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6.4 When the transaction qualifies as a sale
Publication date: 30 Jun 2021
us Leases guide
If the buyer-lessor obtains control of the asset, the sale (by the seller-lessee) or purchase (by the buyer-lessor) and the leaseback should be accounted for separately, with the lease being accounted for in accordance with ASC 842.
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:
a. The seller-lessee shall:
1. Recognize the transaction price for the sale at the point in time the buyer-lessor obtains control of the asset in accordance with paragraph 606-10-25-30 in accordance with the guidance on determining the transaction price in paragraphs 606-10-32-2 through 32-27
2. Derecognize the carrying amount of the underlying asset
3. Account for the lease in accordance with Subtopic 842-20.
b. The buyer-lessor shall account for the purchase in accordance with other Topics and for the lease in accordance with Subtopic 842-30.
The accounting considerations for the purchase and sale transaction, as well as the leaseback, are discussed in the following section.
6.4.1 Accounting by the seller-lessee
The seller-lessee should derecognize the underlying asset and recognize a gain or loss on sale as appropriate. If the transaction is at market terms, the presence of the leaseback does not affect the recognition of a gain or loss on sale. Therefore, if a seller-lessee leases back an entire asset or a portion of the asset (e.g., one floor of a multi-floor office building), the gain or loss generated from the sale is not affected.
A seller-lessee should account for the gain or loss generated from a sale and leaseback transaction consistent with the guidance in the revenue standard, similar to a sale without a leaseback.
See LG 6.4.4 for a discussion of accounting for a transaction entered into at off-market terms.
Example LG 6-8 and Example LG 6-9 illustrate how a seller-lessee would account for a gain or loss on sale generated from a sale and leaseback transaction.
EXAMPLE LG 6-8
Sale and leaseback transaction – gain on sale
Sale and leaseback transaction – gain on sale
A seller-lessee enters into a sale and leaseback transaction of its corporate headquarters with a buyer-lessor for a market value sales price of $20 million. The seller-lessee leases back the asset for ten years in exchange for $200,000 per year in rental payments. The seller-lessee’s net carrying amount of the asset at the date of sale is $15 million. Assume the leaseback is classified as an operating lease for purposes of this example.
How should the seller-lessee account for the asset sale?
Analysis
The sale results in a gain on sale of $5 million ($20 million sales price - $15 million carrying amount of asset). Since the sale and leaseback transaction is at market value and the leaseback is classified as an operating lease, the presence of the leaseback does not impact the accounting for the sale; the seller-lessee should recognize the gain on sale of $5 million in the period in which the sale is recognized.
EXAMPLE LG 6-9
Sale and leaseback transaction – loss on sale
Sale and leaseback transaction – loss on sale
A seller-lessee enters into a sale and leaseback transaction of its corporate headquarters with a buyer-lessor for a market value sales price of $20 million. The seller-lessee leases back the asset for ten years in exchange for $200,000 per year in rental payments. The seller-lessee’s net carrying amount of the asset at the date of sale is $25 million. Assume the leaseback is classified as an operating lease.
How should the seller-lessee account for the asset sale?
Analysis
The sale results in a loss on sale of $5 million ($20 million sales price - $25 million carrying amount of asset). Since the sale and leaseback transaction is at market value, the presence of the leaseback does not impact the accounting for the sale; the seller-lessee should recognize the loss on sale of $5 million in the period in which the sale is recognized (assuming an impairment of the asset was not required to be recorded in an earlier period).
6.4.2 Accounting by the buyer-lessor
To determine the appropriate accounting treatment, a buyer-lessor should determine if the transaction meets the definition of a business combination under ASC 805, Business Combinations, or if the transaction will be accounted for as an asset acquisition. The buyer-lessor should value the tangible property independently from the terms of the leaseback and should value and account for the leaseback in the same manner as any other lease. See LG 3 and LG 4 for guidance on lease classification and the accounting for leases, respectively. See PwC’s Business combinations and noncontrolling interests guide for information on accounting related to business combinations and asset acquisitions.
6.4.3 Costs in a sale and leaseback transaction
The seller-lessee will incur costs in connection with a sale and leaseback transaction. Transaction costs that the seller-lessee would have had to pay to a third party if the asset were sold outright (e.g., absent a leaseback) should be accounted for as part of the sale transaction. These seller expenses reduce the gain (or increase the loss) on the sale. Any additional costs due to the leaseback should be evaluated to determine if they should be deferred as initial direct costs. See LG 4.2.2.2 for information about the evaluation of initial direct costs.
In some cases, the seller-lessee may be required to pay costs incurred by the buyer-lessor in connection with purchasing the asset, financing the acquisition of the asset, or entering into the sale and leaseback transaction. The seller-lessee will need to use judgment to determine if these costs should be accounted for as a reduction of the sales price or as a cost associated with the leaseback.
Certain transactions may occur in which a seller-lessee sells an asset for an amount that is less than its fair value. See Example LG 6-10. In this situation, the seller-lessee should apply the guidance for sale and leaseback transactions entered into at off-market terms, as discussed in LG 6.4.4.
The buyer-lessor's accounting for transaction costs depends on whether the transaction is considered a business combination or an asset acquisition. If the transaction is considered a business combination, transaction costs are expensed as incurred; if considered an asset acquisition, transaction costs are capitalized. The buyer-lessor should defer any debt acquisition costs (e.g., costs relating to the financing) and initial direct costs of entering into the lease (e.g., negotiating and arranging the lease). See LG 4.3.1.2 for information on initial direct costs.
If a sale and leaseback transaction does not qualify for sale accounting, it is considered a failed sale and leaseback and should be accounted for as a financing transaction. All transaction costs incurred by the seller-lessee and buyer-lessor should be evaluated to determine if they should be accounted for as debt issuance or debt origination costs, respectively. See FG 1.2.2 for information on debt issuance costs. See LI 4.4 for information on debt origination fees and costs.
When debt origination costs are capitalized by a buyer-lessor in a failed sale and leaseback transaction that subsequently qualifies as a sale, the buyer-lessor should record the underlying asset (e.g., property, plant, and equipment) or net investment in the lease at the carrying amount of the financial asset (e.g., loan receivable) when the lease is classified as an operating lease or direct financing lease, respectively. Regardless of the classification, the initial measurement of the asset recognized when the buyer-lessor obtains control of the underlying asset (i.e., when the transaction qualifies as a sale) should include any unamortized debt origination costs. See LG 6.5.2 for information on the accounting for a failed sale and leaseback by a buyer-lessor.
6.4.4 Off-market sale and leaseback transactions
Sale and leaseback transactions entered into at off-market terms should be adjusted so that the sale is recorded at fair value. A reporting entity should determine whether the sale and leaseback is an off-market transaction by considering either of the following, whichever is more readily determinable:
- The sale price compared to the fair value of the underlying asset
- The present value of the contractual lease payments compared to the present value of fair market value lease payments
The use of observable prices and observable information should be maximized when making this assessment. For example, if comparable sales of assets similar to an underlying asset exist, an observable fair value for the underlying asset can be determined at the time of the transaction. The observable fair value should be used to determine the gain or loss and any related adjustment, rather than basing an adjustment on an estimate of market rental rates if comparable rental rates are not readily available.
If part of the consideration includes amounts related to the settlement of preexisting contracts or other arrangements, those other arrangements should be considered before determining whether the transaction was entered into at off-market terms. Similarly, if the sales proceeds or lease payments include variable amounts (e.g., contingent consideration), the variable amounts should be estimated and included in the evaluation.
When the sale of an asset is not at fair value or the lease payments are not at market rates, the seller-lessee and buyer-lessor should make adjustments so that the sale is recognized at fair value, as discussed in 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:
a. Any increase to the sale price of the asset as a prepayment of rent
b. 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 discussed in ASC 842-40-30-4, if a sale and leaseback transaction is between related parties, the adjustments required by ASC 842-40-30-2 should not be made; however, the lessee and lessor should disclose the related party transaction in accordance with ASC 850, Related Party Disclosures.
6.4.4.1 Seller-lessee: transaction with off-market terms
A seller-lessee may sell an asset for an amount that is different than the fair value of the asset. If the sales proceeds are less than the fair value of the asset, the difference should be recognized as prepaid rent. If the sales proceeds are higher than the fair value of the asset, the excess should be considered additional borrowing.
An off-market adjustment must also be considered when assessing the classification of the leaseback. It is possible that the adjustment could cause an otherwise operating lease to be classified as a finance lease, precluding sale accounting altogether.
Sale price or leaseback payments are less than fair value
The stated sale price of an underlying asset may be less than its fair value, or the present value of the contractual leaseback payments may be less than the present value of market rental payments. A seller-lessee should increase the initial leaseback right-of-use asset for the difference between the sale price and fair value, similar to prepaid rent. This would have the effect of increasing the gain or reducing the loss on sale.
Example LG 6-10 illustrates the seller-lessee’s accounting when the stated sale price of an underlying asset is less than its fair value.
EXAMPLE LG 6-10
Sale and leaseback transaction – seller-lessee sells underlying asset for less than fair value
Sale and leaseback transaction – seller-lessee sells underlying asset for less than fair value
A seller-lessee purchases manufacturing equipment at a price of $5.5 million, which equals fair value. Shortly after buying the equipment, the seller-lessee sells it to a buyer-lessor for $5 million. The seller-lessee leases back the equipment for 10 years in exchange for annual rent payments of $400,000, payable at the beginning of each year. The seller-lessee’s incremental borrowing rate is 6%.
How should the seller-lessee account for the difference between the property’s sales price and its fair value?
Analysis
The seller-lessee sold the underlying asset for $5 million, which is less than its fair value of $5.5 million. The seller-lessee should account for the difference as an adjustment to the initial leaseback right-of-use asset, similar to the accounting for a prepayment of rent. The adjustment also increases the sale price to $5.5 million (for accounting purposes), and as a result, the seller-lessee would not record a loss on sale.
The right-of-use asset is initially equal to the lease liability. The lease liability is $3,120,676, calculated by determining the present value of the contractual lease payments of $4,000,000 at 6%. The off-market adjustment of $500,000 is added to the right-of-use asset. Because the off-market adjustment is accounted for similar to a prepayment of rent to the buyer-lessor (i.e., a day-one payment), it should not be discounted.
The seller-lessee should record the following journal entry to record this transaction.
Dr. Cash |
$5,000,000 |
||
Dr. Right-of-use asset |
$3,620,676 |
||
Cr. Equipment |
$5,500,000 |
||
Cr. Lease liability |
$3,120,676 |
Sale price or leaseback payments are greater than fair value
The stated sale price of an underlying asset may be greater than its fair value, or the present value of contractual leaseback payments may be greater than the present value of market rental payments.
A seller-lessee should account for the excess of the sale price or leaseback payments over the fair value of the asset as additional financing from the buyer-lessor separate from the lease liability. The initial measurement of the right-of-use asset is not impacted by recording the adjustment as additional financing. The seller-lessee’s total rental payments should be allocated between the lease liability and the additional buyer-lessor financing. If the rent payments contain variable consideration, we believe amounts allocated to the additional buyer-lessor financing should be accounted for by analogy to the interest method described in ASC 310. See LG 2.4.5 for information on the allocation of payments between lease liability and financing. See LI 6.5.1.2 for information on accounting for variable rate loans, which we believe should be applied in these fact patterns.
Example LG 6-11 illustrates the accounting by the seller-lessee when the sale price of an underlying asset is greater than its fair value.
EXAMPLE LG 6-11
Sale and leaseback transaction – seller-lessee sells underlying asset for a price that is greater than fair value
Sale and leaseback transaction – seller-lessee sells underlying asset for a price that is greater than fair value
A seller-lessee sells a building with a remaining economic life of 40 years to an unrelated buyer-lessor for a price of $30 million. The seller-lessee’s net carrying amount of the building is $20 million. Simultaneously, the seller-lessee enters into a lease contract with the buyer-lessor for the right to use the asset for 10 years, with annual rental payments of $1 million payable at the end of each year.
The buyer-lessor obtains control of the asset in accordance with the requirements in the revenue standard and therefore the transaction is accounted for as a sale and leaseback by both the seller-lessee and buyer-lessor. Initial direct costs of the transaction are ignored for purposes of this example.
Comparable sales figures of recent transactions for similar properties are readily available. Based on those comparable sales, the estimated fair value of the underlying asset is $28 million. Both the seller-lessee and buyer-lessor determine that these comparable sales provide better evidence to assess whether the transaction is priced off-market than determining the market rental payments of the leaseback. Since the sales price of the underlying asset is not at fair value, both the seller-lessee and buyer-lessor are required to make adjustments to recognize the sale and leaseback transaction at fair value.
The leaseback is classified as an operating lease by both the seller-lessee and buyer-lessor and the seller-lessee’s incremental borrowing rate is 6% (the buyer-lessor’s interest rate implicit in the leaseback is not known to the seller-lessee).
How should the seller-lessee account for the amount by which the sales price of the property exceeds its fair value?
Analysis
The seller-lessee sold the building for $30 million, which is greater than its fair value of $28 million. The difference should be recorded by the seller-lessee as additional financing from the buyer-lessor separate from the lease liability.
The right-of-use asset is equal to the lease liability. The lease liability is $5,360,087, calculated as the present value of the contractual lease payments of $10 million at 6% ($7,360,087), less the $2 million off-market adjustment. The financial liability is equal to the difference between the sales price and the fair value of $2 million. The gain on sale is the difference between the sale price ($30 million) and carrying value ($20 million), less the off-market adjustment of $2 million.
The seller-lessee should record the following journal entry to record this transaction.
Dr. Cash |
$30,000,000 |
||
Dr. Right-of-use asset |
$5,360,087 |
||
Cr. Building |
$20,000,000 |
||
Cr. Lease liability |
$5,360,087 |
||
Cr. Financial liability |
$2,000,000 |
||
Cr. Gain on sale |
$8,000,000 |
Each annual rental payment of $1,000,000 would be allocated pro rata between the lease liability and the financial liability. The amount allocated to the financial liability would be $271,736 ($1,000,000 × [$2,000,000/$7,360,087]). The remaining $728,264 of the total rental payment would be allocated to the lease. The seller-lessee will recognize $728,264 as lease expense each year of the leaseback. The $271,736 represents payment of the financial liability and interest expense. Interest expense is calculated as $120,000 in year 1, declining to $15,381 in year 10 based on an amortization schedule using the 6% incremental borrowing rate.
See LG 4.4.2 for information on operating lease expense recognition.
6.4.4.2 Buyer-lessor: transaction with off-market terms
The buyer-lessor may purchase an asset for an amount that is different from the fair value of the asset. If the sales proceeds (i.e., purchase price) are less than the fair value of the asset, the difference should be recognized as prepaid rent. If the sales proceeds are higher than the fair value of the asset, the excess should be considered a loan to the lessee.
Sale price or leaseback payments are less than fair value
The stated sale price of an underlying asset may be less than its fair value, or the present value of the contractual leaseback payments may be less than the present value of market rental payments. A buyer-lessor should account for such a difference as a prepayment of rent by the seller-lessee, which should be recognized as lease income along with the contractual leaseback payments. See LG 4.2.2.1 for details on the accounting for the prepayment of rent. The buyer-lessor should record the underlying asset at its fair value.
Sale price or leaseback payments are greater than fair value
The stated sale price of underlying asset may be greater than its fair value, or the present value of the contractual leaseback payments may be greater than the present value of market rental payments. A buyer-lessor should account for the excess of the sale price or leaseback payments over the fair value as additional financing (i.e., a loan receivable) to the seller-lessee and record the underlying asset at its fair value. The buyer-lessor’s total leaseback payment should be allocated between the lease and additional financing. If the leaseback payment contains variable consideration, amounts allocated to the additional financing should be accounted for in accordance with ASC 310. See LG 2.4.4 for information on the allocation of leaseback payments between the lease and additional financing. See LI 6.5.1.2 for information on accounting for variable rate loans.
Example LG 6-12 illustrates the buyer-lessor's accounting when the sale price of an underlying asset has been increased (i.e., is greater than its fair value).
EXAMPLE LG 6-12
Sale and leaseback transaction – buyer-lessor buys an underlying asset for an amount greater than fair value
Sale and leaseback transaction – buyer-lessor buys an underlying asset for an amount greater than fair value
A seller-lessee sells a building with a remaining economic life of 40 years to an unrelated buyer-lessor for a price of $30 million. The seller-lessee’s net carrying amount of the building is $20 million. Simultaneously, the seller-lessee enters into a lease contract with the buyer-lessor for the right to use the asset for 10 years, with annual rental payments of $1 million payable at the end of each year.
The buyer-lessor obtains control of the asset in accordance with the requirements in the revenue standard and therefore the transaction is accounted for as a sale and leaseback by the buyer-lessor and the seller-lessee. Initial direct costs of the transaction are ignored for purposes of this example.
Comparable sales figures of recent transactions for similar properties are readily available. Based on those comparable sales, the estimated fair value of the underlying asset is $28 million. The buyer-lessor determines that these comparable sales provide better evidence to assess whether the transaction is priced off-market than determining the market rental payments of the leaseback. Since the sales price of the underlying asset is not at fair value, the buyer-lessor is required to make an adjustment to recognize the sale and leaseback transaction at fair value.
The leaseback is classified as an operating lease by the buyer-lessor. The buyer-lessor’s interest rate implicit in the leaseback is 8%.
How should the buyer-lessor account for the amount by which the sales price of the property exceeds its fair value?
Analysis
The buyer-lessor acquired the building for $30 million, which is greater than its fair value of $28 million; therefore, there is an excess of sale price as compared to the fair value of the underlying asset of $2 million.
The buyer-lessor should account for the purchase, including the additional financing to the seller-lessee, as follows.
Dr. Building |
$28,000,000 |
||
Dr. Loan receivable |
$2,000,000 |
||
Cr. Cash |
$30,000,000 |
Each annual leaseback payment of $1,000,000 would be allocated between the lease income and the loan receivable by the buyer-lessor. To calculate the repayment of principal, the $1,000,000 annual lease payments would be allocated using the percentage derived by taking the excess of $2,000,000 divided by $6,710,081 (which is the present value of ten lease payments of $1,000,000 discounted at 8%). This yields a percentage of 29.8%, in which case the annual lease payment of $1,000,000 would be allocated as follows.
Debt service |
$298,059 |
|
Lease income |
$701,941 |
The buyer-lessor would recognize $701,941 as lease income each period of the leaseback. Interest income on the loan receivable would be calculated as $160,000 in year 1, declining to $22,078 in year 10 based on an amortization schedule using the 8% implicit interest rate.
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