The adoption of ASC 842 has now come and passed for companies. However, the impacts of the transition continue to be far reaching as the nuances of the guidance present themselves just when we think we have a grasp on the material. One such example surrounds the accounting for sale and leaseback transactions (encompassing ASC 842 and ASC 606 concepts), and in particular the accounting for a failed sale which can easily be overlooked when negotiating contracts.

Let us go back in time to recall the evolution of the sale and leaseback guidance from ASC 840 to ASC 842. Under ASC 840, the sale and leaseback model was not applicable to buyer-lessors. With the transition to ASC 842, buyers-lessors are subject to the model along with seller-lessees which requires an assessment to determine whether the purchase from a buyer-lessor perspective is successful or not.

The sale and leaseback model under ASC 842

A sale and leaseback transaction as defined under ASC 842-40-15-2 involves the transfer of an asset from one entity (seller-lessee) to another entity (buyer-lessor) which the seller-lessee subsequently leases back from the buyer-lessor. 

The first assessment needed to determine the accounting under the sale and leaseback model is whether the asset transfer qualifies as a sale under the revenue standard, ASC 606. This assessment requires consideration of the following:

• Is there a contract in accordance with ASC 606-10-25-1 through 24-8?
• Has a transfer of control occurred? (ASC 606-10-25-30)

Under ASC 842-40-25-2, the buyer-lessor has not gained control of the asset if the leaseback would be classified as a direct financing lease or a sales-type lease. In addition, ASC 842-040-25-3 precludes sale treatment if an option from the seller-lessee to repurchase the asset exists unless both of the following are true:

• The exercise price of the option is the fair value of the asset at the time the option is exercised.
• There are alternative assets, substantially the same as the transferred asset, readily available in the marketplace.

If the transfer of control criteria is successfully met and none of the exceptions above apply, then there is a “successful” sale and leaseback transaction. The accounting for this from a buyer-lessor perspective is simple. The asset is recorded as property, plant and equipment under ASC 360 and the lease is accounted for under the lessor model from ASC 842. From a seller-lessee standpoint, the asset is removed from the books with any gain or loss recognized at the sale date. The leaseback for a seller-lessee follows the lessee model under ASC 842.

If there is no transfer of control, the applicable accounting for a “failed” sale and leaseback is as a financing transaction. From a buyer-lessor standpoint, there is no asset to record on the books, but rather a loan or financing receivable. Interest is accrued on the loan receivable and payments made by the seller-lessee reduce the receivable balance. From a seller-lessee standpoint, the asset is not derecognized and amounts received from the buyer-lessor at the failed sale date are treated as a financial liability.

Challenges under the new model

The new guidance has proved to present some challenges for buyer-lessors in ensuring that these sale and leaseback transactions are structured to be successful. While there can be challenges in meeting the ASC 606 criteria, the challenges from a buyer-lessor perspective are often going to come from the leaseback terms. This is due to the criteria that disallows successful sale and leaseback treatment if the lease is structured as a direct financing or sales-type lease. While companies generally will have standard terms and conditions when it comes to leases, unique transactions could arise that require negotiation of other than standard terms. Any residual value guarantees, for instance, or renewal options that meet the “reasonably certain” criteria could result in a direct financing or sales-type lease.

In addition, it is quite common for leases to include repurchase options for equipment. Under the guidance, the existence of fixed price repurchase options may prove to be problematic and may result in a failed sale if at lease commencement it is considered reasonably certain to be exercised.

It may be compelling from an economic standpoint to negotiate terms in such a way that would result in a direct financing or sales-type lease, but the downstream impacts may not be as compelling. As a failed sale-leaseback is accounted as a financing, there could be unintended impacts to the additional financing on the books from a leverage standpoint. For instance, finance lease obligations are typically included in the leverage calculation while operating lease obligations typically are not. This could be more impactful for a seller-lessee with a failed sale and leaseback that must account for the amounts received under the leaseback as a financial liability, but is also worth considering from a buyer-lessor perspective depending on the magnitude of the financing given these potential impacts to debt covenant calculations.

The benefits of successful sale and leaseback transactions

There can be several benefits to both the seller-lessee and buyer-lessor under the new guidance.

For a seller-lessee the benefits include:

• Creating a less expensive (and generally a fixed rate) form of financing
• Freeing up of cash that can be utilized in the business, while continuing to use the asset

For a buyer-lessor the benefits include:

• Ability to manage the return on the investment based on negotiated lease terms
• Consistent income for the term of the lease
• Hard equipment asset on the books
• Tax ownership may result in accelerated or bonus depreciation

While the guidance to achieve successful sale and leaseback transactions may seem daunting, having the knowledge and understanding of the guidance will go a long way to affect the desired organizational outcomes. The benefits above may be attractive, and thus it is important to ensure careful attention is paid to the structure of the agreement. On the flip side, there could be instances where a failed sale and leaseback transaction is not problematic to either party. The moral of this story here: Ensure your technical accountants are involved in discussions early on to ensure appropriate accounting outcomes.