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Sale and leaseback transactions

construction (i.e., under ASC 360, Property, Plant, and Equipment). Additionally, any construction
costs paid for by Developer Corp should be recorded by University as a financial liability.

In symmetry with University’s accounting, Developer Corp should not recognize the asset under
construction. Rather, Developer Corp should account for any payments it makes during the
construction period as a collateralized loan to the lessee in accordance with ASC 310, Receivables.

EXAMPLE 6-4

Sale and leaseback transactions – lessee does not obtain control of construction in process (real estate)

Law Firm enters into an arrangement with Developer Corp to lease an office building for 10 years
contingent upon Developer Corp completing construction of the asset in accordance with the
construction plan. The construction plan includes Law Firm specific improvements necessary for Law
Firm to begin operations at the lease commencement date. The budgeted cost of construction is $10
million. The useful life of the asset is 40 years. Law Firm is obligated to reimburse Developer Corp for
increases in the cost of steel from the inception date of the arrangement to the completion date of the
construction project up to a maximum of $250,000. During the construction period, Law Firm has
access to the building in order to inspect the progress of the construction and to make discretionary
improvements.

During the construction period, Law Firm reimburses Developer Corp for $200,000 due to increases
in the cost of steel during the construction period. In addition, Law Firm incurred $100,000 of
additional construction costs related to discretionary tenant improvements, including branding
elements.

Does Law Firm control the underlying asset during the construction period?

Analysis

Law Firm did not obtain control of the underlying asset during the construction period, therefore it
should account for the transaction as a lease arrangement with Developer Corp. Although Law Firm
had access to the asset, incurred costs related to both structural and normal tenant improvements, and
had financial risks related to the construction of the asset, Law Firm did not obtain control of the asset
under construction before the lease commencement date (i.e., the construction completion date).
Except for the payment for increases in the cost of steel, Developer Corp does not have an enforceable
right to payment unless and until construction is completed. Law Firm’s exposure to steel costs is
insignificant relative to the overall construction budget. In addition, none of the other indicators of
control in ASC 842-40-55-5 are present.

6.3.3.1 Accounting when lessee controls the asset under construction

If a lessee obtains control of an underlying asset under construction before the lease commencement
date, the arrangement is within the scope of the sale and leaseback guidance and both the lessee and
the lessor should evaluate whether the transaction represents a qualified sale and leaseback or a
financing arrangement. Initially, the evaluation should occur as of the date the lessee is determined to
have obtained control. Unless, and until, the lessee transfers control of the underlying asset to the
lessor, the lessee is deemed to be the accounting owner of the underlying asset.

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