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Sale and leaseback transactions

The existence of a lessee-provided indemnification for preexisting environmental contamination does
not, in isolation, result in the lessee obtaining control of the underlying asset prior to lease
commencement regardless of the likelihood of loss as a result of the indemnity.

The list of circumstances provided by ASC 842-40-55-5 is not all inclusive; there may be other
circumstances that individually or in combination demonstrate that a lessee controls an underlying
asset under construction before the lease commencement date. As additional circumstances have not
yet substantially developed in practice, entities will be required to carefully evaluate the facts and
circumstances of each arrangement. For example, we believe if a lessee is required to make lease
payments regardless of whether the lessor completes construction of the asset (i.e., a date-certain
lease) and the lease is expected to be classified as a finance lease, the lessee has obtained control of the
asset from lease inception, rather than the lease commencement date. Additionally, we believe a lessee
that is required to fund substantially all (i.e., 90% or more) of the costs of construction that are
probable of being incurred during the construction period may have obtained control. However, we do
not believe this example is similar to the prescriptive rules in ASC 840. For example, we do not believe
a lessee has obtained control of the asset under construction solely because it is required to pay the
first costs of construction or is responsible for cost overruns that are unlimited when such cost
overruns are not probable of representing substantially all of the costs of construction.

We believe a put option held by the lessor to put the asset under construction to the lessee should be
assessed to determine whether the lessor has a significant economic incentive to exercise its put right
consistent with the guidance regarding repurchase agreements in the new revenue standard. If an
incentive exists, the lessee would be assumed to control the construction in process and would be
considered the owner of the asset during the construction period. For further guidance, refer to RR
8.7.

Example 6-3 and Example 6-4 illustrate the assessment of whether a lessee has obtained control of the
underlying asset under construction prior to lease commencement. See ASC 842-40-55-39 through
55-44 for additional examples.

EXAMPLE 6-3

Sale and leaseback transactions – lessee obtains control of construction in progress

University would like to construct a new library on a parcel of land next to its campus. University
acquires the parcel of land and enters into an agreement with Developer Corp, an independent third
party, under which Developer Corp will lease the parcel of land from University, construct the library,
and lease the completed library to University. Both the ground lease to Developer Corp and the library
lease to University have 20-year lease terms. Rental rates on both leases are consistent with prevailing
market rents for similar leased assets. The economic life of the library is 40 years.

Does University control the underlying asset during the construction period?

Analysis

University controls the underlying asset during the construction period because the ground lease to
Developer Corp is for a term that is less than substantially all of the economic life of the property
improvements (20-year ground lease/40-year economic life = 50%). Accordingly, University should
account for the underlying asset during the construction period similar to any other owned asset under

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