Chapter 16 — Effective Date and Transition

16.9 Transition for Sale-and-Leaseback Transactions

ASC 842-10

65-1 The following represents the transition and effective date information related to Accounting Standards Update . . . No. 2016-02, Leases (Topic 842) . . .

Sale and Leaseback Transactions Before the Effective Date

aa. If a previous sale and leaseback transaction was accounted for as a sale and a leaseback in accordance with Topic 840, an entity shall not reassess the transaction to determine whether the transfer of the asset would have been a sale in accordance with paragraphs 842-40-25-1 through 25-3.

bb. If a previous sale and leaseback transaction was accounted for as a failed sale and leaseback transaction in accordance with Topic 840 and remains a failed sale at the effective date:

1. If an entity elects the transition method in (c)(1), the entity shall reassess whether a sale would have occurred at any point on or after the beginning of the earliest period presented in the financial statements in accordance with paragraphs 842-40-25-1 through 25-3. The sale and leaseback transaction shall be accounted for on a modified retrospective basis from the date a sale is determined to have occurred.

2. If an entity elects the transition method in (c)(2), the entity shall reassess whether a sale would have occurred at the beginning of the reporting period in which the entity first applies the pending content that links to this paragraph in accordance with paragraphs 842-40-25-1 through 25-3 and recognize the sale as an adjustment to equity. The entity shall then account for the leaseback in accordance with the guidance in Subtopic 842-20 after the beginning of the reporting period in which the entity first applies the pending content that links to this paragraph.

cc. An entity shall account for the leaseback in accordance with the lessee and lessor transition requirements in (k) through (y).

dd. If a previous sale and leaseback transaction was accounted for as a sale and capital leaseback in accordance with Topic 840, the transferor shall continue to recognize any deferred gain or loss that exists at the later of the beginning of the earliest comparative period presented in the financial statements and the date of the sale of the underlying asset (if an entity elects the transition method in (c)(1)) or that exists at the beginning of the reporting period in which the entity first applies the pending content that links to this paragraph (if an entity elects the transition method in (c)(2)), as follows:

1. If the underlying asset is land only, straight line over the remaining lease term.

2. If the underlying asset is not land only and the leaseback is a finance lease, in proportion to the amortization of the right-of-use asset.

3. If the underlying asset is not land only and the leaseback is an operating lease, in proportion to the recognition in profit or loss of the total lease cost.

ee. If a previous sale and leaseback transaction was accounted for as a sale and operating leaseback in accordance with Topic 840, the transferor shall do the following:

1. Recognize any deferred gain or loss not resulting from off-market terms (that is, where the consideration for the sale of the asset is not at fair value or the lease payments are not at market rates) as a cumulative-effect adjustment to equity unless the entity elects the transition method in (c)(1) and the date of sale is after the beginning of the earliest period presented, in which case any deferred gain or loss not resulting from off-market terms shall be recognized in earnings in the period the sale occurred.

2. Recognize any deferred loss resulting from the consideration for the sale of the asset not being at fair value or the lease payments not being at market rates as an adjustment to the leaseback right-of-use asset at the later of the beginning of the earliest comparative period presented in the financial statements and the date of the sale of the underlying asset (if an entity elects the transition method in (c)(1)) or at the beginning of the reporting period in which the entity first applies the pending content that links to this paragraph (if an entity elects the transition method in (c)(2)).

3. Recognize any deferred gain resulting from the consideration for the sale of the asset not being at fair value or the lease payments not being at market rates as a financial liability at the later of the beginning of the earliest comparative period presented in the financial statements and the date of the sale of the underlying asset (if an entity elects the transition method in (c)(1)) or at the beginning of the reporting period in which the entity first applies the pending content that links to this paragraph (if an entity elects the transition method in (c)(2)).

According to the transition provisions for sale-and-leaseback transactions, (1) previous transactions that were accounted for as successful sale-and-leaseback transactions are grandfathered from consideration under the ASC 842 sale-and-leaseback derecognition rules and (2) previous transactions that were accounted for as failed sales are reassessed for possible derecognition under ASC 842. The real estate sale-and-leaseback rules are much less onerous under ASC 842, which will result in the unwinding of certain failed sales in the transition to ASC 842. Specifically, if a transaction was a failed sale-and-leaseback transaction under ASC 840 and remains so as of the effective date, the entity must reassess whether a sale would have occurred at any point on or after the date of initial application in accordance with the sale-and-leaseback provisions in ASC 842 (see Chapter 10). The sale-and-leaseback transaction must be recognized from the date a sale is determined to have occurred under ASC 842; if the sale occurred before the date of initial application, any gain or loss will be reflected in equity, and if the sale occurred during the comparative periods (which is only possible if a lessee does not elect the Comparatives Under 840 Option), any gain or loss must be recognized in the respective period. For successful sales, the related lease should be recorded in accordance with the ASC 842 transition requirements in a manner consistent with any other lease.

Connecting the Dots

Lease Classification Assessment in Transition for Unsuccessful Sale-and-Leaseback Transactions Under ASC 840

The lease classification determination in transition for previously unsuccessful sale-and-leaseback transactions is important because the classification of the lease is one of the primary conditions for achieving a sale in a sale-and-leaseback transaction under ASC 842. That is, a sale can only be recognized under ASC 842 if the leaseback would be classified as an operating lease (see Section 10.3.2). Since the lease (from an accounting perspective) did not exist under ASC 840 and a lease cannot be recognized under ASC 842 unless the leaseback would not be classified as a finance lease, the seller-lessee must determine the appropriate “would be” classification of the lease in transition before achieving sale-and-leaseback accounting under ASC 842.

The transition guidance is not clear on whether ASC 840 or ASC 842 should be used in these circumstances as the basis for determining the classification of the leaseback. However, we generally believe that if a previously unsuccessful sale-and-leaseback transaction meets the other criteria necessary to achieve a sale under ASC 842 (see Section 10.3), the “would be” classification of the lease will depend on the following:

If the practical expedient package is not elected, lease classification should be determined under ASC 842 as follows:
- If the lease commenced before the date of initial application, lease classification would generally be determined as of the later of the (1) lease commencement date or (2) date the lease was last modified. If a lease was renewed or extended before the date of initial application, the renewal or extension date would be considered the lease commencement date for this purpose unless the renewal was assumed to be reasonably certain as of the initial lease commencement date.
- If the lease commenced after the date of initial application, the initial lease classification would generally be determined as of the lease commencement date.
The transition guidance is not clear on situations in which the practical expedient package is elected and the lessee has accounted for the transaction as a failed sale and leaseback through the effective date of ASC 842. We believe that, notwithstanding the election of the practical expedient package, it would be acceptable to determine lease classification in accordance with ASC 842 (i.e., as of the later of the (1) lease commencement date or (2) date the lease was last modified — see bullet above), because the lease (for accounting purposes) was never recognized or assessed under ASC 840 (i.e., the lease classification is assessed for the first time upon adopting ASC 842). However, we understand that others believe, because of the lack of clear guidance, that it would also be acceptable to determine lease classification as of lease inception under ASC 840. We think that either approach would be acceptable as an accounting policy that must be applied consistently.

On the other hand, if a previously successful sale-and-leaseback transaction was accounted for as a sale and capital leaseback under ASC 840, the lessee continues to recognize any deferred gain or loss that exists at the later of the date of initial application presented in the financial statements or the date of the sale of the underlying asset. The deferred gain or loss should be subsequently recognized into income as follows:

If the underlying asset is land only, straight-line over the remaining lease term.
If the underlying asset is not land only and the leaseback is a finance lease under ASC 842, in proportion to the amortization of the ROU asset.
If the underlying asset is not land only and the leaseback is an operating lease under ASC 842, in proportion to the recognition in profit or loss of the total lease cost.

If a previously successful sale-and-leaseback transaction was accounted for as a sale and operating leaseback under ASC 840, as long as the sale and the leaseback were at fair value and market terms, respectively, the lessee should recognize any deferred gain or loss as (1) a cumulative-effect adjustment to equity (if the sale would have occurred before the date of initial application) or (2) earnings in the respective comparative period (if the sale would have occurred during the comparative periods and provided that the entity does not elect the Comparatives Under 840 Option). If the sale and leaseback were not at fair value and market terms, respectively, at the time the sale-and-leaseback transaction was entered into, the amount by which the transaction was not at fair value and market terms should not be recognized in transition. Rather, the lessee should recognize any such deferred loss or deferred gain that results because the consideration for the sale of the asset was not at fair value or the lease payments were not at market rates as an adjustment to the ROU asset or finance liability, respectively, at the later of lease commencement or the date of initial application. Any remaining gain/loss after the lessee adjusts for off-market values and terms would be recognized in a manner consistent with the criterion in ASC 842-10-65-1(ee)(1).

Connecting the Dots

Buyer-Lessors Do Not Reassess Previous Sale-and-Leaseback Accounting

ASC 840 did not require that buyer-lessors assess whether the seller was able to obtain sale recognition. That is, accounting symmetry was not required between the buyer-lessor and the seller-lessee; instead, the buyer-lessor would generally account for a sale-and-leaseback transaction as a purchase with a leaseback to the lessee even if the lessee accounts for the sale as a financing. Under ASC 842, such accounting symmetry is required, as described in Section 10.2. In transition, because the lessor generally considered all sale-and-leaseback transactions to be successful purchase-leasebacks, the lessor does not have to reassess any sale-and-leaseback transactions executed before the effective date of ASC 842. Therefore, there will continue to be asymmetry in the accounting for certain sale-and-leaseback transactions entered into under ASC 840 in which the lessee continues to fail sale-and-leaseback transaction under ASC 842 (i.e., both the lessor and lessee will continue to recognize the asset). In the unusual circumstance in which a lessor did conclude that an arrangement was a financing under ASC 840, we would expect it to revisit that accounting under ASC 842.

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