SALE AND LEASEBACK

”A lease is an agreement whereby the lessor conveys to the lessee in return for payment or a series of
payments the right to use an asset for an agreed period of time.”

• A sale and leaseback transaction involves the sale of an asset and the leasing back of the same
asset.

– the lease payment & the sale price are usually interdependent because they are
negotiated as a package

– the accounting treatment of a sale and leaseback transaction depends on the type of
lease (finance or operating).

• This approach works for all business sizes and has many benefits for the seller and for the buyer
in the transaction.

• This transaction occurs when the seller transfers an asset to the buyer, and then leases the asset
from the buyer. This arrangement most commonly occurs when the seller needs the funds
associated with the asset being sold, despite still needing to occupy the space.

When such a transaction occurs, the first accounting step is to determine whether the
transaction was at fair value. This can be judged from either of the following comparisons:

– Compare the difference between the sale price of the asset and its fair value.
– Compare the present value of the lease payments and the present value of market
rental payments. This can include an estimation of any variable lease payments
reasonably expected to be made.

• Recognition of sale & finance leaseback

– the seller-lessee defers recognition of income (ie does not recognise any excess of sales
proceeds over the carrying amount in profit or loss immediately)
– Deferred income is recognised in profit or loss over the lease term

• Recognition of sale & operating leaseback by seller-lessee

– if at FV, recognise profit or loss immediately
– if SP < FV & lease payments not adjusted, recognise profit or loss immediately
– if SP < FV & lease payments are adjusted, defer & amortise such loss in proportion to
the lease payments over the period for which the asset is expected to be used.
– If SP > FV defer the excess over fair value and amortise it over the period for which the
asset is expected to be used.

 A seller-lessee sells one of its assets to a buyer-lessor in exchange for consideration and makes
periodic rental payments to the buyer-lessor in exchange for retaining the use of the asset.
The benefits of SLB transactions are as follows:
  Generate cash flows for the seller-lessee
 Represent an alternative and more effective financing for the seller-lessee
 Transfer the tax ownership and related benefits to the buyer-lessors
 Strengthen the balance sheet of the seller-lessee by reflecting a lower amount
of financing.

 In transferring the asset the ff are the requirements for the recognition of sale to beaccountes in
SLB transaction:
1. Sale -- Seller-lessees can account for the transfer of assets as a sale if the following two
conditions exist.
 A contract exists
 The seller-lessee satisfies its performance obligation by transferring control of
assets to the buyer-lessor
2. Lease agreement for the same asset
 Customer has legal title
 Customer has physical possession
 Customer has the significant risks and rewards of ownership
 Customer has accepted the asset
 Seller has a present right to payment.

Problem 15-3

1. Initial measurement of lease liability – it is measured at the present value of the lease
payments.

Annual rental payable at the end of each year P600, 000

PV of an ordinary annuity of 1 at 10% for 5 pd x 3.791
Present value of lease liability P 2,274,600

2. Cost of right use of an asset – it arises from the leaseback at the proportion of the previous CA
of the asset.

Present value of lease liability P2, 274, 600 /

Fair Value x Carrying amount P5,000,000 x P4,500,000
P2,047,140
3. Gain on right to transferred to buyer-lessor – gain or loss of seller-lessee is not recognized.
Because it is the initial lease liability in FV of the asset. But the gain or loss of B to L is the FV
minus the initial LEASE LIAB.

Sale Price P5,000,000

Carrying Amount (P4,500,000)
Total Gain P500,000

Fair Value P5,000,000

Right retained by seller to lessee (P2,274,600)
Rights transferred to buyer-lessor P2,725,400
 Gain to be recognized
Rights transferred to buyer-lessor P2,725,400 /
FV x Total Gain P5,000,000 x P500,000
P272,540

4. Books of seller-lessee – finance lease model shall apply in acco. For SLB transaction.

1. Cash 5,000,000
Right of use asset 2,074,140
Machinery 4,500,000
Lease Liab. 2,274,600
Gain on Trans. 272,540

2. Interest Expense(10% x 2,274,600) 227,460

Lease Liability 372,540
Cash 600,000

3. Depreciation (2,074,140/5) 409,428

Accu. Depreciation 409,428

5. Books of buyer-lessor – he/she shall account the urchase of the asset applying the LESSOR
ACCOUNTING STANDARD
1. Machinery 4,500,000
Cash 4,500,000

2. Cash 600,000
Rent Income 600,000

3. Depreciation (4,500,000 / 10 yrs) 450,000

Accu. Depreciation 450,000

Problem 15-11 – Sale price at above fair value

1. Initial Lease Liability
Annual rental payable 600,000
PV of an ord. annuity of 1 at 12% for 4 pd x 3.037
A. 1,822,200
2. Cost of right of use asset
Sale Price 9,000,000
Fair Value (8,000,000)
Excess SP over FV 1,000,000

Initial Lease Liab. 1,822,200

Excess SP – addntl financing (1,000,000)
PV related to lease/rental 822,200
Cost of right to use (822,200/8,000,000 x 7,200,000) B. 739,980
 3. Gain on right transferred to buyer-lessor
Fair Value 8,000,000
Carrying Amount (7,200,000)
Total Gain 800,000

Fair Value 8,000,000

Right retained to seller-lessee ( 822,200)
Right transferred to buyer-lessor 7,177,800

Gain to be recognized (7,177,800/ 8,000,000 x 800,000) C. 717,780

4. Annual rental income of buyer-lessor

PV related to rental income 822,200
PV related to financing 1,000,000
Total PV 1,822,200

Annual Rental Income (822,200/ 1,822,200 x 600,000) 270,728

Rent related to financing (1,000,000/ 1,822,200 x 600,000) (329,272)
Total A. 600,000

Problem 15-12 – Sales Price below Fair Value

1. Cost of right of use asset

Initial lease liability
Annual Rental 500,000
PV of 6% at 5 pd x 4.21
2,105,000
Initial Lease Liability 2,105,000 /
FV x Carrying Amount 5,000,000 x 6,000,000
Cost of right of use asset B. 2,526,000

2. Loss on right transferred to the buyer-lessor

Sales Price 5,000,000
CA 6,000,000
Total loss (1,000,000)