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Sale and leaseback transactions

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.

Example 6-9 illustrates the accounting by the seller-lessee when the sale price of an underlying asset is
greater than its fair value.

EXAMPLE 6-9

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%.

How should the seller-lessee account for the amount by which the sales price of the property exceeds
its fair value?

6-20