Page 234 - pwc-lease-accounting-guide_Neat

Sale and leaseback transactions

In this example, an imputed interest rate of approximately 7.89% results in interest expense of
$75,000, which is equivalent to the annual lease payment. Because the interest expense no longer
exceeds the annual lease payment, there would not be any negative amortization.

Application of the financing method based on the imputed interest rate of approximately 7.89% is
illustrated below:

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 1,200,000 480,000 950,000 – 75,000
Year 2 640,000 1,200,000 560,000 950,000 – 75,000
Year 3 560,000 1,200,000 640,000 950,000 – 75,000

Year 4 480,000 1,200,000 720,000 950,000 – 75,000
Year 5 400,000 1,200,000 800,000 950,000 – 75,000

At the end of the five-year leaseback term, the seller-lessee would recognize the sale of the building
with a gain of $550,000 (financial liability of $950,000 – $400,000 net carrying amount).

EXAMPLE 6-13
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 $200,000.

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% is illustrated below:

Net carrying Accumulated Financial Reduction of Interest
Period amount Asset value depreciation liability liability expense
Inception $800,000 $1,200,000 $400,000 $950,000 $ – $ –
Year 1 720,000 1,200,000 480,000 838,350 111,650 88,350

Year 2 640,000 1,200,000 560,000 716,317 122,033 77,967
Year 3 560,000 1,200,000 640,000 582,934 133,383 66,617
Year 4 480,000 1,200,000 720,000 437,147 145,787 54,213
Year 5 400,000 1,200,000 800,000 277,802 159,345 40,655

Use of the seller-lessee’s incremental borrowing rate results in a financial liability of $277,802, which
is less than the asset’s carrying amount of $400,000; therefore, a built-in loss exists. Since a built-in
loss is prohibited, the seller-lessee would increase the interest rate until the financial liability equaled

6-27