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Sale and leaseback transactions

Analysis

Because the seller-lessee has a repurchase option and there are no alternative assets that are
substantially the same and readily available in the marketplace, the transaction would not qualify for
sale accounting. It should be accounted for as a lending transaction by the buyer-lessor. The asset
would not be recorded by the buyer-lessor and the original purchase price of $950,000 would be
recorded as a financial asset.

The annual leaseback payments from the seller-lessee of $100,000 would be allocated between
interest income and principal repayments on the financial asset. Because the cash flows supporting the
financial asset are the same as the cash flows underlying the leaseback, applying the guidance to
determine the appropriate interest rate in ASC 835 results in a rate similar to the rate implicit in the
leaseback, or 9%. In year 1, for example, the buyer-lessor would record interest income of $85,500
(calculated by multiplying the beginning balance of the financial asset, $950,000 by 9%). The
principal repayment is calculated as the difference between the annual leaseback payment and the
allocation of interest income ($100,000 payment – interest income of $85,500 = $14,500).

At the end of the fifth year, the leaseback and repurchase option expire and the buyer-lessor would
obtain control of the asset. At that time, the buyer-lessor would recognize the purchase of the asset and
remove the financial asset from its books.

Application of the financing method is illustrated below:

Principal
Period Lease payment Financial asset repayment Interest income

Inception $ – $950,000 $ – $ –
Year 1 100,000 935,500 14,500 85,500
Year 2 100,000 919,695 15,805 84,195
Year 3 100,000 902,468 17,227 82,773

Year 4 100,000 883,690 18,778 81,222
Year 5 100,000 863,222 20,468 79,532

At the end of the five-year leaseback term, the buyer-lessor would record its purchase of the asset at a
purchase price of $863,222, the remaining balance of the financial asset at that time.

EXAMPLE 6-17
Buyer-lessor obtains 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 lease contract is modified at the end of
the third year to remove the seller-lessee’s repurchase option. As a result, the buyer-lessor obtains
control of the asset at the end of the third year. In addition, the buyer-lessor’s interest rate implicit in
the leaseback is 9%.
How should the buyer-lessor account for the sale and leaseback of the building?

6-31