Chapter 10 — Sale-and-Leaseback Transactions

10.4 Recognition and Measurement

As illustrated in the decision tree in Section 10.2.1, the analysis performed to determine whether the transfer of the underlying asset is a sale (as discussed in Section 10.3) governs the recognition and measurement of the transaction. Effectively, if the transfer of the asset by the seller-lessee to the buyer-lessor is determined to be a sale, the transaction is accounted for as a sale and leaseback. In addition, if the transfer of the asset is a sale, the measurement of the sale and leaseback further depends on whether the transfer is at fair value. However, if the transfer of the asset by the seller-lessee to the buyer-lessor is not determined to be a sale, both parties would account for the transaction as a financing arrangement.

The decision tree below illustrates the recognition and measurement guidance.

10.4.1 Transfer of the Asset Is a Sale

ASC 842-40

25-4 If the transfer of the asset is a sale in accordance with paragraphs 842-40-25-1 through 25-3, both of the following apply:

The seller-lessee shall:
1. Recognize the transaction price for the sale at the point in time the buyer-lessor obtains control of the asset in accordance with paragraph 606-10-25-30 in accordance with the guidance on determining the transaction price in paragraphs 606-10-32-2 through 32-27
2. Derecognize the carrying amount of the underlying asset
3. Account for the lease in accordance with Subtopic 842-20.
The buyer-lessor shall account for the purchase in accordance with other Topics and for the lease in accordance with Subtopic 842-30.

Effectively, when the transfer of the asset is determined to be a sale, both the seller-lessee’s and the buyer-lessor’s accounting can be divided into two steps:

Step	Seller-Lessee	Buyer-Lessor
1	At the time the buyer-lessor obtains control of the underlying asset in accordance with ASC 606-10-25-30 (see Section 10.3.1), (1) derecognize the carrying amount of the asset and (2) recognize the profit or loss on sale, calculated as the difference between the transaction price determined in accordance with ASC 606 and the carrying amount of the asset	At the time the buyer-lessor obtains control of the underlying asset in accordance with ASC 606-10-25-30 (see Section 10.3.1), recognize the underlying asset under other U.S. GAAP (e.g., ASC 330, ASC 360)
2	Account for the lease in accordance with the lessee accounting model in ASC 842-20 (see Chapter 8)	Account for the lease in accordance with the lessor accounting model in ASC 842-30 (see Chapter 9)

ASC 842-40-25-4(a)(1) requires the seller-lessee to consider the transaction price guidance in ASC 606. Therefore, we think that a seller-lessee should consider the comprehensive discussion in Chapter 6 of Deloitte’s Roadmap Revenue Recognition to determine the transaction price for the sale. If the sale-and-leaseback transaction is at market, the transaction price and the fair value of the underlying asset should be equal. However, when the transaction is not at market, the transaction price for the seller-lessee’s profit recognition would include an “adjustment” to arrive at market-based terms as indicated in ASC 842-40-30-1 and ASC 842-40-30-3 (reproduced below). Such adjustments are further discussed in Section 10.4.1.1.

Connecting the Dots

Buyer-Lessor’s Measurement of the Underlying Asset

ASC 842-40-25-4 (reproduced above) clarifies that ASC 842’s sale-and-leaseback accounting guidance is more prescriptive regarding the seller-lessee’s recognition and initial measurement requirements than it is regarding the buyer-lessor’s. ASC 842-40-25-4(b) does not address the transaction price determined in accordance with ASC 606 and directs the buyer-lessor to other U.S. GAAP for guidance on determining the appropriate recognition and measurement requirements for the underlying asset. Therefore, as discussed in Section 10.3.1.2, while a buyer-lessor clearly must apply ASC 606 to determine whether and, if so, when it obtains control of an asset (i.e., step 5 of the revenue model), it is unclear whether it should apply the measurement concepts in ASC 606 (i.e., step 3 of the revenue model) to initially measure the asset it must recognize. For example, it is unclear whether the buyer-lessor should apply the guidance in ASC 606 on estimating variable consideration. This could create an inconsistency in the extent to which the concepts in ASC 606 are used in sale-and-leaseback accounting.

The buyer-lessor should consider the relevant measurement concepts in other applicable U.S. GAAP (e.g., ASC 330, ASC 360).

Changing Lanes

All or None

The existing sale-and-leaseback accounting guidance in ASC 840-40 restricted the amount of profit that a seller-lessee may recognize and requires deferral of profit amounts depending on the extent of the seller-lessee’s retained use of, or continuing involvement in, the underlying asset.

This is not the case under ASC 842’s sale-and-leaseback accounting guidance. That is, if the transfer of the underlying asset is a sale, the full profit or loss (to the extent that the terms of the sale are at fair value) is recognized when the buyer-lessor obtains control of the asset. Alternatively, if the transfer of the asset is not a sale, no profit or loss may be recognized. There is no accounting that is “in between” those two recognition requirements, so either all or none of the profit or loss on the transaction is recognized.

In paragraph BC360 of ASU 2016-02, the FASB noted that certain stakeholders had suggested that the sale-and-leaseback guidance should require deferral of profit or loss in certain situations. Accordingly, the Board considered recognition and measurement guidance that would have precluded recognizing the amount of profit or loss associated with the rights in the underlying asset retained by the seller-lessee through the leaseback. However, the Board ultimately rejected such an approach on the basis that the accounting for the transfer of control (i.e., the sale) of the underlying asset, as well as the accounting for the transfer of the right to use (i.e., the lease of) the asset, should not be affected by each other when the transaction in its entirety is priced at fair value.

Bridging the GAAP

Gains Limited Under IFRS Accounting Standards

As described above, under ASC 842, If the transaction qualifies as a sale, the entire gain on the transaction would be recognized by the seller-lessee (if the transaction is at fair value). However, under IFRS 16, the seller-lessee measures the ROU asset arising from the leaseback at the proportion of the previous carrying amount of the PP&E related to the right of use retained by the seller-lessee. Accordingly, under IFRS Accounting Standards, the seller-lessee only recognizes a gain related to the rights transferred to the buyer-lessor (i.e., the portion of the asset sold). See Appendix B for additional information about the differences between ASC 842 and IFRS 16.

10.4.1.1 Determining Whether the Sale Is at Fair Value

ASC 842-40

30-1 An entity shall determine whether a sale and leaseback transaction is at fair value on the basis of the difference between either of the following, whichever is more readily determinable:

The sale price of the asset and the fair value of the asset
The present value of the lease payments and the present value of market rental payments.

30-3 A sale and leaseback transaction is not off market solely because the sale price or the lease payments include a variable component. In determining whether the sale and leaseback transaction is at fair value, the entity should consider those variable payments it reasonably expects to be entitled to (or to make) on the basis of all of the information (historical, current, and forecast) that is reasonably available to the entity. For a seller-lessee, this would include estimating any variable consideration to which it expects to be entitled in accordance with paragraphs 606-10-32-5 through 32-9.

30-5 See Examples 1 and 2 (paragraphs 842-40-55-22 through 55-38) for illustrations of the requirements for a sale and leaseback transaction.

ASC 842-40 requires that a sale-and-leaseback transaction be accounted for at market (i.e., at fair value). Accordingly, the seller-lessee’s profit or loss on the transaction will be calculated as the difference between the carrying amount of the underlying asset and its fair value.

Connecting the Dots

Off-Market Terms

Because the sale and the leaseback are negotiated together as a single transaction, there is an opportunity to structure payment terms and move cash flows between the two to achieve a certain result. The FASB acknowledged this in paragraph BC361 of ASU 2016-02:

The lease payments and the sales price in a sale and leaseback transaction are interdependent because they are negotiated as a package (for example, as part of the same contract or in two or more contracts that will be combined in accordance with the contract combinations guidance in paragraph 842-10-25-19). That is, the sales price might be more than the fair value of the asset because the leaseback lease payments are above a market rate; conversely, the sales price might be less than the fair value because the leaseback lease payments are below a market rate. That could result in the misstatement of both gains and losses on disposal of the asset for the seller-lessee and the carrying amount of the asset for the buyer-lessor, as well as result in misleading lease expense (for the seller-lessee) or lease income (for the buyer-lessor) related to the leaseback.

To remove this structuring opportunity, the Board decided to require that the accounting for sale-and-leaseback transactions be at fair value. Any difference from market terms is reflected as an adjustment in the amount of profit or loss (see Section 10.4.1.3).

ASC 842-40-30-1 indicates that in determining whether the transaction is at fair value, the parties to the transaction must compare either the (1) sale price and fair value or (2) present value of lease payments and present value of market rental rates. The parties are required to use whichever benchmark is more readily determinable. In addition, paragraph BC364 of ASU 2016-02 notes that the parties should “maximize the use of observable prices and observable information” when selecting the most appropriate benchmark.

In a transaction negotiated between independent parties, the sale price of the asset is generally the best indicator of its fair value. However, there may be instances in which the stated fair value of the asset does not equal its sale price. In those instances, a valuation specialist should determine the fair value of the asset by using other standard valuation techniques (e.g., comparison to the sale price of comparable assets, discounted cash flow analysis, calculation of replacement cost), keeping in mind the guidance noted above from ASC 842-40-30-1 and paragraph BC364 of ASU 2016-02.

In accordance with ASC 842-40-30-3, the “sale price” referred to in ASC 842-40-30-1(a) could be described as the transaction price determined in accordance with ASC 606 before constraining any estimate of variable consideration. (The same could be said for the “present value of lease payments” referred to in ASC 842-40-30-1(b).) That is, the transaction is not off-market solely because the sale price includes (or lease payments include) variable amounts. To determine whether the sale-and-leaseback transaction is at fair value, the sale price (or present value of lease payments) should include an estimate of variable payments.

Example 10-4

Seller-Lessee agrees to sell tower assets to Buyer-Lessor and lease them back under the following terms:

Carrying amount of assets: $3 million.
Fair value of assets: $9 million.
Economic life of assets: 7 years.
Sale price of assets: $7 million paid up front, with a bonus of $2 million if certain local government permits are approved.
Lease term: 5 years.
Lease payments: $2 million fixed annually.
Seller-Lessee’s incremental borrowing rate: 9.00 percent.11
Buyer-Lessor’s rate implicit in the lease: 7.35 percent.

Seller-Lessee concludes that the transfer of the tower assets is a sale (i.e., control has been transferred to Buyer-Lessor) in accordance with ASC 842-40-25-1 through 25-3.

Seller-Lessee estimates its sale price to be $9 million in accordance with ASC 842-40-30-3. Seller-Lessee used a most likely amount of $2 million to estimate variable consideration (before any constraint) in the sale price. Seller-Lessee recognizes the full profit on the sale of the tower assets. Profit is unadjusted because, in accordance with ASC 842-40-30-1, the sale price is equal to fair value.

In accordance with ASC 842-40-25-2, control has not been transferred to Buyer-Lessor from Buyer-Lessor’s perspective. In using the rate implicit in the lease (which is lower than Seller-Lessee’s incremental borrowing rate), Buyer-Lessor concludes that the present value of the lease payments represents substantially all of the fair value of the tower assets and the lease is therefore a sales-type lease. As noted in Section 10.3, it may be reasonable for a seller-lessee and a buyer-lessor to reach different conclusions about whether control of the asset is transferred to the buyer-lessor.

See Example 10-7 in Section 10.4.2.2 for Buyer-Lessor’s accounting for this transaction as well as its basis for the lease classification conclusions described above.

10.4.1.1.1 Sale and Leaseback of an Asset Portfolio

When a company sells a portfolio of assets to a single purchaser and leases back all of the assets under the terms of a master leasing arrangement, each sale-and-leaseback transaction in the portfolio should be accounted for separately as long as there is sufficient evidence that the terms of the transaction were not affected by other sale-and-leaseback transactions in the portfolio entered into at approximately the same time. If the terms of a transaction are such that the sale price of the asset does not represent a market price or the lease arrangement provides for off-market rental rates, that transaction should be accounted for collectively with other similar transactions.

Regardless of whether the transactions are accounted for individually or collectively, each individual transaction must be evaluated to determine whether the fair value of the individual asset is less than its carrying amount. In such circumstances, a loss should be recognized immediately.

Example 10-5

Company A sells and leases back five shopping centers, all of which are physically separated and in different locations. The transfer of the assets is a sale in accordance with ASC 842-40-25-1 through 25-3. The sale price of the properties equals their fair market value on a portfolio basis but not on an individual property basis. Because the terms of the individual transactions were affected by the fact that they were negotiated at the same time, A should calculate its gain on a portfolio basis. If, however, A determines that there is a loss on one or more of the shopping centers (i.e., the carrying value of the shopping center exceeds its fair value), that loss should be recognized immediately and should not be offset against the gain for the portfolio.

10.4.1.2 Sale Is Not at Fair Value

ASC 842-40

30-2 If the sale and leaseback transaction is not at fair value, the entity shall adjust the sale price of the asset on the same basis the entity used to determine that the transaction was not at fair value in accordance with paragraph 842-40-30-1. The entity shall account for both of the following:

Any increase to the sale price of the asset as a prepayment of rent
Any reduction of the sale price of the asset as additional financing provided by the buyer-lessor to the seller-lessee. The seller-lessee and the buyer-lessor shall account for the additional financing in accordance with other Topics.

As indicated in Section 10.4.1.1 and in ASC 842-40-30-1, sale-and-leaseback transactions are always accounted for at fair value. The profit or loss on the transactions is determined by reference to the fair value of the asset and its carrying value. Accordingly, the sale price may need to be adjusted to reflect the appropriate profit or loss calculation, resulting in the following:

When the sale price is above market, both the seller-lessee and the buyer-lessor in the transaction must allocate the payments under the leaseback between those for the lease and those for the additional financing (i.e., for the financial liability or the financial asset). For the seller-lessee, the allocation must result in a zero balance at the end of the lease term for both the financial liability and the lease liability. For the buyer-lessor, the allocation must result in a zero balance at the end of the lease term for the financial asset (and if the lease is classified as a direct financing lease, a zero balance in the lease receivable in the net investment).

Any adjustment of lease payments that results from off-market terms must also be considered in the classification assessment of the lease component. For example, an increase in prepaid rent that results when a sale price is concluded to be below market should be included in the assessment of all lease payments when an entity evaluates the classification of that leased-back asset.

Example 1 in ASC 842-40-55-23 through 55-30 illustrates the accounting by both parties in a sale-and-leaseback transaction when the sale is not at fair value.

ASC 842-40

Illustration of Sale and Leaseback Transaction

55-22 Examples 1 and 2 illustrate the accounting for sale and leaseback transactions.

Example 1 — Sale and Leaseback Transaction

55-23 An entity (Seller) sells a piece of land to an unrelated entity (Buyer) for cash of $2 million. Immediately before the transaction, the land has a carrying amount of $1 million. At the same time, Seller enters into a contract with Buyer for the right to use the land for 10 years (the leaseback), with annual payments of $120,000 payable in arrears. This Example ignores any initial direct costs associated with the transaction. The terms and conditions of the transaction are such that Buyer obtains substantially all the remaining benefits of the land on the basis of the combination of the cash flows it will receive from Seller during the leaseback and the benefits that will be derived from the land at the end of the lease term. In determining that a sale occurs at commencement of the leaseback, Seller considers that, at that date, all of the following apply:

Seller has a present right to payment of the sales price of $2 million.
Buyer obtains legal title to the land.
Buyer has the significant risks and rewards of ownership of the land because, for example, Buyer has the ability to sell the land if the property value increases and also must absorb any losses, realized or unrealized, if the property value declines.

55-24 The observable fair value of the land at the date of sale is $1.4 million. Because the fair value of the land is observable, both Seller and Buyer utilize that benchmark in evaluating whether the sale is at market term. Because the sale is not at fair value (that is, the sales price is significantly in excess of the fair value of the land), both Seller and Buyer adjust for the off-market terms in accounting for the transaction. Seller recognizes a gain of $400,000 ($1.4 million – $1 million) on the sale of the land. The amount of the excess sale price of $600,000 ($2 million – $1.4 million) is recognized as additional financing from Buyer to Seller (that is, Seller is receiving the additional benefit of financing from Buyer). Seller’s incremental borrowing rate is 6 percent. The leaseback is classified as an operating lease.

55-25 At the commencement date, Seller derecognizes the land with a carrying amount of $1 million. Seller recognizes the cash received of $2 million, a financial liability for the additional financing obtained from Buyer of $600,000, and a gain on sale of the land of $400,000. Seller also recognizes a lease liability for the leaseback at the present value of the portion of the 10 contractual leaseback payments attributable to the lease of $38,479 ($120,000 contractual lease payment – $81,521 of that lease payment that is attributable to the additional Buyer financing), discounted at the rate of 6 percent, which is $283,210, and a corresponding right-of-use asset of $283,210. The amount of $81,521 is the amount of each $120,000 annual payment that must be attributed to repayment of the principal of the financial liability for that financial liability to reduce to zero by the end of the lease term.

55-26 After initial recognition and measurement, at each period of the lease term, Seller will do both of the following:

Decrease the financing obligation for the amount of each lease payment allocated to that obligation (that is, $81,521) and increase the carrying amount of the obligation for interest accrued using Seller’s incremental borrowing rate of 6 percent. For example, at the end of Year 1, the balance of the financial obligation is $554,479 ($600,000 – $81,521 + $36,000).
Recognize the interest expense on the financing obligation (for example, $36,000 in Year 1) and $38,479 in operating lease expense.

55-27 At the end of the lease term, the financing obligation and the lease liability equal $0.

55-28 Also, at the commencement date, Buyer recognizes the land at a cost of $1.4 million and a financial asset for the additional financing provided to Seller of $600,000. Because the lease is an operating lease, at the date of sale Buyer does not do any accounting for the lease.

55-29 In accounting for the additional financing to Seller, Buyer uses 6 percent as the applicable discount rate, which it determined in accordance with paragraphs 835-30-25-12 through 25-13. Therefore, Buyer will allocate $81,521 of each lease payment to Buyer’s financial asset and allocate the remaining $38,479 to lease income. After initial recognition and measurement at each period of the lease term, Buyer will do both of the following:

Decrease the financial asset for the amount of each lease payment received that is allocated to that obligation (that is, $81,521) and increase the carrying amount of the obligation for interest accrued on the financial asset using Seller’s incremental borrowing rate of 6 percent. Consistent with Seller’s accounting, at the end of Year 1, the carrying amount of the financial asset is $554,479 ($600,000 – $81,521 + $36,000).
Recognize the interest income on the financing obligation (for example, $33,269 in Year 2) and $38,479 in operating lease income.

55-30 At the end of the lease term, the carrying amount of the financial asset is $0, and Buyer continues to recognize the land.

Example 10-6

Seller-Lessee agrees to sell a ship to Buyer-Lessor and lease it back under the following terms:

Carrying amount of assets: $10 million.
Fair value of assets: $8 million.
Economic life of assets: 20 years.
Sale price of assets: $6 million.
Lease term: 5 years.
Lease payments: $500,000 fixed annually.
Seller-Lessee’s incremental borrowing rate: 10.00 percent.12
Buyer-Lessor’s rate implicit in the lease: 10.32 percent.

Both Seller-Lessee and Buyer-Lessor conclude that the transfer of the ship is a sale (i.e., control of the ship has been transferred to Buyer-Lessor) in accordance with ASC 842-40-25-1 through 25-3. As part of that analysis, both classify the lease as an operating lease in accordance with ASC 842-10-25-2.

In accordance with ASC 842-40-30-1, the sale is off-market because the sale price is below market (i.e., the sale price is less than fair value). Accordingly, Seller-Lessee and Buyer-Lessor must adjust both the sale price and purchase price, respectively, to account for the transaction at fair value in accordance with ASC 842-40-30-2.

Each party would record the transaction at commencement as follows:

10.4.1.3 Related-Party Leases

ASC 842-40

30-4 If the transaction is a related party lease, an entity shall not make the adjustments required in paragraph 842-40-30-2, but shall provide the required disclosures as discussed in paragraphs 842-20-50-7 and 842-30-50-4.

In a manner similar to the guidance in ASC 842-10-55-12, a related-party lease in a sale-and-leaseback transaction should be accounted for according to its contractually stated — and legally enforceable — terms rather than according to economic substance as required by ASC 840. Accordingly, an entity is not required to adjust the sales price for off-market terms in these arrangements.

See Section 13.2 for more information about related-party leases. See Chapter 15 for a detailed discussion of the disclosure requirements in ASC 842. See Section 17.3.1.10 for a discussion of ASU 2023-01 (released in March 2023), which provides guidance on leasing arrangements between entities under common control.

10.4.2 Transfer of the Asset Is Not a Sale

10.4.2.1 Seller-Lessee Accounting

ASC 842-40

25-5 If the transfer of the asset is not a sale in accordance with paragraphs 842-40-25-1 through 25-3, both of the following apply:

The seller-lessee shall not derecognize the transferred asset and shall account for any amounts received as a financial liability in accordance with other Topics. . . .

The accounting by a seller-lessee for a failed sale and leaseback is fairly straightforward. The substance of the transaction when control of the underlying asset is not transferred to the buyer-lessor is that of a financing arrangement. Accordingly, in such cases, the seller-lessee should keep the asset on its books and recognize a corresponding financial liability for the cash received from the buyer-lessor.

The seller-lessee’s accounting for a failed sale-and-leaseback transaction is consistent with the accounting for failed sale-and-leaseback transactions in ASC 840 as well as with the accounting for a failed sale in ASC 606 (e.g., when a sale with a repurchase agreement prevents the customer from obtaining control of the good or service). The FASB acknowledges the consistency with both standards in paragraph BC368 of ASU 2016-02.

The asset should continue to be subsequently measured as any other owned asset in accordance with ASC 360 (e.g., depreciated, subject to impairment testing). See Section 11.4 for additional discussion of the subsequent measurement of an asset in a failed sale-and-leaseback transaction. The initial and subsequent measurement of the financial liability should generally be determined in accordance with other applicable GAAP (e.g., ASC 470, ASC 835-30). However, ASC 842-40 does provide limited guidance on the interest rate to be used in measuring the financial liability.

ASC 842-40

30-6 The guidance in paragraph 842-40-25-5 notwithstanding, the seller-lessee shall adjust the interest rate on its financial liability as necessary to ensure that both of the following apply:

Interest on the financial liability is not greater than the payments on the financial liability over the shorter of the lease term and the term of the financing. The term of the financing may be shorter than the lease term because the transfer of an asset that does not qualify as a sale initially may qualify as a sale at a point in time before the end of the lease term.
The carrying amount of the asset does not exceed the carrying amount of the financial liability at the earlier of the end of the lease term or the date at which control of the asset will transfer to the buyer-lessor (for example, the date at which a repurchase option expires if that date is earlier than the end of the lease term).

In paragraph BC370 of ASU 2016-02, the FASB notes that the guidance in ASC 842-40-30-6 under which an entity must adjust the seller-lessee interest rate “is generally consistent with practice in previous GAAP” (i.e., with practice under the sale-and-leaseback accounting guidance in ASC 840-40).

In addition, paragraph BC369 of ASU 2016-02 clarifies certain aspects of the subsequent measurement of the financial liability recognized by the seller-lessee:

As the seller-lessee makes the scheduled payments in the contract, it will allocate those payments between interest expense on the financial liability and repayment of principal on the financial liability. At the end of the “leaseback” period (or at the point in time the buyer-lessor obtains control of the underlying asset), the seller-lessee will recognize any remaining balance of the financial liability as the proceeds on the sale of the asset. The gain or loss recognized at that point will reflect any difference between those proceeds and the carrying amount of the asset.

Connecting the Dots

Transaction Subsequently Qualifies as a Sale and Leaseback

Paragraph BC369 of ASU 2016-02 (reproduced above) notes an additional important point: control of the underlying asset may be transferred to the buyer-lessor after contract commencement. In other words, the “failed” sale may be rectified, and the transaction may qualify for sale-and-leaseback accounting, at the point when the buyer-lessor obtains control of the underlying asset. This could occur if a seller-lessee repurchase option expires unexercised, the classification of the leaseback changes from a finance lease to an operating lease in accordance with ASC 842-10-25-1, or control is transferred before the end of the contract term in a manner consistent with the control principle and indicators in ASC 606.

When this happens, in a manner similar to the seller-lessee’s accounting at the end of the contract term when control of the asset is never transferred, the seller-lessee would derecognize the underlying asset, derecognize the financial liability, and recognize profit or loss for the difference between the two. The leaseback would be accounted for in accordance with the lessee accounting model in ASC 842-20 (see Chapter 8), as indicated in Section 10.4.1.

However, the guidance in ASC 842-40-30-6 indicates that the interest rate on the financial liability should be adjusted to avoid recognition of a loss at the time when control of the asset is transferred. Therefore, when control of the underlying asset is subsequently transferred, we would expect loss recognition to be rare (i.e., only in situations in which control is transferred earlier than expected).

Example 2 in ASC 842-40-55-31 through 55-38 (reproduced in Section 10.4.2.3) illustrates the accounting for a transaction that subsequently qualifies as a sale and leaseback.

10.4.2.1.2 Recognition of an Impairment Loss in a Failed Sale and Leaseback

When the carrying value of an asset exceeds its fair value, questions have arisen about whether the seller-lessee should recognize an immediate loss if the transaction does not meet the requirements for sale-and-leaseback accounting under ASC 842-40.

If the transaction is a financing arrangement because the buyer-lessor does not obtain control of the underlying asset, the seller-lessee should determine whether an impairment charge is required under ASC 360. Under the ASC 360 model, an impairment charge is required if the sum of the cash flows (undiscounted) expected to result from the use of the asset and its eventual disposition is less than the carrying amount of the asset. The amount of the impairment is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset.

If, thereafter, control of the underlying asset is subsequently transferred to the buyer-lessor and the transaction subsequently meets the requirements in ASC 842-40 for sale-and-leaseback accounting, an immediate loss should be recognized for the excess of the carrying amount of the underlying asset over the carrying amount of the financial liability as of the date on which sale-and-leaseback accounting becomes appropriate.

10.4.2.1.3 Interest Rate Considerations for a Failed Sale and Leaseback

Under ASC 842-40-30-6(b), the seller-lessee’s interest rate applied to the deemed financing arrangement in a failed sale and leaseback must be adjusted to avoid a “built-in loss” at the end of the arrangement. Specifically, ASC 842-40-30-6(b) stipulates that the interest rate on a seller-lessee’s financial liability must be adjusted, as necessary, to ensure that “[t]he carrying amount of the asset does not exceed the carrying amount of the financial liability at the earlier of the end of the lease term or the date at which control of the asset will transfer to the buyer-lessor.” However, ASC 842-40-30-6(b) is silent on whether the interest rate should be subsequently adjusted if the underlying asset is impaired, thereby reducing or eliminating the original built-in loss.

Under a financing model, the asset accounting is divorced or delinked from the liability accounting after initial recognition and measurement of the financing arrangement. Accordingly, we believe that it would not be appropriate to make corresponding adjustments to the interest rate on the liability upon the recognition of an impairment of the underlying asset. Thus, a seller-lessee is required to adjust its interest rate to avoid a built-in loss upon initial recognition of the financing. However, the seller-lessee should not subsequently adjust this interest rate to avoid a built-in-loss resulting from a later impairment of the underlying asset.

10.4.2.2 Buyer-Lessor Accounting

ASC 842-40

25-5 If the transfer of the asset is not a sale in accordance with paragraphs 842-40-25-1 through 25-3, both of the following apply: . . .

b. The buyer-lessor shall not recognize the transferred asset and shall account for the amounts paid as a receivable in accordance with other Topics.

A buyer-lessor’s accounting for a failed sale and leaseback is also straightforward. The substance of the transaction when the buyer-lessor does not obtain control of the underlying asset is that of a financing arrangement. Accordingly, under ASC 842, the buyer-lessor should not recognize the underlying asset but should instead recognize a financial asset for the cash paid. The buyer-lessor should look to other GAAP (e.g., ASC 310, ASC 835-30, ASC 326) to determine the appropriate initial and subsequent measurement of the financial asset. Note that the seller-lessee interest rate guidance in ASC 842-40-30-6 does not apply to the buyer-lessor’s accounting for the financial asset.

Changing Lanes

Accounting for a Failed Purchase and Leaseback

As mentioned previously in this chapter, ASC 842-40 provides guidance on the buyer-lessor’s accounting. The same is true when the transfer of the underlying asset in the transaction is not a sale. The sale-and-leaseback accounting guidance in ASC 840 did not prescribe accounting requirements for buyer-lessors in a failed sale and leaseback. Accordingly, it was entirely possible for the asset to remain on the books of the seller-lessee but for the buyer-lessor to recognize that same asset in accordance with ASC 360, ASC 805, or both. That is no longer the case under ASC 842, which requires both parties to account for the substance of a failed sale-and-leaseback transaction as a financing arrangement.

Connecting the Dots

Transaction Subsequently Qualifies as a Purchase and Leaseback

Paragraph BC369 of ASU 2016-02 and Section 10.4.2.1 of this Roadmap indicate that the buyer-lessor may obtain control of the underlying asset after contract commencement (i.e., after the initial assessment of whether control has been transferred). However, paragraph BC369 of ASU 2016-02 does not mention the buyer-lessor’s accounting for situations in which this occurs, nor does it discuss the buyer-lessor’s accounting at the end of the contract term.

In either situation, the buyer-lessor would derecognize the financial asset and recognize the underlying asset at the same amount. The leaseback would be accounted for in accordance with the lessor accounting model in ASC 842-30 (see Chapter 9), as indicated in Section 10.4.1.

Example 2 in ASC 842-40-55-31 through 55-38 (reproduced in Section 10.4.2.3) illustrates the accounting for a transaction that subsequently qualifies as a sale and leaseback.

Example 10-7

This example is a continuation of the fact pattern from Example 10-4. Buyer-Lessor has concluded that the present value of the lease payments ($8,123,34713) represents substantially all (90.26 percent) of the fair value of the tower assets ($9,000,000). The lease would therefore be classified as a sales-type lease and, in accordance with ASC 842-40-25-2, Buyer-Lessor has not obtained control of the tower assets.

Buyer-Lessor accounts for the financing arrangement at commencement as follows:

10.4.2.3 Illustrative Example

Example 2 in ASC 842-40-55-31 through 55-38 illustrates the accounting by both parties when the transfer of the underlying asset is not a sale.

ASC 842-40

Example 2 — Accounting for a Failed Sale and Leaseback Transaction

55-31 An entity (Seller) sells an asset to an unrelated entity (Buyer) for cash of $2 million. Immediately before the transaction, the asset has a carrying amount of $1.8 million and has a remaining useful life of 21 years. At the same time, Seller enters into a contract with Buyer for the right to use the asset for 8 years with annual payments of $200,000 payable at the end of each year and no renewal options. Seller’s incremental borrowing rate at the date of the transaction is 4 percent. The contract includes an option to repurchase the asset at the end of Year 5 for $800,000.

55-32 The exercise price of the repurchase option is fixed and, therefore, is not the fair value of the asset on the exercise date of the option. Consequently, the repurchase option precludes accounting for the transfer of the asset as a sale. Absent the repurchase option, there are no other factors that would preclude accounting for the transfer of the asset as a sale.

55-33 Therefore, at the commencement date, Seller accounts for the proceeds of $2 million as a financial liability and continues to account for the asset. Buyer accounts for the payment of $2 million as a financial asset and does not recognize the transferred asset. Seller accounts for its financing obligation, and Buyer accounts for its financial asset in accordance with other Topics, except that, in accordance with paragraph 842-40-30-6, Seller imputes an interest rate (4.23 percent) to ensure that interest on the financial liability is not greater than the payments on the financial liability over the shorter of the lease term and the term of the financing and that the carrying amount of the asset will not exceed the financial liability at the point in time the repurchase option expires (that is, at the point in time Buyer will obtain control of the asset in accordance with the guidance on satisfying performance obligations in Topic 606). Paragraph 842-40-30-6 does not apply to the buyer-lessor; therefore, Buyer recognizes interest income on its financial asset on the basis of the imputed interest rate determined in accordance with paragraphs 835-30-25-12 through 25-13, which in this case Buyer determines to be 4 percent.

55-34 During Year 1, Seller recognizes interest expense of $84,600 (4.23% × $2 million) and recognizes the payment of $200,000 as a reduction of the financial liability. Seller also recognizes depreciation expense of $85,714 ($1.8 million ÷ 21 years). Buyer recognizes interest income of $80,000 (4% × $2 million) and recognizes the payment of $200,000 as a reduction of its financial asset.

55-35 At the end of Year 1, the carrying amount of Seller’s financial liability is $1,884,600 ($2 million + $84,600 – $200,000), and the carrying amount of the underlying asset is $1,714,286 ($1.8 million – $85,714). The carrying amount of Buyer’s financial asset is $1,880,000 ($2 million + $80,000 – $200,000).

55-36 At the end of Year 5, the option to repurchase the asset expires, unexercised by Seller. The repurchase option was the only feature of the arrangement that precluded accounting for the transfer of the asset as a sale. Therefore, upon expiration of the repurchase option, Seller recognizes the sale of the asset by derecognizing the carrying amount of the financial liability of $1,372,077, derecognizing the carrying amount of the underlying asset of $1,371,429, and recognizing a gain of $648. Buyer recognizes the purchase of the asset by derecognizing the carrying amount of its financial asset of $1,350,041 and recognizes the transferred asset at that same amount. The date of sale also is the commencement date of the leaseback for accounting purposes. The lease term is 3 years (8 year contractual leaseback term – 5 years already passed at the commencement date). Therefore, Seller recognizes a lease liability at the present value of the 3 remaining contractual leaseback payments of $200,000, discounted at Seller’s incremental borrowing rate at the contractually stated commencement date of 4 percent, which is $555,018, and a corresponding right-of-use asset of $555,018. Seller uses the incremental borrowing rate as of the contractual commencement date because that rate more closely reflects the interest rate that would have been considered by Buyer in pricing the lease.

55-37 The lease is classified as an operating lease by both Seller and Buyer. Consequently, in Year 6 and each year thereafter, Seller recognizes a single lease cost of $200,000, while Buyer recognizes lease income of $200,000 and depreciation expense of $84,378 on the underlying asset ($1,350,041 ÷ 16 years remaining useful life).

55-38 At the end of Year 6 and at each reporting date thereafter, Seller calculates the lease liability at the present value of the remaining lease payments of $200,000, discounted at Seller’s incremental borrowing rate of 4 percent. Because Seller does not incur any initial direct costs and there are no prepaid or accrued lease payments, Seller measures the right-of-use asset at an amount equal to the lease liability at each reporting date for the remainder of the lease term.

10.4.3 Subsequent Business Combinations

There may be situations in which an entity (either a seller-lessee or buyer-lessor) that meets the definition of a business has previously entered into sale-and-leaseback transactions and is acquired in a business combination accounted for in accordance with ASC 805-10. Accounting questions may arise regardless of (1) which party to a sale-and-leaseback transaction is being acquired and (2) whether the past transactions were successful or failed sales.

If the initial transfer of the asset in the sale-and-leaseback transaction was determined to be a sale in accordance with ASC 842-40, the acquirer in a business combination should account for the leaseback in the manner described in Section 8.3.5.1.1.

If the seller-lessee or buyer-lessor in a failed sale-and-leaseback transaction is subsequently acquired in a business combination, the acquirer should not reassess the transaction. For example, the acquirer may continue to use the acquiree’s accounting for the failed sale-and-leaseback transaction until the transaction meets the requirements in ASC 842-40 and ASC 606 for the transfer to be accounted for as a sale as described in the Connecting the Dots in Section 10.4.2.1 and the Connecting the Dots in Section 10.4.2.2 for seller-lessees and buyer-lessors, respectively. The assets and liabilities related to the arrangement should be measured at their acquisition-date fair values.

See Chapter 4 of Deloitte’s Roadmap Business Combinations for more information.

Footnotes

The rate implicit in the lease is not readily determinable by Seller-Lessee.

See footnote 11.

Calculated on the basis of a fixed annual lease payment of $2 million and a rate implicit in the lease of 7.35 percent.

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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.