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Sale and leaseback transactions

Sale price or leaseback payments are greater than fair value

The stated sale price of underlying asset may be greater than its fair value, or the present value of the
contractual leaseback payments may be greater than the present value of market rental payments. A
buyer-lessor should account for the excess of the sale price or leaseback payments over the fair value
as additional financing (i.e., a loan receivable) to the seller-lessee. The buyer-lessor should record the
underlying asset at its fair value.

Example 6-10 illustrates the buyer-lessor’s accounting when the sale price of an underlying asset has
been increased (i.e., is greater than its fair value).

EXAMPLE 6-10
Sale and leaseback transaction – buyer-lessor buys an underlying asset for an amount greater than fair
value

Assume the same fact pattern as Example 6-9.

The buyer-lessor’s interest rate implicit in the leaseback, which was not known to the seller-lessee in
Example 6-9, is 8%.

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

Analysis

The buyer-lessor acquired the building for $30 million, which is greater than its fair value of $28
million; therefore, there is an excess of sale price as compared to the fair value of the underlying asset
of $2 million.

The buyer-lessor should account for the purchase, including the additional financing to the seller-
lessee, as follows.

Dr. Building $28,000,000
Dr. Loan receivable $2,000,000
Cr. Cash $30,000,000

Each annual leaseback payment of $1,000,000 would be allocated between the lease income and the
loan receivable by the buyer-lessor. To calculate the repayment of principal, the $1,000,000 annual
lease payments would be allocated using the percentage derived by taking the excess of $2,000,000
divided by $6,710,081 (which is the present value of ten lease payments of $1,000,000 discounted at
8%). This yields a percentage of 29.8%, in which case the annual lease payment of $1,000,000 would
be allocated as follows.

Debt service $298,059
Lease income $701,941

The buyer-lessor would recognize $701,941 as lease income each period of the leaseback. Interest
income on the loan receivable would be calculated as $160,000 in year 1, declining to $22,078 in year
10 based on an amortization schedule using the 8% implicit interest rate.

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