights and obligations, it will meet the criterion in ASC 842-40-25-1(a). However, both the seller-lessee and the buyer-lessor should assess any such transaction in accordance with ASC 606-10-25-1 through 25-8. Chapter 4 of Deloitte’s Roadmap Revenue Recognition contains a comprehensive analysis of these requirements in ASC 606, and an entity should use that analysis in evaluating whether the criterion in ASC 842-40-25-1(a) is met.

10.3.1.2 Transferring Control at a Point in Time

Once a seller-lessee and a buyer-lessor apply the guidance on identifying a contract in ASC 606 and conclude that a contract exists, each party must assess whether control of the underlying asset has been transferred to the buyer-lessor at a point in time. This assessment of control is also required for asset sales that are accounted for under ASC 610-20, including sales of assets in exchange for legal-entity ownership.

Connecting the Dots

Buyer-Lessor Must Use ASC 606 to Determine Whether It Has Purchased the Asset

As noted in Section 10.2.1, a buyer-lessor must assess whether it has obtained control of the underlying asset in a transfer and lease arrangement to determine whether it has purchased the asset and must apply the sale-and-leaseback accounting guidance in ASC 842-40. Accordingly, the buyer-lessor effectively applies the revenue recognition guidance in ASC 606 to determine whether it has obtained control of the underlying asset. If so, the arrangement reflects a purchase of the underlying asset and the buyer-lessor must recognize that asset.

No other standards in U.S. GAAP (e.g., ASC 805, ASC 330, ASC 350, ASC 360) contain a requirement under which a buyer of an asset uses the control transfer notion developed for revenue recognition to determine when it has obtained control of the asset and must recognize that asset.

In accordance with the control transfer principle in ASC 606-10-25-25, to have control, the buyer-lessor must have “the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset.” Further, under ASC 842-40-25-1(b), the parties to the contract should use the guidance and indicators in ASC 606-10-25-30 to determine whether and, if so, when control has been transferred to the buyer-lessor.

However, paragraph BC155 of ASU 2014-09 cautions that the indicators in ASC 606-10-25-30 “are not a list of conditions that must be met before an entity can conclude that control of a good . . . has transferred to a customer.” Rather, the indicators “are a list of factors that are often present if a customer has control of an asset and that list is provided to assist entities in applying the principle of control.” Accordingly, an entity must assess all relevant facts and circumstances to determine when control has been transferred to the buyer-lessor.

The implementation guidance in ASC 842-40 contains an example of when certain contractual provisions — in this case, a seller-provided residual value guarantee — may lead to different conclusions about whether control of the asset has been transferred to the buyer-lessor in accordance with ASC 606-10-25-30.

ASC 842-40

55-20 The seller-lessee may guarantee to the lessor that the residual value will be a stipulated amount at the end of the lease term. If the transfer of the asset is a sale in accordance with paragraphs 842-40-25-1 through 25-3, the seller-lessee residual value guarantee should be accounted for in the same manner as any other residual value guarantee provided by a lessee.

55-21 The residual value guarantee does not, on its own, preclude accounting for the transaction as a sale and leaseback, but should be considered in evaluating whether control of the asset has transferred to the buyer-lessor in accordance with paragraph 606-10-25-30. For example, a significant residual value guarantee by the seller-lessee may affect an entity’s consideration of the transfer of control indicator in paragraph 606-10-25-30(d).

ASC 842-40-55-21 above is careful to note that (1) the seller-provided residual value guarantee may (or may not) affect an entity’s assessment of the indicator in ASC 606-10-25-30(d) (i.e., whether significant risks and rewards of ownership have been transferred to the buyer-lessor) and (2) an entity’s assessment of the indicator in ASC 606-10-25-30(d), by itself, is not determinative of whether control of the asset has been transferred. These points are further emphasized in paragraph BC353 of ASU 2016-02, where the FASB acknowledges that “there may be substantial judgment involved in determining whether a sale has occurred.”

Paragraph BC353 of ASU 2016-02 goes on to note that, because of the significant judgments involved, an assessment of the indicators in ASC 606-10-25-30 may depend on the facts and circumstances of an arrangement:

For example, in determining when and whether a sale occurs, a seller-lessee may conclude that the buyer-lessor has obtained control of the asset if the buyer-lessor has obtained legal title to the asset, the seller-lessee has a present right to payment for the asset for the sale price, and the buyer-lessor has accepted the significant risks and rewards of ownership. In contrast, an entity may not reach the same conclusion if, for example, the seller-lessee provides a significant residual value guarantee such that the buyer-lessor has not accepted the significant risks and rewards of ownership. If the buyer-lessor has not accepted the significant risks and rewards of ownership . . . , careful evaluation of the facts and circumstances to determine when and whether a sale occurs in accordance with the principle in Topic 606 may be required.

Connecting the Dots

Potential for Additional Emphasis on Risks and Rewards

In applying the indicators in ASC 606-10-25-30 to a typical sale-and-leaseback transaction, an entity may need to place additional emphasis on its assessment of whether the buyer-lessor has obtained the significant risks and rewards of owning the underlying asset. In a typical sale-and-leaseback transaction, the buyer-lessor takes legal title to the underlying asset and is obligated to pay the seller-lessee for the asset. However, the seller-lessee generally retains physical possession of the underlying asset through the leaseback, and the buyer-lessor’s acceptance of the asset is generally not applicable. Accordingly, additional emphasis may need to be placed on (1) assessing contractual provisions that affect whether the risks and rewards of owning the underlying asset are conveyed to the buyer-lessor and (2) the control principle in ASC 606, to the extent that an assessment of the indicators in ASC 606-10-25-30 alone does not prove conclusive in the determination of which party has control.

In addition, ASC 606-10-25-30 directs entities to consider not only the indicators listed therein but also the guidance in ASC 606 on repurchase agreements and their effect on control transfer. See Section 10.3.3 for further discussion of repurchase options.

Therefore, we think that a seller-lessee and a buyer-lessor should consider the comprehensive discussion in Section 8.6 of Deloitte’s Roadmap Revenue Recognition about when control of an asset is transferred at a point in time. Further, Section 8.7 of Deloitte’s Roadmap Revenue Recognition includes a robust discussion of the guidance that applies when repurchase agreements affect an entity’s conclusion about whether control of a good has been transferred.

Connecting the Dots

Relinquishing Control Is Not Enough

Conceptually, the transfer of control can be assessed from both the buyer’s and the seller’s perspective; however, the principle in ASC 606 is clear that control should be viewed from the buyer’s perspective. While the timing of control transfer will often be the same from both perspectives (i.e., when the seller surrenders control and the buyer obtains control), under ASC 606-10-25-30 — and thus under ASC 842-40-25-1(b) — the transfer of control is determined on the basis of “the point in time at which a customer obtains control of a promised asset.” Accordingly, to proceed with applying the sale-and-leaseback accounting guidance in ASC 842-40, an entity must perform an assessment from the perspective of the customer and conclude that the buyer-lessor has obtained control of the asset.

While the FASB decided that an entity should use the control transfer notion in ASC 606 to determine when a seller-lessee has sold an underlying asset to a buyer-lessor in a sale-and-leaseback transaction, the Board acknowledges in paragraph BC352 of ASU 2016-02 that the leaseback is a unique feature of such arrangements. Accordingly, the Board decided to clarify the application of ASC 606’s control transfer notion in sale-and-leaseback transactions as follows:

Under ASC 842-40-25-2, the existence of the leaseback, by itself, does not prevent the seller-lessee from transferring control of the underlying asset to the buyer-lessor. See the next section for further discussion.
ASC 842-40-25-2 further suggests that if the leaseback is classified by the seller-lessee as a finance lease (by the buyer-lessor as a sales-type lease), the seller-lessee retains control of the underlying asset. See the next section for further discussion.
In accordance with ASC 842-40-25-3, the seller-lessee retains control of the underlying asset if it holds an option to repurchase the asset, unless (1) the option is exercisable only at fair value and (2) there are alternative assets, readily available in the marketplace, that are substantially the same as the underlying asset. See Section 10.3.3 for further discussion.

10.3.2 Leaseback Is a Finance Lease or a Sales-Type Lease

ASC 842-40

25-2 The existence of a leaseback (that is, a seller-lessee’s right to use the underlying asset for a period of time) does not, in isolation, prevent the buyer-lessor from obtaining control of the asset. However, the buyer-lessor is not considered to have obtained control of the asset in accordance with the guidance on when an entity satisfies a performance obligation by transferring control of an asset in Topic 606 if the leaseback would be classified as a finance lease or a sales-type lease.

An operating lease, by itself, does not transfer control of the entire underlying asset to the lessee; rather, the operating lease transfers control of the right to use the underlying asset to the lessee for a period of time. The right to use an underlying asset for a period of time represents only certain rights associated with the entirety of the asset. The lessor retains all rights associated with the asset once it is returned by the lessee as well as other rights of ownership while the asset is out on lease. In addition, the lessor obtains benefits from the asset through payments made by the lessee during the lease and controls all benefits associated with the residual asset. Accordingly, while the underlying asset is out on lease, a lessor, when considering the principle in ASC 606-10-25-25 and the indicators in ASC 606-10-25-30, still controls the asset.

In paragraph BC352(a) of ASU 2016-02, the FASB indicates that the same is true when a buyer-lessor obtains control of the underlying asset in a sale-and-leaseback transaction. The fact that the buyer-lessor is a lessor of the underlying asset in an operating lease does not preclude the buyer-lessor from obtaining control of that asset. Paragraph BC352(a) of ASU 2016-02 further notes that a sale-and-leaseback transaction is no different from other types of lease arrangements, in which a lessor purchases an asset from a third-party dealer only when all the terms of the lease are in place and the lessor never receives physical possession until the end of the lease term.

However, paragraph BC352(b) of ASU 2016-02 states that when a lessor leases an underlying asset to a lessee under a finance lease or a sales-type lease, “the lessee, in effect, obtains the ability to direct the use of, and obtain substantially all the remaining benefits from, the underlying asset.” That is, the lessee obtains control of the entire underlying asset. See Chapters 8 and 9 for further discussion of the concepts behind lease classification by lessees and lessors, respectively.

Accordingly, when an asset is transferred and leased back through a finance lease or a sales-type lease, the seller-lessee never effectively transfers control of the underlying asset to the buyer-lessor. Thus, a sale of the underlying asset has not occurred and both parties should account for the arrangement as a financing.

Bridging the GAAP

No Leaseback Classification Restrictions in IFRS 16

As described in the Bridging the GAAP in Section 8.3.3.1, ASC 842 includes a dual-model approach for lessees under which a lease is accounted for as either a finance lease or an operating lease, but IFRS 16 prescribes a single-model approach for lessees under which all leases are accounted for in a manner similar to that under the U.S. GAAP accounting model for finance leases. As a result, IFRS 16 does not contain any leaseback classification restriction to sale accounting. See Appendix B for more information about the differences between ASC 842 and IFRS 16.

10.3.2.1 Real Estate With Finance or Sales-Type Leaseback of Building and Operating Leaseback of Land

In accordance with ASC 842-10-15-29, land must always be accounted for as a separate lease component unless the impact of doing so would be insignificant. Therefore, lease classification must be performed separately for land lease components and, as a result, there may be scenarios in which entities that engage in sale-and-leaseback transactions of real estate reach differing land and building leaseback classification conclusions. More specifically, because the economic life test is considered for building and not land (given its indefinite economic life), a building lease component may be classified as a finance or sales-type lease and land may be classified as an operating lease.

We believe that there may be two acceptable approaches to accounting for situations in which the real estate is single-tenant or single-floor real estate with a single combined title for the entire property, and the building (the finance or sales-type lease component) is a more than minor portion of the entire property:

Successful sale-and-leaseback of the combined parcel would be precluded — This approach is acceptable under ASC 606-10-25-30(b), which describes one of the indicators of the transfer of control as the transfer of legal title to the buyer-lessor, potentially establishing a unit of account for sale accounting purposes since the land and building are not separately titled. Accordingly, the sale of the land and building is one distinct performance obligation involving a binary outcome of an either successful or failed sale. As a result, if one of the lease components has a failed sale-leaseback (building) and comprises a more than minor portion, sale accounting would be precluded for the real estate property as a whole and neither the land nor the building would be derecognized.
Successful sale-and-leaseback of the land may be possible — This approach may also be acceptable. ASC 610-20-25-6 states that the sale of nonfinancial assets to noncustomers should be evaluated for “each distinct nonfinancial asset” and ASC 360-10 identifies land as a nondepreciating asset (i.e., an asset with different attributes compared with other PP&E assets within the scope of ASC 360-10). Accordingly, land may be treated separately for sale accounting purposes.

In addition, paragraph BC147 of ASU 2016-02, as well as the guidance in ASC 842-10-15-29 that requires preparers to identify land, when not insignificant, as a separate lease component, further supports the view that land is always a distinct asset. See Section 4.2.2 for more information.

We recommend that entities consult their auditors or accounting advisers in the situations described above. Further, similar considerations may arise when an entity sells an entire building (and, potentially, land) to another party (the buyer-lessor) and only leases back a portion of the building. See Section 10.3.5 for further details on those considerations.

10.3.3 Repurchase Options

ASC 842-40

25-3 An option for the seller-lessee to repurchase the asset would preclude accounting for the transfer of the asset as a sale of the asset unless both of the following criteria are met:

The exercise price of the option is the fair value of the asset at the time the option is exercised.
There are alternative assets, substantially the same as the transferred asset, readily available in the marketplace.

As stated in ASC 606-10-55-68 (and further discussed in Section 8.7 of Deloitte’s Roadmap Revenue Recognition), a seller’s option or obligation to repurchase an asset generally precludes a buyer from obtaining control of that asset because the buyer “is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset even though the [buyer] may have physical possession of the asset.” In short, an arrangement to transfer an asset when the seller retains an option, or is obligated, to repurchase that asset is not a sale. The guidance that follows in ASC 606 describes the accounting, which will depend on the facts and circumstances of the repurchase agreement.

The control transfer notion from ASC 606, as applied in ASC 842-40, is no different — control of the underlying asset generally is not transferred to the buyer-lessor when the seller-lessee has the option or obligation to repurchase the same asset. However, paragraph BC352(c) of ASU 2016-02 notes that when an option (1) only permits the seller-lessee to repurchase the asset at its then fair value and (2) other, similar assets are available in the marketplace such that the buyer-lessor could easily obtain a replacement, the buyer-lessor is not “constrained in its ability to direct the use of and obtain substantially all the remaining benefits from the asset.” Accordingly, when a sale of an underlying asset with a call option meets both of the conditions in ASC 842-40-25-3, neither the seller-lessee nor the buyer-lessor is prevented from applying sale-and-leaseback accounting because of the existence of a repurchase option. An entity must use judgment in applying the criterion in ASC 842-40-25-3(b), under which other assets must be “readily available in the marketplace” and “substantially the same.” This criterion is generally regarded as a high hurdle, given that the FASB used the words “substantially the same,” rather than merely “similar,” to refer to the assets (“substantially the same” would be closer to “the same” or “identical”). Factors that an entity may consider in assessing whether non-real-estate assets (see discussion of real estate assets in Section 10.3.3.1) are substantially the same may include, but are not limited to, whether the assets (1) can be easily exchanged, (2) have the same technological functionality and features (e.g., the same make, model, and year of production with similar features), (3) have similar uses, and (4) have values that are affected similarly by macroeconomic factors.

Changing Lanes

Sale-and-Leaseback Accounting May Be Harder to Achieve for Equipment

Under ASC 840-40, a repurchase option generally does not preclude sale-and-leaseback accounting for non-real-estate assets (i.e., equipment) unless the option is a bargain. Therefore, it is common for sale-and-leaseback transactions of equipment that are structured under the accounting requirements in ASC 840-40 to contain a fixed-price repurchase option. Contrastingly, any repurchase option on real estate — at any strike price — is generally a form of continuing involvement that precludes sale-and-leaseback accounting under ASC 840-40.

As a result, under ASC 842-40, it will be harder for sale-and-leaseback transactions of equipment that contain a repurchase option to meet the conditions in ASC 842-40-25-3 (reproduced above). Accordingly, we expect that more equipment transactions may be structured to contain fair value repurchase options rather than fixed-price repurchase options (or may contain no repurchase options at all). Otherwise, we would expect more equipment transactions to result in a failed sale conclusion in the assessment of the sale-and-leaseback accounting guidance in ASC 842-40.

As discussed in Section 10.3.3.1, any repurchase option on real estate will continue to preclude sale- and-leaseback accounting under ASC 842.

10.3.3.1 Alternative Assets for Real Estate

ASC 842-40-25-3(b) indicates that purchase options would preclude accounting for the transfer of an asset as a sale if there are no “alternative assets, substantially the same as the transferred asset, readily available in the marketplace.” For real estate, alternative assets that are substantially the same as the asset transferred are generally not readily available in the marketplace. This observation is based on paragraph BC352(c) of ASU 2016-02, which states, in part:

Board members generally observed that real estate assets would not meet [the] criterion [in ASC 842-40-25-3(b)]. This is because real estate is, by nature, “unique” (that is, no two pieces of land occupy the same space on this planet) such that no other similar real estate asset is “substantially the same.”

Accordingly, an entity could never achieve successful sale-and-leaseback accounting under ASC 842-40 in an arrangement involving (1) the transfer of real estate and a leaseback of that same real estate and (2) an option (or obligation) held by the seller to repurchase that real estate. This would be the case regardless of the option’s (or obligation’s) pricing. The seller and buyer would account for the arrangement as a financing. (See Section 10.4.2 for further discussion of the accounting requirements that apply when an arrangement subject to the scope of ASC 842-40 does not qualify as a sale.)

Example 10-3

Developer A develops and owns four office buildings as well as the land on which they are built. All of the buildings are designed and built to the same specifications, and all are located on the same street next to each other. Developer A uses building 1, in its entirety, for its own office space.

Developer A sells buildings 2–4 to REIT B. Control of all three buildings is transferred to REIT B in accordance with ASC 610-20. In a separate transaction, Developer A sells building 1 to Partnership C, a real estate venture, and leases the entire building back for 15 years to continue to use it as office space. As part of the arrangement with Partnership C, Developer A holds a call option, exercisable at the then-prevailing market value of the building, to repurchase building 1 at any point during the lease term.

Although there are three other office buildings in the marketplace that (1) could serve as alternative office space for Developer A, (2) are located in substantially the same location, and (3) are designed and built substantially the same, Developer A’s repurchase option on building 1 would not meet the condition in ASC 842-40-25-3(b). This is because land and real estate are so unique that they cannot occupy the exact same spot; therefore, they cannot be “substantially the same” by definition.

10.3.3.2 Sale and Leaseback With a Residual Value Guarantee and a Fair Value Purchase Option

In assessing sale-and-leaseback transactions under ASC 842-40-25-3, some have asked whether the existence of a residual value guarantee that includes a fair value purchase option would preclude sale accounting for an equipment asset. This concern stems from a view that the existence of the residual value guarantee effectively changes the exercise price of the purchase option from “fair value at date of exercise” to “the greater of fair value at date of exercise or the guaranteed residual value,” thus deviating from the prescriptive pricing guidance in ASC 842-40-25-3(a).

The existence of a residual value guarantee5 combined with a fair value purchase option6 in an operating leaseback does not preclude the buyer-lessor from obtaining control of an equipment asset and therefore should not preclude accounting for the transfer of the asset as a sale.

The notion of control used in determining whether a sale has occurred is generally the same as that used in assessing when control of an asset is transferred to a customer in accordance with ASC 606 or ASC 610-20. In paragraph BC352(c) of ASU 2016-02, the FASB described the impact of a fair value purchase option on this control assessment, stating, “a buyer-lessor is not constrained in its ability to direct the use of and obtain substantially all the remaining benefits from the asset if the seller-lessee can only repurchase the asset at its then-prevailing fair market value and the buyer-lessor could use the proceeds from the repurchase to acquire an asset that is substantially the same in the marketplace. This notion was expressed in a similar manner in the basis for conclusions in Update 2014-09.”

The addition of a residual value guarantee does not result in a conclusion that the buyer-lessor does not obtain control of the asset. Paragraph BC431 of ASU 2014-09 explains that “when the entity guarantees that the customer will receive a minimum amount of sales proceeds, the customer is not constrained in its ability to direct the use of, and obtain substantially all of the benefits from, the asset.” Further, the residual value guarantee would only be triggered if the fair value of the asset declined below that guaranteed amount. That is, the buyer-lessor would always receive consideration at least equal to the fair value of the asset.

In these situations, the buyer-lessor obtains control of the equipment asset because it is not restricted by either the residual value guarantee or the fair value purchase option (individually or together) from directing the use of and obtaining substantially all the economic benefits from the underlying asset.

Although the guidance in ASC 842-40-25-3 is derived from, and consistent with, principles in ASC 606,the relationship between the guidance in ASC 842-40-25-3 and that in ASC 606-10-55 on repurchase agreements (through ASC 842-40-25-1) can be difficult to navigate. The decision tree below7 helps clarify this relationship with respect to situations in which there is a forward or call option on the underlying asset; Section 10.3.3.3 helps clarify this relationship with respect to situations in which there is a put option.

10.3.3.3 Buyer-Lessor Holds a Put Option

ASC 606 contains guidance on sales of assets in which the buyer has written an option to put the asset back to the seller. ASC 606-10-55-72 and ASC 606-10-55-74 through 55-76 state the following with respect to the effect of that put option on determining whether control of the asset has been transferred:

ASC 606-10

55-72 If an entity has an obligation to repurchase the asset at the customer’s request (a put option) at a price that is lower than the original selling price of the asset, the entity should consider at contract inception whether the customer has a significant economic incentive to exercise that right. The customer’s exercising of that right results in the customer effectively paying the entity consideration for the right to use a specified asset for a period of time. Therefore, if the customer has a significant economic incentive to exercise that right, the entity should account for the agreement as a lease in accordance with Topic 842 on leases unless the contract is part of a sale and leaseback transaction. If the contract is part of a sale and leaseback transaction, the entity should account for the contract as a financing arrangement and not as a sale and leaseback transaction in accordance with Subtopic 842-40.

55-74 If the customer does not have a significant economic incentive to exercise its right at a price that is lower than the original selling price of the asset, the entity should account for the agreement as if it were the sale of a product with a right of return as described in paragraphs 606-10-55-22 through 55-29.

55-75 If the repurchase price of the asset is equal to or greater than the original selling price and is more than the expected market value of the asset, the contract is in effect a financing arrangement and, therefore, should be accounted for as described in paragraph 606-10-55-70.

55-76 If the repurchase price of the asset is equal to or greater than the original selling price and is less than or equal to the expected market value of the asset, and the customer does not have a significant economic incentive to exercise its right, then the entity should account for the agreement as if it were the sale of a product with a right of return as described in paragraphs 606-10-55-22 through 55-29.

In an arrangement in which an asset is transferred and leased back and the buyer holds an option to put the asset back to the seller, the put option is not subject to the guidance in ASC 842-40-25-3 in the determination of whether sale-and-leaseback accounting may be applied.

ASC 842-40-25-3 only addresses “option[s] for the seller-lessee to repurchase the asset” (i.e., call options). However, ASC 606 contains guidance on accounting for the sale of an asset in which the seller is obligated to repurchase that asset at the buyer’s request. ASC 606-10- 55-72 specifically addresses arrangements in which the transfer with the put option is part of a potential sale-and-leaseback transaction and, accordingly, circumstances in which the transaction would be accounted for as a financing arrangement.

The sections below address other facts and circumstances related to sale-and-leaseback transactions in which the seller-lessee holds (in substance) a repurchase option.

10.3.3.4 Impact of Contingent Repurchase Provisions on Sale-and- Leaseback Accounting

A seller-lessee’s option8 to repurchase the underlying asset generally precludes sale-and-leaseback accounting unless the conditions in ASC 842-40-25-3 are met.9 However, ASC 842 does not address whether an option to repurchase the underlying asset upon the occurrence of a contingent event should preclude sale-and-leaseback accounting.

If the seller-lessee can unilaterally trigger the contingent event, the repurchase option would generally be assessed in the same manner as a repurchase option without a contingency (see Section 10.3.3). Conversely, if the contingent event is entirely within the control of the buyer-lessor, the repurchase option should generally be assessed in the same manner as a buyer-lessor put option (see Section 10.3.3.3). If the contingency is not entirely within the control of the seller-lessee or buyer-lessor, an entity must consider the substance of the contingent event to determine whether control has been transferred to the buyer-lessor in a manner consistent with the framework in ASC 606 (see Sections 8.7 and 8.7.1.1 in Deloitte’s Roadmap Revenue Recognition for a detailed discussion of analyzing contingent call options).

10.3.3.5 Renewal Options in Which a Leaseback Could Potentially Be Extended for the Entire Economic Life of the Underlying Asset

The mere existence of renewal rights that cover substantially all the estimated economic life of the asset is not determinative that a sale is not achieved. If it is reasonably certain that the renewal options will be exercised, the lease term would represent a major part of the economic life of the asset and the leaseback would be classified as a finance lease. In that case, the transaction would fail to qualify for sale-and-leaseback accounting in accordance with ASC 842-40-25-2. Key to this failed-sale determination is the conclusion that the inclusion of the renewal option(s) will result in finance lease (or sales-type lease) classification and, because control of the leased asset has thus not been transferred (see ASC 842-40-25-2), a sale has not been achieved. However, the existence of renewal rights that do not result in a finance lease (or sales-type lease) classification would not automatically lead to a failed sale even when such rights cover a term that comprises substantially all of the estimated economic life of the underlying asset.10 Rather, if the renewal rights do not result in a finance lease classification, the transaction should be assessed in a manner consistent with the discussion below.

Legacy guidance in ASC 840-40 indicates that the buyer-lessor’s obligation to share any portion of the appreciation of the property with the seller-lessee is a form of continuing involvement that precludes sale-and-leaseback accounting. Therefore, under ASC 840, renewal options for substantially all of the remaining estimated economic life of the leased asset, at any rate other than a fair market value rate as determined at the time of renewal (e.g., rents that increase by the CPI but are not otherwise adjusted to a market rate at renewal), represent continuing involvement that precludes sale-and-leaseback accounting.

However, the sale-and-leaseback accounting guidance in ASC 842-40 moves away from focusing on continuing involvement to determining whether a sale in a sale-and-leaseback transaction has occurred. Under ASC 842-40, the control transfer principle in ASC 606 is used to determine whether the transfer of the underlying asset is a sale. Specifically, under ASC 842-40-25-1, an entity must consider the guidance in ASC 606-10-25-30 on when it satisfies a performance obligation by transferring control of an asset (see Section 10.3.1.2).

ASC 606-10-25-30 refers to the guidance on control transfer in ASC 606-10-25-23 through 25-26 and the guidance on repurchase agreements in ASC 606-10-55 and provides five indicators for an entity to consider when determining whether a customer has obtained control of an asset. However, as discussed in Section 10.3.1.2, paragraph BC155 of ASU 2014-09 cautions that the indicators in ASC 606-10-25-30 are not a list of conditions that need to be met for an entity to conclude that control has been transferred. Rather, the assessment should be based on the underlying principle in ASC 606-10-25-25, which states, in part, that “[c]ontrol of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset” and that “[c]ontrol includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset.”

Accordingly, under ASC 842-40, a sale-and-leaseback transaction in which the leaseback grants a seller-lessee the right to renew the lease for a term that comprises substantially all of the economic life of the underlying asset should be assessed to determine whether the buyer-lessor has obtained control of that asset. In such transactions, at least three of the indicators in ASC 606-10-25-30 often will be met (i.e., the buyer-lessor has accepted the asset, has a present obligation to pay for the asset, and has legal title to the asset). Therefore, in line with the discussion in the Connecting the Dots in Section 10.3.1.2, the assessment is likely to focus on whether the renewal options affect the buyer-lessor’s ability to direct the use of, and obtain, substantially all of the remaining economic benefits of the asset.

In a manner similar to the guidance in legacy GAAP noted above, we do not believe that fair market value renewal options that extend throughout the economic life of the underlying asset would preclude a successful sale determination. In addition, under the control principle that underlies ASC 842 (and ASC 606), we believe that fixed-price renewal options that extend throughout the entire economic life of the underlying asset would not automatically preclude a successful sale conclusion. In each of these circumstances, the buyer-lessor and seller-lessee must evaluate whether the buyer-lessor obtains control of the underlying asset. If the buyer-lessor is able to control the asset (i.e., has the ability to direct the use of and obtain substantially all of the economic benefits from the asset), we believe that sale recognition is appropriate. However, if the seller-lessee retains control of the asset, the transaction would represent a failed sale and leaseback and should be accounted for as a financing arrangement.

10.3.3.6 Seller-Lessee’s Right of First Offer or Right of First Refusal

In certain circumstances, sale-and-leaseback arrangements include provisions that give the seller-lessee a right of first offer (ROFO), a right of first refusal (ROFR), or both. An entity should carefully analyze such provisions to determine whether they create a purchase option that would preclude the sale-and-leaseback from being accounted for as a successful sale.

A ROFO provision gives the seller-lessee the right to make an offer to repurchase the underlying asset in a sale-and-leaseback arrangement before the buyer-lessor receives offers from third parties. A ROFR provides the seller-lessee with the right to repurchase the underlying asset in a sale-leaseback arrangement in the event that the buyer-lessor receives a bona fide offer from a third party. In a sale-and-leaseback arrangement, an entity should contemplate both ROFOs and ROFRs in determining whether control has truly been transferred to the buyer-lessor and whether sale accounting is achieved. See Section 8.7 of Deloitte’s Roadmap Revenue Recognition for further discussion of repurchase options, including considerations and examples related to whether a ROFO or ROFR would prevent the transfer of control and, accordingly, preclude sale accounting.

10.3.4 Transfer of Tax Benefits

The frequency of cross-border tax-benefit lease transactions has declined because many foreign countries have eliminated the related tax advantages. However, ASC 842 contains certain implementation guidance on applying the sale-and-leaseback accounting provisions of ASC 842-40 to determine whether it is appropriate to recognize income in such transactions.

ASC 842-40

55-11 A U.S. entity purchases an asset and enters into a contract with a foreign investor that provides that foreign investor with an ownership right in, but not necessarily title to, the asset. That ownership right enables the foreign investor to claim certain benefits of ownership of the asset for tax purposes in the foreign tax jurisdiction.

55-12 The U.S. entity also enters into a contract in the form of a leaseback for the ownership right with the foreign investor. The contract contains a purchase option for the U.S. entity to acquire the foreign investor’s ownership right in the asset at the end of the lease term.

55-13 The foreign investor pays the U.S. entity an amount of cash on the basis of an appraised value of the asset. The U.S. entity immediately transfers a portion of that cash to a third party, and that third party assumes the U.S. entity’s obligation to make the future lease payments, including the purchase option payment. The cash retained by the U.S. entity is consideration for the tax benefits to be obtained by the foreign investor in the foreign tax jurisdiction. The U.S. entity may agree to indemnify the foreign investor against certain future events that would reduce the availability of tax benefits to the foreign investor. The U.S. entity also may agree to indemnify the third-party trustee against certain future events.

55-14 The result of the transaction is that both the U.S. entity and the foreign investor have a tax basis in the same depreciable asset.

55-15 An entity should determine whether the transfer of the ownership right is a sale based on the guidance in paragraphs 842-40-25-1 through 25-3. Consistent with paragraphs 842-40-25-2 through 25-3, if the leaseback for the ownership right is a finance lease or if the U.S. entity has an option to repurchase the ownership right at any exercise price other than the fair value of that right on the exercise date, there is no sale. If the transfer of the ownership right is not a sale, consistent with the guidance in paragraph 842-40-25-5, the entity should account for the cash received from the foreign investor as a financial liability in accordance with other Topics.

55-16 If the transfer of the ownership right is a sale, income recognition for the cash received should be determined on the basis of individual facts and circumstances. Immediate income recognition is not appropriate if there is more than a remote possibility of loss of the cash consideration received because of indemnification or other contingencies.

55-17 The total consideration received by the U.S. entity is compensation for both the tax benefits and the indemnification of the foreign investor or other third-party trustee. The recognition of a liability for the indemnification agreement at inception in accordance with the guidance in Topic 460 on guarantees would reduce the amount of income related to the tax benefits that the seller-lessee would recognize immediately when the possibility of loss is remote.

10.3.5 Considerations Related to Sale and Partial Leaseback

Rather than selling and subsequently leasing back an entire property, some entities may want to sell an entire property and then subsequently lease back a portion of the property. For example, a seller-lessee may sell its 10-story corporate headquarters, after which it will only lease back five of the floors. An entity must carefully consider the sale-and-leaseback accounting requirements in these scenarios since the legal structure of the property that is sold as well as the leaseback terms may affect the resulting accounting. For example, if the property subject to the sale is not legally subdivided and the portion of the property that is being leased back is classified as a finance lease, the arrangement will not qualify for sale treatment unless the portion being leased back is only a minor portion of the overall property. If, in contrast, the property subject to the leaseback has been legally subdivided, it may be appropriate to separately evaluate each legally subdivided portion of the larger asset when applying the sale-and-leaseback model.

We have also observed complexities in the application of the financing method when some space is leased back and other space is not. For example, questions have arisen about whether a seller-lessee in a failed sale-and-leaseback transaction should assume that space that is not leased back is being leased to the buyer-lessor (since it was previously concluded that the space was not sold to the buyer-lessor but nonetheless that it is the party that controls that space). At issue in such circumstances is whether that imputed lease could qualify as a sales-type lease, thus leading to partial derecognition on the balance sheet and potentially a gain or loss on sale. Because accounting professionals’ views on such issues may differ, we recommend that entities contemplating such a transaction consult their auditors or accounting advisers.

Footnotes

Assume that the residual value guarantee, in and of itself, would not preclude transfer of control in the assessment of the risk/reward control indicator in ASC 606-10-25-30(d). See ASC 842-40-55-21 and paragraph BC353 of ASU 2016-02 for further discussion.

Assume that the fair value purchase option would satisfy the conditions in ASC 842-40-25-3 to achieve sale accounting. That is, the exercise price of the option is the fair value of the asset at the time the option is exercised and alternative assets, substantially the same as the transferred asset, are readily available in the marketplace.

Note that this decision tree is intended to reflect how an entity would proceed with applying the relevant guidance (the appropriate Codification paragraphs are cited) when a contract contains a forward or call option to repurchase the asset for less than its original selling price; it should be read in conjunction with the referenced Codification paragraphs. For example, if such a contract is not with a customer, an entity would be required to apply the scoping guidance in ASC 610-20 to determine whether the contract is part of a sale-and-leaseback transaction. If not, the entity must consider the control transfer guidance in ASC 606-10-25-30 as well as the guidance on repurchase agreements in ASC 606-10-55.

Although this section focuses on a seller-lessee’s option to repurchase the underlying asset, we believe that the same concepts would apply to a seller-lessee’s obligation to repurchase the underlying asset upon the occurrence of a contingent event.

If the underlying asset is real estate, as discussed in Section 10.3.3.2, the condition in ASC 842-40-25-3(b) cannot be met and sale-and-leaseback accounting is therefore always precluded for a transaction that includes an unconditional repurchase option (or obligation) because there are no alternative assets available in the marketplace that are substantially the same as the real estate transferred in the arrangement.

In developing our view, we considered the discussion in paragraph BC218 of ASU 2016-02, which suggests that purchase options and extension options for all of the remaining economic life of the underlying asset should be accounted for in the same way. Ultimately, however, we did not think that the Board’s intent was to create a form of double jeopardy for sale-and-leaseback transactions that satisfy the condition in ASC 842-40-25-2 after considering the probability of exercise of the lessee’s extension options.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.