Page 226 - pwc-lease-accounting-guide_Neat

Sale and leaseback transactions

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 6-8 illustrates the seller-lessee’s accounting when the stated sale price of an underlying asset
is less than its fair value.

EXAMPLE 6-8
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 end 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.

6-19