Some lease accounting impacts of the shift to a control-based model
THERE WAS A TIME
when accounting professors drummed into you and the rest of the class that accounting for transactions was based upon whether or not the risks and rewards of ownership had passed from the seller to the buyer. The now superseded FAS 13/Topic 840 on leasing was built around the application of a risks-and-rewards approach to lease accounting. Revenue recognition for sales of goods and services was also based upon this approach. This view of the world has faded away over the past 20 years, as transactional accounting standards have adopted a control-based model and both the new leases and revenue standards are built upon control and whether it has passed from one party to another.
There have been articles on both of these standards in the Financial Watch column, but there is still much to absorb. As companies move into a world in which they are dealing with both standards simultaneously, they are sometimes encountering results that are not in keeping with the way they are used to analyzing the accounting for transactions. This is particularly true when one is attempting to analyze sale leaseback transactions. This article will:
- Compare the definitions of control in the leases standard to that in the revenue standard, and
- Consider several implications of the control model on sale leaseback transactions.
How Do the Definitions of Control Differ?
ASC 606, Revenue from Contracts with Customers
, and ASC 842, Leases, have similar approaches to control, but there are some differences that are apparent when the two approaches are put side by side. This issue matters because the first step in sale leaseback accounting is the sales leg. The following table considers some of the important accounting considerations that need to be anticipated and highlights the significant similarities and differences between the standards.
In total the two approaches to control are the same, except for the provisions that allow for:
- The leaseback to exist and not compromise the transfer of control, and
- The existence of a seller-lessee purchase option.
If a sale leaseback is entered into, the seller-lessee must meet the ASC 842 sale (transfer of control) requirements to get into sale leaseback accounting or they will have a failed sale and would keep the asset on their books and record the sales proceeds effectively as a loan. The lessor would also record a loan receivable rather than a purchase and a lease.
While the control approaches are similar, there is an important difference between ASC 842 and ASC 606. Revenue recognition is built on whether control has passed to the customer, and it takes the customer perspective when deciding if a sale has occurred. It does not, however, state when the customer/buyer needs to recognize a payable. It only addresses the accounting for revenue. ASC 842 does incorporate symmetry into lease accounting (e.g., in sale leaseback transactions). As a result, there may be circumstances when control has passed to the customer under ASC 606, but the customer does not have an asset. For example, the situation could exist where the seller has delivered an asset to a customer and has recognized revenue before the final installation is complete and customer acceptance has been received because installation performance is considered perfunctory. If the asset is then leased to the customer, the seller-lessor may have to consider how the prior revenue recognition and passage of control to the customer influences their lessor lease.
The Question of Scope
Among the most difficult questions accountants face is the question of what accounting guidance a transaction falls under. It is an often-repeated truism that the accounting for a transaction is easy—but the analysis of the scope is what is difficult.
If a company has an asset they are currently using in their business, a sale leaseback of that asset would be within the scope of ASC 842 as the seller controlled the asset prior to the sale. In other situations, where the asset has not been delivered, it is not as clear whether the ultimate lessee has control over the undelivered asset. If the lessor and lessee are going to avoid sale leaseback accounting, additional effort may be required. For example, a company that wants to lease an asset that has not yet been ordered could identify a lessor before committing to buy and making down payments on the asset. Alternatively, the lessee could sign an agency agreement with prospective lessors stating the future lessee is acting as an agent of the lessor and is not a principal. An agent is not responsible for providing the asset to be sold and leased back, takes no inventory risk and does not set the price (the price would be the asset cost) or have a profit element other than a fee, if any, for services.
In addition to these considerations, there is an evolving view that if the future lessee has had some involvement with an asset that is being constructed (for example it has accepted delivery of steel that will be used in construction of an asset), the transaction might not be subject to sale leaseback accounting since the asset is under construction and does not have the same utility as the completed asset. This approach recognizes that the old approach to lessee involvement in asset construction developed when there was a significant on/off switch for balance sheet recognition. Now that all leases are on balance sheet the lessee recognition is less of an accounting issue. Under lease accounting, the lessee will ultimately record the asset and liability is determined by its actual liability under the lease agreement. This is a positive outcome that springs directly from the capitalization of lease obligations under ASC 842.