11.2 Lessee’s Involvement With an Asset Before Lease Commencement
ASC 842-40
55-1 A lessee may obtain legal title to the underlying asset before that legal title is transferred to the lessor and the asset is leased to the lessee. 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.
55-2 If the lessee obtains legal title, but does not obtain control of the underlying asset before the asset is transferred to the lessor, the transaction is not a sale and leaseback transaction. For example, this may be the case if a manufacturer, a lessor, and a lessee negotiate a transaction for the purchase of an asset from the manufacturer by the lessor, which in turn is leased to the lessee. For tax or other reasons, the lessee might obtain legal title to the underlying asset momentarily before legal title transfers to the lessor. In this case, if the lessee obtains legal title to the asset but does not control the asset before it is transferred to the lessor, the transaction is accounted for as a purchase of the asset by the lessor and a lease between the lessor and the lessee.
ASC 842-40-55-1 and 55-2 clarify that the notion of control is used to determine
whether a transaction is within the scope of the sale-and-leaseback guidance — if
the lessee controls the underlying asset before transferring it to the lessor (and
is thus the deemed owner), the transaction is accounted for in accordance with ASC
842-40. Section
10.2.2.1 includes an example illustrating such a scenario.
When the lessee obtains legal title to the underlying asset before transferring
title to the lessor (i.e., the lessee obtains “flash title”) and the lessee does not
control the underlying asset before transferring the asset to the lessor, the
transaction is not accounted for in accordance with ASC 842-40. This is consistent
with ASC 606-10-55-37, which clarifies that an entity that obtains legal title to a
good momentarily before the legal title is transferred to a customer does not
necessarily control the specified good. ASC 842-40-55-2 provides an example of such
a situation, in which an entity often obtains financing or a certain tax
treatment.
These same concepts apply to the transfer of an asset under construction, as
discussed in Section
11.3.
Connecting the Dots
Control of the Underlying Asset
Before Lease Commencement in Arrangements That Involve Parties in
Addition to the Lessee and Lessor
Some lease arrangements may involve parties in addition to
the lessee and lessor. For example, an arrangement may involve an asset
manufacturer that manufactures the underlying asset and delivers it for
lease (e.g., an original equipment manufacturer or OEM), the entity that
will ultimately lease the equipment (i.e., the end customer), and a
financing entity (e.g., a bank) that purchases an asset at the inception of
the contract from the asset manufacturer with the explicit intent of leasing
out the asset to the end customer.
As discussed in Section 11.2, depending on the facts
and circumstances, the end customer (i.e., the lessee in the arrangement)
may obtain control of the underlying asset before lease commencement. Since
the eventual lease of the asset is between the financing entity and the end
customer, the applicability of the guidance in ASC 842-40 would depend on
whether the financing entity obtains control of the underlying asset from
the end customer (as opposed to from the asset manufacturer). In such
situations, we believe that an entity may need to apply the
principal-versus-agent guidance in ASC 606 to determine whether the end
customer is the principal in the sale of the underlying asset to the
financing entity (the ultimate lessor). See Chapter 10 of Deloitte’s Roadmap
Revenue Recognition for a
discussion of principal-versus-agent considerations.
We encourage entities that identify such situations to consult with their accounting
advisers.