Jerald Jay C.

Catacutan Intermediate Accounting

Learning Resource 10: Sale and Leaseback

A. Theoretical Exercises (Individual Task)

Provide a convincing and concise account to the following situations via applicable
appropriate accounting principles discussed in Activity 1.

1. Provide a scholarly account of the following:

Answer: One of the main reasons for entering into a sale and leaseback arrangement is
that it can be a quick and effective way of raising cash from existing real estate assets. It
can provide an opportunity for growth and companies can reallocate capital back into the
operational business. Logistic and last mile businesses have been able to use the
Covid19 pandemic to thrive and this model has been one way to raise a much needed
cash boost. A sale and leaseback can be beneficial for both the buyer and seller alike, as
the seller is able to receive a lump sum of cash quickly, and the buyer acquires a lower-
than-market value purchase price, along with a long-term lease at an attractive yield. The
advantages of sale and leaseback
 It converts property assets into capital without the need of the occupier to lose
control of the building they occupy
 It avoids costs usually associated with conventional debt financing for real estate
transactions such as valuation, brokerage and bank commitment fees
 Rental payments are tax-deductible
 If there is borrowing on the asset it will remove the associated debt from the
balance sheet and improve the company’s debt to equity ratios

Entities normally enter into sale and leaseback arrangements to generate immediate cash
flows while still retaining the use of the asset. Such arrangements are particularly
attractive where the fair value of an asset is considerably higher than its carrying amount,
or where a large amount of capital is tied up in property and plant. In substance, the
lessee gives up legal ownership but still retains control over some or all of the asset’s
future economic benefits via the lease agreement. Generally, the asset is sold at a price
equal to or greater than its fair value, and is leased back for lease payments sufficient to
repay the purchaser for the cash invested plus a reasonable return. Therefore, the lease
payment and the sale price are usually interdependent because they are negotiated as a
package. The major accounting issue revolves around the sale rather than the lease
component of the transaction. The lease is classified and accounted for in exactly the
same fashion as normal lease transactions, but accounting for the sale transaction differs
according to whether the lease is classified as a finance lease or an operating lease.
If a sale and leaseback transaction results in a finance lease, any excess of sales
proceeds over the carrying amount shall not be immediately recognized as income by a
lessee. Instead, it shall be deferred and amortized over the lease term.

Sale and leaseback transactions are subject to the same disclosure requirements
prescribed for lessees and lessors in relation to both operating and finance leases.
Unique or unusual provisions of the agreement should be disclosed as part of the required
description of material leasing arrangements. Additionally, sale and leaseback
transactions may fall under the separate disclosure criteria in IAS 1 Presentation of
Financial Statements with respect to gains or losses on the sale of assets.

b. important consideration in accounting for sale and leaseback transaction.

Answer: Under IFRS 16, paragraph 99. An entity shall apply the requirements for
determining when a performance obligation is satisfied in IFRS 15 to determine whether
the transfer of an asset is accounted for as a sale of that asset.

IFRS 16, paragraph 100 states that if the transfer of an asset by the seller-lessee
satisfies the requirements of IFRS 15 to be accounted for as a sale of the asset:

(a) the seller-lessee shall measure the right-of-use asset arising from the
leaseback at the proportion of the previous carrying amount of the asset that relates to
the right of use retained by the seller-lessee. Accordingly, the seller-lessee shall
recognise only the amount of any gain or loss that relates to the rights transferred to the
buyer-lessor.

(b) the buyer-lessor shall account for the purchase of the asset applying
applicable Standards, and for the lease applying the lessor accounting requirements in
this Standard.

c. the accounting procedures when the leaseback is an operating lease.

Answer: As IFRS 16 has withdrawn the concepts of operating leases and finance leases from
lessee accounting, the accounting requirements that the seller-lessee must apply to a sale
and leaseback are more straight forward. In addition, IFRS 16 provides an overview of the
accounting requirements for buyer-lessors too. When a seller-lessee has undertaken a sale
and lease back transaction with a buyer-lessor, both the seller-lessee and the buyer-lessor
must first determine whether the transfer qualifies as a sale. This determination is based on
the requirements for satisfying a performance obligation in IFRS 15. The accounting
treatment will vary depending on whether or not the transfer qualifies as a sale.

d. the accounting procedures when the sale price is at fair value.

Answer: If the sale price is equal to the fair value, there has, in effect, been a normal
sales transaction and any profit or loss on sale should be recognized immediately.

e. the accounting procedures when the sale price is at below fair value.
Answer: Under IFRS, paragraph 101, provides that if the fair value of the consideration
for the sale of an asset does not equal the fair value of the asset, or if the payments for
the lease are not at market rates, an entity shall make the following adjustments to
measure the sale proceeds at fair value:
(a) any below-market terms shall be accounted for as a prepayment of lease
payments; and
(b) any above-market terms shall be accounted for as additional financing
provided by the buyer-lessor to the seller-lessee.

f. the accounting procedures when the sale price is at fair value and there is an
indicated loss.

Answer: If the fair value at the time of the transaction is less than the carrying amount of
the asset, a loss equal to the amount of the difference between the carrying amount and
the fair value should be recognized immediately.

g. the accounting for a transfer of asset that is not a sale.

Answer: IFRS 16, paragraph 103 states that if the transfer of an asset by the seller-lessee
does not satisfy the requirements of IFRS 15 to be accounted for as a sale of the asset:
(a) the seller-lessee shall continue to recognise the transferred asset and shall
recognise a financial liability equal to the transfer proceeds. It shall account for the
financial liability applying IFRS 9.
(b) the buyer-lessor shall not recognise the transferred asset and shall recognise
a financial asset equal to the transfer proceeds. It shall account for the financial asset
applying IFRS 9.

II. Individual Task

Solve the following problems with solutions presented in good form; and choose the
correct answer (re: letter-answer) from the given probable answers.

1. SHERYL Company

1. A
Solution:
Initial lease liability (600,000 x 3.037) P 1,822,200

2.B
Solution:
Sale price P 9,000,000
Fair value 8,000,000
Excess sale price over fair value 1,000,000
 Initial lease liability 1,822,200
Excess sale price-additional financing (1,000,000)
Present value related to lease 822,200

Cost of right of use asset (822,200/8,000,000 x 7,200,000) P 739,980

3.C
Solution:
Fair value of building P 8,000,000
Carrying amount 7,200,000
Total gain 800,000

Fair value of building 8,000,000

Gain to be recognized (7,717,800/8,000,000 x 800,000) P 717,780

4. C
Solution:
PV related to rental income P 822,200
PV related to financing 1,000,000
Total present value 1,822,200

Annual rental income (822,200/1,822,200 x 600,000) 270,728

2. KAREN Company

1.B
Solution:
Initial lease liability (500,000 x 4.21) P 2,105,000
Cost of right of use asset (2,105,000/5,000,000 x 6,000,000) P 2,526,000

2.A
Solution:
Sales price P5,000,000
Carrying amount 6,000,000
Total loss (1,000,000)
 Loss on right transferred (2,895,000/5,000,000 x 1,000,000) P 579,000

3.C
Solution:
Lease liability- 1/1/2020 P2,105,000
Principal payment- 12/31/2020
Rental 500,000
Interest (6% x 2,105,000) (126,300) 373,700
Lease liability- 12/31/2020 P 1,731,300
4.D
Solution:
Annual rental income P500,000
Depreciation of lessor (250,000)
Net annual rent income P 250,000

3.
1.A
Solution:
Lease liability (800,000 x 3.17) P 2,536,000

2.A
Solution:
Cost of right of use asset (2,536,000/6,000,000 x 4,500,000) P 1,902,000

3.A
Solution:
Gain on right transferred (3,464,000/6,000,000 x 1,500,000) P 866,000

4.A
Solution:
Annual depreciation of right of use asset (1,902,000/4 years) P475,500