The current leasing standard, ASC 840, is getting an overhaul! ASC 842 Leases is bringing big changes to lease accounting. One of the areas impacted by the new standard is the accounting for sale and leaseback transactions and, as you’ll see, the guidance under ASC 842 is a lot different from ASC 840!
A sale and leaseback is a transaction in which an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) and leases that asset back from the buyer-lessor. As outlined in the chart below, there are specific criteria that must be met in order for a leaseback transaction to be able to apply the sale and leaseback accounting guidance within ASC 842. If the criteria aren’t met, the transaction is considered a “failed sale” and the transaction must be accounted for as a financing arrangement.
Let’s discuss each of these criteria in more detail.
For a transaction to qualify for sale and leaseback accounting under ASC 842, an entity needs to determine whether the transfer of the underlying asset meets the definition of a sale under the new revenue standard, ASC 606 Revenue from Contracts with Customers. In making this determination, there are two key criteria that an entity must assess:
- Whether there is a contract between the parties (ASC 606-10-25-1 to 25-8); and
- Whether control of the asset has transferred (ASC 606-10-25-30)
Under ASC 606, a contract is defined as an agreement between two or more parties that creates enforceable rights and obligations. All of the following criteria must be met for a contract to exist:
It’s important to note that all five criteria must be met for a contract to exist. For more information on these criteria, check out this post.
In addition, ASC 606 outlines indicators that may be considered to determine whether control of an asset has transferred. The indicators include, but are not limited to:
Additional guidance on these five criteria can be found in this post.
The FASB concluded in Basis for Conclusion to ASU 2016-02, paragraph 352b that
in a finance/sales type lease, the lessee in effect, obtains the ability to direct the use of and obtain substantially all the remaining benefits from the underlying asset. Consequently, if a transaction in which the leaseback would be classified as a finance/sales-type lease were determined to be a sale and a leaseback, one would effectively conclude that the seller-lessee transferred control of the asset to the buyer-lessor and immediately reobtained control of the asset.”
Therefore, if a leaseback results in a lease that would be classified as a sales-type lease or finance lease, the leaseback would not qualify for sale-leaseback accounting under ASC 842.
If the contract between the buyer-lessor and seller-lessee includes a repurchase option, the agreement does not qualify for sale-leaseback accounting under ASC 842, unless:
- The option is exercisable at the fair value on the exercise date; and
- There are alternative assets substantially the same as the transferred asset available in the market place.
When assessing whether there are alternative assets that are substantially the same, the FASB has indicated that real estate assets cannot be substantially the same as “real estate by nature is unique”.
If the transfer of the underlying asset meets the definition of a sale, the leaseback does not result in a lease that would be classified as a sales-type lease or finance lease, and the contract does not contain a purchase option (unless the two criteria mentioned above are met), the leaseback should be accounted for as a sale and leaseback transaction under ASC 842 by both the seller-lessee and the buyer-lessor.
The seller-lessee should:
- Recognize the transaction price for the sale at the point in time the buyer-lessor obtains control of the asset;
- Adjust the transaction price for any off-market terms and recognize the entire gain/loss on the sale of the asset;
- Derecognize the carrying amount of the underlying asset; and
- Account for the lease in accordance with ASC 842.
The buyer-lessor should account for the purchase of the asset in accordance with other ASC topics and for the lease in accordance with ASC 842.
In summary, the guidance for sale and leaseback accounting under ASC 842 is significantly different than under current guidance. Most notably, under current U.S. GAAP, there is separate guidance for the sale and leaseback of real estate, but there isn’t separate guidance for such transactions under ASC 842. Additionally, it may be harder for leaseback transactions to qualify for sale and leaseback accounting under ASC 842 because of the repurchase option criteria, which is not included within ASC 840. Need more training on ASC 842 and sale and leaseback accounting? We can help! Check out this post for a listing of helpful resources and/or contact us today!
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