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Sale and leaseback transactions

Analysis

At the end of the third year, the buyer-lessor obtains 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 for this scenario 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

At the end of the third year, the buyer-lessor would record its purchase of the asset at a purchase price
of $902,468, the remaining balance of the financial asset at that time. Any unamortized debt
origination costs are inherently in the purchase price of the asset (i.e., the initial carrying amount of
the property, plant, and equipment).

The buyer-lessor would classify the lease as an operating lease when control transfers (i.e., the lease
commencement date).

If the lease were classified as a direct finance lease, the buyer-lessor would record the net investment
in the lease at the carrying amount of the financial asset (i.e., $902,468). The buyer-lessor would
subsequently recognize income based on the rate that produces a constant periodic rate of return on
the net investment in the lease. See LG 4.3.2 for information on the accounting for direct finance
leases.

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