Chapter 10 — Sale-and-Leaseback Transactions
Chapter 10 — Sale-and-Leaseback Transactions
10.1 Introduction and Overview
A sale-and-leaseback transaction is a common and important financing method for
many companies; these transactions involve the transfer of an asset by an owner
(“seller-lessee”) to an acquirer (“buyer-lessor”) and a transfer of the right to
control the use of that same asset back to the original owner for a period.
Sale-and-leaseback transactions offer seller-lessees a number of advantages, including:
- The ability to free up the cash invested in the asset and invest that cash in more profitable or more pressing projects (e.g., paying off corporate debt, reinvesting the cash into operations, funding stock buybacks). This may be particularly advantageous in tight credit markets.
- In a sale-and-leaseback arrangement, essentially 100 percent of the asset is financed. This may be a higher level of financing than the seller-lessee ordinarily would be able to obtain.
- Under the legacy sale-and-leaseback accounting requirements in ASC 840, a seller-lessee may have been allowed to remove the asset and any related debt from its balance sheet; as a result, the seller-lessee’s financial ratios may improve. However, the lessee accounting model in ASC 842 (see Chapter 8) removes the off-balance-sheet benefits of sale-and-leaseback transaction structures for seller-lessees. That is, while the underlying asset and corresponding debt may be removed, they are replaced with the ROU asset and lease liability, albeit typically at a lower value.
- The transaction also may improve the seller-lessee’s income statement. Depreciation expense and interest expense could be reduced, and the cash freed up by the transaction could be invested to obtain a greater return than could be obtained when the cash was invested in the asset. In addition, the seller-lessee may have lower income tax expense, since tax deductions arising from the rental payments could exceed the deductions that had been generated by debt payments. These favorable income statement effects may be offset to some extent by the additional rental expense that will be recognized and reduced tax deductions for depreciation expense.
- The transaction allows the seller-lessee to refocus its resources on its primary business operations instead of managing and maintaining fixed assets or real estate.
The buyer-lessor in a sale-and-leaseback transaction benefits from receiving a steady return on its investment in the form of annual rental payments and may receive certain tax advantages. Furthermore, the buyer-lessor will receive benefits through owning the asset, including any future asset appreciation.
10.2 Scope of the Sale-and-Leaseback Accounting Guidance
10.2.1 General Scope Considerations
ASC 842-40
05-1 This Subtopic addresses accounting for sale and leaseback transactions when a lease has been accounted for in accordance with Subtopic 842-10 and either Subtopic 842-20 or Subtopic 842-30.
15-1 This Subtopic follows the same Scope and Scope Exceptions as outlined in the Overall Subtopic; see Section 842-10-15.
15-2 If an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) and leases that asset back from the buyer-lessor, both the seller-lessee and the buyer-lessor shall account for the transfer contract and the lease in accordance with Sections 842-40-25, 842-40-30, and 842-40-50.
15-3 See paragraphs 842-40-55-1 through 55-21 for implementation guidance on the scope of this Subtopic. See Example 3 (paragraphs 842-40-55-39 through 55-44) for an illustration of the scope of this Subtopic.
As noted in paragraph BC349 of ASU 2016-02, the guidance on accounting for
sale-and-leaseback transactions in ASC 842-40 substantially differs from that in
ASC 840-40. The decision tree below illustrates how an entity would apply the
guidance in ASC 842-40 to identify the appropriate accounting for situations in
which it transfers an asset to another entity and obtains the right to use that
asset.
Changing Lanes
Scope of Sale-and-Leaseback Accounting Guidance for
Buyer-Lessors
As illustrated in the decision tree above, the scope of ASC 842-40 applies to
both the seller-lessee and the buyer-lessor in a sale-and-leaseback
transaction. Thus, the scope of sale-and-leaseback accounting in ASC
842-40 differs from the scope in ASC 840-40, which applied only to the
seller-lessee. ASC 842 will therefore result in a significant change for
buyer-lessors in sale-and-leaseback transactions, since they must now
also assess whether the seller-lessee has transferred control of the
underlying asset in the sale leg of the transaction (i.e., they must
assess whether they have obtained control).
The decision tree above outlines the scope of the sale-and-leaseback guidance
under ASC 842-40 in its simplest form. The implementation guidance in ASC
842-40-55 addresses specific transactions (not all-inclusive) that may be within
the scope of the sale-and-leaseback guidance in ASC 842-40. Further, as stated
above, the guidance in ASC 842-40-15-2 applies to transactions in which “an
entity (the seller-lessee) transfers an asset to another entity (the
buyer-lessor) and leases that asset back from the buyer-lessor” but does not
specify the type of consideration received from the buyer-lessor in exchange for
the transfer of the asset from the seller-lessee. As described in Section 10.1, most
sale-and-leaseback transactions are entered into for financing purposes and will
involve cash consideration. However, we are aware of transactions that involve
all or some nonmonetary consideration (e.g., equity interests in the
buyer-lessor in exchange for an asset).
Moreover, the “leaseback” in a sale-and-leaseback transaction must meet the
definition of a lease as outlined in Chapter
3. While this determination may be straightforward for real
estate or equipment, for which sale-and-leaseback transactions are most common,
entities in certain industries such as power and utilities may sometimes enter
into unique transactions and may find it more challenging to determine whether a
lease exists in such situations.
Connecting the Dots
Sale and Contemporaneous
Agreement to Receive the Output of an Asset by the Original
Owner
It can be challenging to determine the scope of the sale-and-leaseback
guidance in scenarios in which the ongoing exchange transaction may or
may not involve the use of an underlying asset. In such cases, it is
important to carefully consider whether the leaseback transaction meets
the definition of a lease. Specifically, exchange transactions may
involve an asset for which HAFWP the asset is used throughout the period
of use is predetermined (see Section
3.4.2.3). In such situations, an entity needs to consider
whether the customer operates the asset throughout the period of use or
whether the customer designed the asset.
Such considerations may apply to exchange transactions
in which energy-generating fixed assets (e.g., a solar farm) are sold by
the original owner of the asset (that was also involved in building the
asset) and the original owner enters into a contemporaneous agreement to
receive the asset’s output for a period after the sale. With such
assets, it is often common for HAFWP the asset is used throughout the
period to be predetermined and for the original owner not to have the
right to operate the asset during the period after sale. Accordingly,
regarding the determination of whether the contemporaneous agreement to
receive the asset’s output is a lease, the original owner must assess
whether it designed the asset (see Section 3.4.2.3.2). We believe
that because the seller is the original owner that was also involved in
building the asset, most will conclude that the seller designed the
asset and that, accordingly, this arrangement will be subject to the
accounting guidance in ASC 842-40. These arrangements may be common in
the power and utilities industry but may also exist for other types of
assets such as cell towers and technology servers.
10.2.2 Control of the Underlying Asset Before Lease Commencement
Under ASC 842-40-55-1 through 55-6, transactions in which a lessee controls an
underlying asset before the commencement date of the lease are within the scope
of the sale-and-leaseback guidance. That is, under ASC 842-40, if a lessee
controls an underlying asset before lease commencement, it would recognize the
entire asset on its balance sheet and determine whether derecognition is
appropriate at lease commencement as a sale-and- leaseback transaction. ASC
842-40-55-1 and 55-2 cover transactions in which the lessee obtains control of
the asset before transferring it to the lessor, and ASC 842-40-55-3 through 55-6
address transactions in which the lessee obtains control of a construction
project (i.e., the underlying asset that will be subject to the lease is in the
process of being constructed).
See Chapter 11 for further details on the guidance in ASC 842-40-55-1 through 55-6 on when the lessee controls an underlying asset before the commencement date of the lease as well as on the subsequent accounting that results.
10.2.2.1 Sale or Transfer of a Purchase Option by a Lessee
Questions have arisen about whether the scope of ASC 842-40
includes transactions in which (1) a company transfers an option to purchase an
asset to an unaffiliated third party and the third party is required to exercise
the option and lease back the asset to the company, (2) the third party
exercises the option, and (3) the company leases back the asset.
If the entity only held the option to purchase the asset but
never held title to the asset itself, it must analyze the substance of the
purchase option to determine whether possession of the option was substantially
the same as control of the asset before it was owned by the unaffiliated third
party. The entity must assess the purchase option itself by applying the
guidance in ASC 842-40-25-1 to determine whether and, if so, when (further
discussed in Section
10.3.1) it transfers control of the asset to the buyer-lessor.
An option that grants to the potential seller-lessee the right
to purchase the underlying asset may convey control by conveying certain rights
related to the asset before exercise. Although certain risks and rewards of the
asset may be transferred to a company when the option is first conveyed to the
company (e.g., a fixed-price purchase option that conveys the right to
participate in any future appreciation in the asset’s value), we believe that
the company typically does not control the underlying
asset at that point. Rather, we think that the company controls the underlying asset at the point when it effectively
exercises the option itself or by transferring it to an unaffiliated third party
(a buyer-lessor) and requiring that the third party exercise it. At that point,
the company controls the underlying asset and what happens to it by requiring
someone else to exercise the option (the owner of the asset is compelled to
transfer the asset in accordance with the option) and requiring the buyer to
provide the company with the right to use the asset. Therefore, such a
transaction would be subject to the sale-and-leaseback accounting guidance in
ASC 842-40. In contrast, simply facilitating the negotiation and sale of an
underlying asset between two unaffiliated third parties with an agreement to
lease the asset from the buyer would not by itself
convey control of the underlying asset to a company.
Example 10-1
Company A writes a call option on real
estate in Orange County, California, to Company B on
January 1, 2020. Company B transfers the call option to
Company C on December 31, 2021, requiring that C
exercise the call option and lease the real estate to B.
In accordance with this requirement, C exercises the
option on December 31, 2021, and leases the real estate
to B for five years.
On December 31, 2021, B controls the
underlying real estate because it effectively exercised
the option by transferring it to C under the condition
of exercise. Accordingly, on December 31, 2021, for both
B and C, the transaction is subject to the
sale-and-leaseback accounting guidance in ASC
842-40.
The discussion and example above represent our perspective on
these arrangements. These issues continue to evolve, and it is possible that the
FASB and SEC staffs will want to share perspectives on this or related fact
patterns. Companies that are involved in these types of arrangements should
consult with their accounting advisers and monitor developments on the topic.
See also Section 7.6.3.1 of Deloitte’s
Roadmap Statement of Cash Flows for
a discussion of cash flow impacts resulting from these transactions.
We also believe that the assessment may differ in a transaction
in which a company holds an option to purchase an asset that is under
construction only at the point at which construction of the asset is complete.
This is because, when a company transfers the purchase option to a third party,
the third party often is required to exercise the purchase option and lease the
asset back to the company only upon completion of
construction, and such a transaction is different from the transactions
described above. In the transaction described in the example above, the
transferred purchase option includes a present right to exercise that option
and, accordingly, differs from a purchase option that can only be exercised upon
completion of construction, since the right associated with that purchase option
is in the future. Accordingly, in these situations, an entity may be required to
perform additional analysis to determine whether the transaction is subject to
the accounting guidance in ASC 842-40.
10.2.3 Other Scope Considerations
The next sections address other scope considerations related to the
sale-and-leaseback accounting guidance in ASC 842-40.
10.2.3.1 Lessee Indemnification for Environmental Contamination
ASC 842-40
55-7 A provision that requires lessee indemnifications for preexisting environmental contamination does not,
on its own, mean that the lessee controlled the underlying asset before the lease commenced regardless of the
likelihood of loss resulting from the indemnity. Consequently, the presence of such a provision does not mean
the transaction is in the scope of this Subtopic.
10.2.3.2 Sale Subject to a Preexisting Lease
ASC 842-40
55-8 An entity owns an interest in an underlying asset and also is a lessee under an operating lease for all or a portion of the underlying asset. Acquisition of an ownership interest in the underlying asset and consummation of the lease occurred at or near the same time. This owner-lessee relationship can occur, for example, when the entity has an investment in a partnership that owns the underlying asset (or a larger asset of which the underlying asset is a distinct portion). The entity subsequently sells its interest or the partnership sells the underlying asset to an independent third party, and the entity continues to lease the underlying asset under the preexisting operating lease.
55-9 A transaction should be subject to the guidance in this Subtopic if the scope or price of the preexisting lease is modified in connection with the sale. If the scope or the price of the preexisting lease is not modified in conjunction with the sale, the sale should be accounted for in accordance with other Topics.
55-10 A lease between parties under common control should not be considered a preexisting lease. Accordingly, the guidance in this Subtopic should be applied to transactions that include nonfinancial assets within its scope, except if Topic 980 on regulated operations applies. That is, if one of the parties under common control is a regulated entity with a lease that has been approved by the appropriate regulatory agency, that lease should be considered a preexisting lease.
The example below illustrates the application of the guidance in ASC 842-40-55-8 and 55-9.
Example 10-2
Company A has a 50 percent ownership interest in a property that consists of
warehouse space and office space. Currently, A
leases all of the warehouse space, which comprises
75 percent of the building’s total square footage,
and the lease is classified as an operating lease.
Company A proposes to sell its entire ownership
interest in the property to an unrelated third
party, Acquirer X, but to continue to lease the
warehouse space.
To the extent that A and X do not modify the price or scope of A’s lease of the warehouse space, neither party would need to assess this transaction by using the sale-and-leaseback accounting guidance in ASC 842-40.
The section below further discusses the
application of the guidance in ASC 842-40-55-10.
10.2.3.2.1 Intercompany Sale-and-Leaseback Transactions
Consider a scenario in which a subsidiary owns equipment
that it leases to its parent company or to other subsidiaries, and the
subsidiary sells the equipment subject to the existing intercompany lease to
an unrelated third party. The subsidiaries are consolidated with the parent
company for financial reporting purposes. Neither of the parties to the
transaction is a regulated entity.
The sale of equipment subject to an existing intercompany
lease should be assessed in accordance with the sale-and-leaseback
accounting guidance in ASC 842-40. The equipment lease that was in effect
before the sale was eliminated in consolidation. Therefore, at the
consolidated level, there was no lease. Since the parent and the subsidiary
had the ability to cancel the lease before the sale to the unrelated third
party but chose not to, there is a presumption that the sale and the terms
of the leaseback were considered together in the seller-lessee’s discussions
with the buyer-lessor and that the transactions should be treated as one
integrated transaction within the scope of ASC 842-40. It would not be
appropriate to consider the lease a preexisting lease in such cases.
10.2.3.2.2 Leaseback of Assets by an Acquiree After a Business Combination
If a seller leases back an asset that was acquired by the acquirer in a
business combination accounted for under ASC 805, the transaction is
outside the scope of the sale-and-leaseback guidance in ASC 842-40. That
is, the lease is evaluated as a new lease and is accounted for in
accordance with other guidance in ASC 842. For more information about
the accounting for leases in a business combination, see Chapter 4 of Deloitte’s Roadmap
Business
Combinations.
10.2.3.2.3 Third-Party Lessor Involvement in a Business Combination
In a business combination, a third party may acquire assets
directly from the acquiree before the business combination and subsequently
lease those assets to the acquirer after the acquisition.
When a third party acquires assets directly from an acquiree
before a business combination to subsequently lease those assets to the
acquirer, and that transaction is either contingent on or in contemplation
of the business combination, we believe the assets have been transferred to
the acquirer (i.e., the acquirer has obtained control of the assets) just
before, or concurrently with, the business combination. This is because the
acquirer could preclude the sale of the assets to the third party by not
completing the business combination. Therefore, the assets acquired by the
third party are effectively controlled by the acquirer, albeit momentarily,
before the sale to the third party can be completed. In this scenario, we
believe that it should be presumed that sale of the assets from the acquiree
to the third party and subsequent leaseback of the assets from the third
party to the acquirer were entered into in contemplation of one another and
in connection with the business combination. In substance, the
acquirer/lessee directed the acquiree to sell the assets to the third party
with a subsequent leaseback to the acquirer, which has the effect of
financing part of the business combination.
We believe that the acquirer/lessee has gained control of
the assets before the third party (lessor) and therefore that the guidance
in ASC 842-40-55-1 would be applicable. This guidance states, in part:
If the lessee controls the underlying asset (that is,
it can direct its use and obtain substantially all of its remaining
benefits) before the asset is transferred to the lessor, the transaction
is a sale and leaseback transaction that is accounted for in accordance
with this Subtopic.
Accordingly, we believe the acquirer/lessee should account
for the transaction as (1) a business combination in which the assets are
included in the acquired asset set and (2) a sale-and-leaseback transaction
with the third party for the assets in accordance with ASC 842-40; it would
not be appropriate to instead exclude the assets from the acquired asset set
in the business combination and record a separate lease of the assets from a
third party. The amount of consideration transferred by the acquirer to
effect the business combination should include the amount paid by the third
party to the acquiree for the assets,1 since it is in effect a payment being made on behalf of the
acquirer.
10.2.3.3 Sale-Leaseback-Sublease Transactions
ASC 842-40
55-18 An entity enters into a sale and leaseback of an asset that meets either of the following criteria:
- The asset is subject to an operating lease.
- The asset is subleased or intended to be subleased by the seller-lessee to another party under an operating lease.
55-19 A sale-leaseback-sublease transaction is within the scope of this Subtopic. The existence of the sublease (that is, the operating lease in paragraph 842-40-55-18(a) or (b)) does not, in isolation, prevent the buyer-lessor from obtaining control of the asset in accordance with paragraphs 842-40-25-1 through 25-3, nor does it prevent the seller-lessee from controlling the asset before its transfer to the buyer-lessor (that is, the seller-lessee is subject to the same requirements for determining whether the transfer of the asset is a sale as it would be without the sublease). All facts and circumstances should be considered in determining whether the buyer-lessor obtains control of the underlying asset from the seller-lessee in a sale-leaseback-sublease transaction.
A seller-lessee (seller-sublessor) and buyer-lessor may enter into a sale-and-leaseback transaction involving an asset that either (1) is subject to an existing operating lease (i.e., such that the original owner sells the asset subject to the operating lease and leases it back to continue performing economically as a lessor) or (2) is or will be subleased to a third party under an operating lease (i.e., such that the original owner sells the asset, leases it back, and executes a sublease agreement with a third party). Contractual provisions allowing a seller-lessee to sublease the underlying asset are common in leaseback arrangements because they allow the seller-lessee to sublease the property without having to renegotiate the terms of its lease with the buyer-lessor. The seller-lessee may wish to retain a right to sublease the property in case its continued leasing of the property becomes uneconomic in light of its business plan. For example, a restaurant owner may want to retain its right to sublease the property in case several years into the lease term the surrounding area’s demographics change and adversely affect the restaurant’s operations.
Such transactions are within the scope of the sale-and-leaseback accounting guidance in ASC 842-40. The seller-sublessor and buyer-lessor must follow the steps in the decision tree in Section 10.2.1 and assess whether the seller-sublessor transfers control of the asset to the buyer-lessor.
See Chapter 12 for a detailed discussion of the sublease accounting requirements in ASC 842.
10.2.3.4 Other Transaction Types
Although ASC 842-40-55 identifies certain scope considerations, it may be
difficult to tell whether other complex transaction types reflect the
economic substance of a sale and leaseback or a financing arrangement. The
sections below address various transaction types that we think should be
assessed in accordance with the guidance in ASC 842-40 on sale-and-leaseback
transactions.
10.2.3.4.1 Separate Analysis of the Land and Building Components of a Lease
If undeveloped land is sold to a developer to construct a
building and the developer leases the completed building and land back to
the seller, the lease of the land and the building should not be accounted
for as a single sale-and-leaseback transaction.
Rather, in this circumstance, the lease of the land and the
building should be accounted for as separate lease components in accordance
with ASC 842-10-15-29. Since the land element was previously controlled by
the lessee, the leaseback of the land should be accounted for as a
sale-and-leaseback transaction. The lease of the building element is not
within the scope of the sale-and-leaseback guidance in ASC 842-40 because
the building was never controlled by the lessee and thus control of an asset
(the building) was not transferred. The building lease should be accounted
for in accordance with the lease classification criteria in ASC 842-10-25-1
and 25-2.
10.2.3.4.2 Treatment of Sales Agreements in Which the Seller Retains an Option to Lease the Asset Transferred
Transactions involving the transfer of an asset to a
purchaser, if the seller has the contractual obligation, or has been granted
the option, to enter into a leasing arrangement with the purchaser for use
of that same asset, generally should be accounted for in accordance with ASC
842-40. The same is presumed when an asset transfer is subsequently followed
by a separate transaction in which the original seller agrees to lease the
same asset from the original purchaser.
An entity would need to have persuasive evidence to support an assertion that
such a transaction is not within the scope of ASC 842-40.
10.2.3.4.3 Concurrent Sale and Leasing Transactions That Involve Different Assets but the Same Counterparty2
When an entity transfers an asset to a purchaser while
entering into a concurrent arrangement to lease a similar, but not the same,
asset from the same purchaser, there is a rebuttable presumption that such
an arrangement should be accounted for as one integrated sale-and-leaseback
transaction, even if the asset being leased is not the exact asset that was
sold. This presumption can only be overcome when there is sufficient
evidence that the transactions are, in fact, independent transactions. If
the presumption cannot be overcome, the seller-lessee and buyer-lessor
should account for the transactions together as a sale-and-leaseback
transaction in accordance with ASC 842-40.
10.2.3.4.4 Sale of Construction in Process With a Leaseback of the Asset After Completion of Construction
A company (the “seller” or “seller-lessee”) may enter into an arrangement
with a developer (the “buyer” or “buyer-lessor”) to transfer construction in
process (CIP) to the developer. In such an arrangement, the developer will
complete construction of the asset (the “completed construction”) and lease
it back to the seller. The CIP that the seller transfers to the buyer can be
in different phases of development. For example, a building may be in the
following phases of construction when transferred to a buyer:
- Only soft costs3 have been incurred.
- The land has been cleared or graded to prepare for construction of the building.
- A physical structure has begun to take form, such as a foundation and steel beams.
- Progress has been made toward a building with an unfinished interior.
- Substantial progress has been made toward completion of a building.
Under the previous leasing guidance in ASC 840-40-55-44, an
entity was subject to the ASC 840 sale-and-leaseback requirements if the
entity had begun construction activities, including the following:
- Begun construction (broken ground)
- Incurred hard costs (no matter how insignificant the hard costs incurred may be in relation to the fair value of the property to be constructed)
- Incurred soft costs that represent more than a minor amount of the fair value of the leased property (that is, more than 10 percent of the expected fair value of the leased property).
ASC 840 included indicators of when an entity with CIP may
be subject to the sale-and-leaseback requirements. However, no such
indicators exist under ASC 842. Rather, ASC 842 does not explicitly address
whether the sale of CIP that will be leased back at completion of the
construction is subject to sale-and-leaseback guidance. On the basis of a
technical inquiry with the FASB staff, we understand that there may be a
range of acceptable approaches to determining whether the transfer of CIP is
subject to sale-and-leaseback accounting. For example, we understand that it
would be acceptable to conclude that the transfer of CIP accompanied by an
agreement to lease the completed construction is always subject to
sale-and-leaseback accounting (regardless of the stage of construction or
the amount of costs incurred). On the other end of the spectrum, we also
understand that it would be acceptable for entities to consider whether (on
the basis of the stage of construction) the CIP sold is substantially
similar to the underlying asset that will be leased back. That is, in some
cases, the CIP might not yet be substantially similar to the asset to be
leased back and, as a result, sale-and-leaseback accounting may not be
required. In determining whether this is the case, an entity will most
likely need to use judgment and consider various qualitative factors. We
believe that it also may be appropriate for an entity to consider
quantitative thresholds (e.g., whether the fair value of the CIP represents
90 percent or more of the expected value of the completed construction) to
help inform an overall qualitative assessment of whether the CIP is
substantially similar to the underlying asset to be leased back at the end
of construction. If an entity chooses to apply a quantitative threshold, the
approach should be applied to real estate on a comparable basis in such a
way that the fair value of the completed construction is not computed by
using inputs in which the subsequent use of the completed asset is
considered. For example, in real estate to be leased, this analysis should
be performed on the basis of the fair value of the partially completed asset
and the vacant completed asset, rather than a completed asset with an
in-place lease.
Although the approaches described above result in very different accounting
treatments, on the basis of the technical inquiry with the FASB staff, we
believe that each of these approaches represents a reasonable application of
the guidance.4 We believe that companies should elect one approach as an accounting
policy and should apply it consistently.
10.2.3.4.5 Seller-Lessee’s Subsequent Accounting for Arrangements Involving the Transfer of CIP
When an arrangement involving the transfer of CIP is subject
to the sale-and-leaseback guidance in ASC 842, questions have arisen about
the subsequent accounting for that arrangement for the seller-lessee. One of
the primary conditions for derecognizing an asset in a sale-and-leaseback
transaction is that the leaseback is not a finance lease. Since certain
components of the lease classification analysis cannot be known as of the
date of the transfer of CIP, such as the discount rate and the fair value of
the property as of the commencement date, it is not possible to assess and
achieve sale-and-leaseback accounting until the lease commencement date.
This conclusion holds true even if the seller-lessee expects
the leaseback to be an operating lease and no purchase option will exist
after the lease commencement date. That is, once the seller-lessee is deemed
the owner of an asset under construction (even if the seller-lessee loses
control of the asset), it will not be possible to achieve sale-and-leaseback
accounting until lease classification is determined, which is not possible
under ASC 842 until lease commencement.
In addition, we believe that costs incurred both before and
after the transfer of CIP to the buyer- lessor are related to a single unit
of account. Therefore, the seller-lessee would perform the following
accounting when the transfer of CIP is subject to the sale-and-leaseback
guidance in ASC 842:
-
Continue to record the existing CIP on the balance sheet (i.e., do not derecognize the partially completed asset).
-
Capitalize all incremental costs of construction (whether funded by the seller-lessee or the buyer-lessor).
-
Record an associated financing obligation (see Section 10.4.2) for costs funded by the buyer-lessor, including any funds received for the transfer of CIP.
-
Upon completion of construction, apply the sale-and-leaseback guidance to determine whether the completed construction can be derecognized (see Section 10.3).
When an arrangement involving the transfer of CIP is determined not to be
subject to the accounting guidance in ASC 842-40 after the substantially
similar quantitative threshold described above is applied, both the
seller-lessee and buyer-lessor will need to apply build-to-suit accounting
to determine whether the lessee is the accounting owner of the CIP (see
Chapter 11). If the lessee is
deemed to be the accounting owner, the lessee should not derecognize the CIP
on the legal sale date. However, if the lessee is not the accounting owner
after the legal sale date, the lessee must apply the appropriate
derecognition framework (for example, ASC 610-20 or, in some cases, ASC 606)
to determine whether a sale occurred.
10.2.3.4.6 Partial Sales Transactions Under ASC 842-40
The guidance in ASC 842-40 also applies to sales and subsequent
leasebacks of nonfinancial assets. For example, if a seller transfers a
real estate asset into a newly formed joint venture, retains a
noncontrolling interest in the joint venture, and subsequently leases
back the real estate asset from the joint venture, the seller would need
to evaluate whether the transfer of the asset represents a successful
sale in accordance with ASC 842-40.
Footnotes
1
We have assumed that the amount paid by the third
party to the acquiree would be known by the acquirer. However, to
the extent this amount is not known, the acquirer should impute a
purchase price for the assets by considering the fair market value
of the assets purchased and any off-market lease terms in the
leaseback.
2
This section addresses the applicability of
sale-and-leaseback guidance to concurrent sales and leases of
similar, completed assets. See Section 10.2.3.4.4 for a
discussion of the applicability of sale-and-leaseback guidance to
sales of CIP with a leaseback of the completed asset.
3
The legacy guidance in ASC 840-40-55-42 states, “In some
build-to-suit lease transactions, the lessee may incur
certain development costs before entering into a lease
agreement with the developer-lessor. Those costs may include
both soft costs (for example, architectural fees, survey
costs, and zoning fees) and hard costs (for example, site
preparation, construction costs, and equipment
expenditures).”
4
In addition, we believe that there may be a range of other acceptable
approaches between the two approaches outlined above. Companies that
are involved in these types of arrangements should consult with
their accounting advisers when electing an approach.
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
5
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.
6
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.
7
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.
8
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.
9
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.
10
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.
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:
- 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
- Derecognize the carrying amount of the underlying asset
- 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.