Page 233 - pwc-lease-accounting-guide_Neat

Sale and leaseback transactions

The financing method is illustrated below:

Net carrying Accumulated Financial Reduction of Interest
Period amount Asset value depreciation liability obligation expense

Inception $800,000 $1,200,000 $400,000 $950,000 $ – $ –

Year 1 720,000 1,200,000 480,000 938,350 11,650 88,350
Year 2 640,000 1,200,000 560,000 925,617 12,733 87,267

Year 3 560,000 1,200,000 640,000 911,699 13,918 86,082

Year 4 480,000 1,200,000 720,000 896,487 15,212 84,788
Year 5 400,000 1,200,000 800,000 879,860 16,627 83,373

Use of the incremental borrowing rate would not produce unusual results (e.g., a built-in loss or
negative amortization). At the end of the five-year leaseback term, the seller-lessee would recognize
the sale of the building with a gain of $479,860 (financial liability of $879,860 – $400,000 net
carrying amount). The interest rate should not be decreased in order to eliminate recognition of the
end-of-transaction gain.

EXAMPLE 6-12

Failed sale and leaseback – buyer-lessor does not obtain control of the underlying asset prior to the
end of the leaseback term
Assume the same fact pattern as Example 6-11 except that the annual leaseback payment is $75,000.
How should the seller-lessee account for the sale and leaseback of the building?

Analysis

In this case, application of the financing method based on the seller-lessee’s incremental borrowing
rate of 9.3% yields the following:

Net carrying Accumulated Financial Increase of Interest
Period amount Asset value depreciation liability liability expense
Inception $800,000 $1,200,000 $400,000 $950,000 $ – $ –

Year 1 720,000 1,200,000 480,000 963,350 13,350 88,350
Year 2 640,000 1,200,000 560,000 977,942 14,592 89,592
Year 3 560,000 1,200,000 640,000 993,891 15,949 90,949

Year 4 480,000 1,200,000 720,000 1,011,323 17,432 92,432
Year 5 400,000 1,200,000 800,000 1,030,376 19,053 94,053

Use of the seller-lessee’s incremental borrowing rate results in annual interest expense in excess of
annual lease payments of $75,000, which increases the financial liability over the term of the lease
(i.e., negative amortization). Since negative amortization is prohibited, the seller-lessee should impute
the interest rate that eliminates the negative amortization.

6-26