SALE AND LEASEBACK

A sale and leaseback is an arrangement whereby one party sells an

asset to another party and then immediately leases the asset back from
the new owner.

Thus, the seller becomes a seller-lessee and the buyer, a buyer-lessor.

CHAPTER A sale and leaseback transaction may occur when the seller-lessee is
15 experiencing cash flow or financing problem or because there are tax
advantages in such an arrangement in the lessee's jurisdiction.

SALE AND LEASEBACK Moreover, the seller-lessee would like to avoid the burden of paying
the executory costs attendant to the asset, such as repairs, insurance and
taxes.

TECHNICAL KNOWLEDGE Transfer of the asset is

IFRS 16, paragraph 100, provides that the transfer of an asset must
satisfy the requirements for the recognition of sale in order to be
accounted for as sale and leaseback.
To define a sale and leaseback.
The important consideration in a sale and leaseback transaction is the
recognition of two separate and distinct transactions.
To recognize a sale and leaseback on
However, it is important to note that there is no physical transfer of
the part of asset.

First - there is a sale.

Second - there is a lease agreement for the same asset in which the
To recognize a sale and leaseback on seller is the lessee and the buyer is the lessor.
the part of However, the lease rent and the sale price are usually interdependent as
they are negotiated as a package.

To know the recognition of a transfer Illustration - Sale price at fair value

of asset that is not a sale At the beginning of the current year, an entity sold machinery with a
remaining life of 10 years for P2,000,000 which is equal to the fair
value of the machinery.

The entity immediately leased the machinery back for 1 year at the
prevailing annual rental of P300,000.
The machinery has a carrying amount of P1,800,000, net of Measurement of lease liability
accumulated depreciation of P1,200,000.
The seller-lessee shall account for the leaseback as a finance lease. The
Books of seller-lessee lease liability is measured at the present value of lease payments.
1. To record the sale: Present value of rentals (800,000 x 3.17) 2,536,000
Cash 2,000,000
Accumulated depreciation 1,200,000 Table of amortization
Machinery 3,000,000 Date Payment 10% interest Principal Present value
Gain on right transferred 200,000 1/1/2020 2,536,000
12/31/2020 800,000 253,600 546,400 1,989,600
12/31/2021 800,000 198,960 601,040 1,388,560
2. To record annual rental: 12/31/2022 800,000 138,856 661,144 727,416
Rent expense 300,000 12/31/2023 800,000 72,584 727,416 -
Cash 300,000
Measurement of right of use, asset
The seller-lessee used the operating lease model because the lease is IFRS 16, paragraph 100, provides that the seller-lessee shall measure
short-term or one year. 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
Books of buyer-lessor retained by the seller-lessee.
1. To record the purchase: Simply stated, the cost of right of use asset is equal to a fraction whose
Machinery 2,000,000 numerator is the present value of lease liability and whose
Cash 2,000,000 denominator is the fair value multiplied by the carrying amount of the
asset.
2. To record the annual rental: Carrying amount 4,500,000
Cash 100,000 Sale price at fair value 6,000,000
Rent income 100,000 Cost of right of use asset
(2,536,000/6,000,000 x 4,500,000) 1,902,000
3. To record depreciation of the machinery:
Depreciation 200,000 Gain or loss to be recognized
Accumulated depreciation 200,000 Paragraph 100 provides that the gain or loss that pertains to the right
(2,000,000/10) retained by the seller-lessee is not recognized.
The right retained by the seller-lessee is the proportion of the initial
Illustration - Sale price at fair value lease liability in relation to the fair value of the asset.
On January 1, 2020, an entity sold an equipment with remaining life of The gain or loss that pertains to the right transferred to the buyer-
10 years and immediately leased it back for 4 years at the prevailing lessor is recognized.
market rental. The right transferred to the buyer-lessor is the fair value of asset minus
Sale price at fair value 6,000,000 the initial lease liability.
Carrying amount of equipment 4,500,000 Sale price at fair value 6,000,000
Annual rental payable at the end of each year 800,000 Carrying amount 4,500,000
Implicit interest rate 10% Total gain 1,500,000
Present value of an ordinary annuity of 1
at 10% for four periods 3.170
Fair value 6,000,000 2. To record the annual rental:
Right retained by seller-lessee equal to lease liability 2,536,000 Cash 800,000
Right transferred to buyer-lessor 3,464,000 Rent income 800,000
Gain to be recognized (3.464M/6M x-1.5M) 866,000
Gain not to be recognized
(2,536,000/6,000,000 x 1,500,000) 634,000 3. To record annual depreciation of equipment:
Total gain 1,500,000 Depreciation (6,000,000/10 years) 600,000
Accumulated depreciation 600,000
Books of seller-lessee
The seller-lessee shall apply the finance lease model in accounting for Illustration - Sale price above fair value
the sale and leaseback transaction. On January 1, 2020, an entity sold a building with remaining life of 20
1. To record the sale and leaseback: years and immediately leased it back for 5 years.
Cash 6,000,000 Sale price 20,000,000
Right of use asset 1,902,000 Fair value of building 18,000,000
Equipment 4,500,000 Carrying amount of building 10,800,000
Lease liability 2,536,000 Annual rental payable at the end of each year 1,500,000
Gain on right transferred 866,000 Implicit interest rate 12%
Present value of an ordinary annuity of
2. To record the annual rental for the first year: 1 at 12% for five periods 3.60
Interest expense (10% x 2,536,000) 253,600 Lease liability (1,500,000 x 3.60) 5,400,000
Lease liability 546,400
Cash 800,000 IFRS 16, paragraph 101, provides that if the sale price does not equal
the fair value of the underlying asset, the seller-lessee shall make
3. To record the annual depreciation of right of use asset: adjustment to measure the sale price at fair value.
Depreciation (1,902,000 14 years) 475,000 Any excess sale price over fair value, shall be accounted for as
Accumulated depreciation 475,500 additional financing provided by the buyer-lessor to seller-lessee.

Books of buyer-lessor Sale price 20,000,000

Paragraph 100 provides that the buyer-lessor shall account for the Fair value of building 18,000,000
purchase of the asset applying lessor accounting standard. Excess sale price over fair value 2,000,000
Accordingly, the buyer-lessor shall apply the operating lease model Present value of lease liability 5,400,000
because the lease term is 4 years or only 40% of the useful life of the Additional financing equal to excess sale price (2,000,000)
underlying asset. Present value of lease liability related to rentals 3,400,000
Moreover, the present value of rentals of P2,536,000 is less than 90% Carrying amount - building 10,800,000
of the fair value of Fair value of building 18,000,000

1. To record the purchase of the underlying asset: Cost of right of use asset
Equipment 6,000,000 (3,400,000/18,000,000 x 10,800,000) 2,040,000
Cash 6,000,000 Fair value of building 18,000,000
Carrying amount - building 10,800,000
Adjusted total gain 7,200,000
Fair value of building 18,000,000 3. To record the annual rental related to financing:
Right retained by seller-lessee equal to lease Cash 555,556
liability, excluding excess sale price 3,400,000 Financial asset 315,556
Right transferred to buyer-lessor 14,600,000 Interest income 240,000
Gain to be recognized (14,600,000/18,000 x 7,200,000) 5,840,000 4. To record depreciation of building
Gain not to be recognized(3,400,000/18,000x7,200,000) 1,360,000 Depreciation (18,000,000/20) 900,000
Adjusted total gain 7,200,000 Accumulated depreciation 900,000

Books of seller-lessee Allocation of the annual rental

1. To record the sale and leaseback: The annual rental of P1,500,000 is partly rental income and partly
Cash 20,000,000 payment of the financial asset.
Right of use asset 2,040,000
Building 10,800,000 Present value Fraction Allocation
Lease liability 5,400,000 Rental income 3,400,000 3,400/5,400 944,444
Financial asset 2,000,000 2,000/5,400 555,556
Gain on right transferred 5,840,000 Total present value 5,400,000 1,500,000

2. To record the annual rental for the first year: Amortization related to financial asset
Interest expense (12% x 5,400,000) 648,000 Date Payment 12% interest Principal Present value
Lease liability 852,000 1/1/2020 2,000,000
Cash 1,500,000 12/31/2020 555,556 240,000 315,556 1,684,444
12/31/2021 555,556 202,133 353,423 1,331,021
12/31/2022 555,556 159,723 395,833 935,188
3. To record the annual depreciation of right of use asset: 12/31/2023 555,556 112,222 443,334 491,854
Depreciation (2,040,000/5 years) 408,000
12/31/2024 555,556 63,702 491,854 -
Accumulated depreciation 408,000
December 31, 2020
Books of buyer-lessor
Payment 555,556
The buyer-lessor shall apply the operating lease model because the
Interest income for 2020 (12% x 2,000,000) (240,000)
lease term is 5 years or only 25% of the 20-year useful life of the
Principal payment 315,556
underlying asset.
Present value - January 1, 2020 2,000,000
Moreover, the present value of lease liability related to rentals of
Principal payment- (315,556)
P3,400,000 is less than 90% of the fair value of the asset of
Present value - December 31, 2020 1,684,444
P18,000,000.
Illustration - Sale price below fair value
1. To record the purchase of the building:
On January 1, 2020, an entity sold an equipment with remaining life of
Building 18,000,000
8 years and leased it back for 5 years.
Financial asset 2,000,000
Cash 20,000,000
Sale price 5,000,000
2. To record the annual rental related lease:
Fair value of equipment 6,000,000
Cash 944,444,
Carrying amount 4,800,000
Rent income 944,444
Implicit interest rate 8%
Present value of an ordinary annuity of
1 at 8% for five periods 3.99
 Gain to be recognized
Measurement of lease liability
Present value rentals (900,000 x 3.99) 3,591,000 Fair value of equipment 6,000,000
Carrying amount 4,800,000
Table of amortization Total gain 1,200,000
Date Payment 8% interest Principal Present value
1/1/2020 3,591,000 Fair value of equipment 6,000,000
12/31/2020 900,000 287,280 612,720 2,978,280
12/31/2021 900,000 238,262 661,738 2,316,542
Right retained by seller-lessee equal to lease
12/31/2022 900,000 185,323 714,677 1,601,865 liability including the excess fair value 4,591,000
12/31/2023 900,000 128,149 771,851 830,014 Right transferred to buyer-lessor 1,409,000
12/31/2024 900,000 69,986 830,014 -
Gain to be recognized
(1,409,000/6,000,000 x 1,200,000) 281,800
Measurement of right of use asset Gain not to be recognized
(4,591,000/6,000,000 x 1,200,000) 918,200
IFRS 16, paragraph 101, provides that if the sale price does not equal Total gain 1,200,000
the fair value of the asset, the seller-lessee shall make adjustment to
measure the sale price at fair value,
Books of seller-lessee
If the sale price is below fair value, the difference is accounted for as
prepayment of rental. 1. To record the sale and leaseback:

Fair value of equipment 6,000,000 Cash 5,000,000

Sale price 5,000,000 Right of use asset 3,672,800
Equipment 4,800,000
Excess fair value over sale price 1,000,000 Lease liability 3,591,000
Gain on right transferred 281,800
Present value of rentals (900,000 x 3.99) 3,591,000
Excess fair value - prepayment of rental 1,000,000 2. To record the annual rental for the first year:

Total lease liability 4,591,000 Interest expense 287,280

Lease liability 612,720
Carrying amount 4,800,000 Cash 900,000
Fair value of equipment 6,000,000
3. To record the annual depreciation of right of use asset:
Cost of right of use asset
(4,591,000/6,000,000 x 4,800,000) 3,672,800 Depreciation (3,672,800/5 years) 734,560
Accumulated depreciation 734,560
Books of buyer-lessor Table of amortization

The buyer-lessor shall apply the operating lease model because the Date Payment 8% interest Principal Present value
lease term of 5 years is less than 75% of the 8-year useful life of the 1/1/2020 1,290,000
12/31/2020 500,000 103,200 396,800 893,200
underlying asset. 12/31/2021 500,000 71,456 428,544 464,656
12/31/2022 500,000 35,344 464,656 -
Moreover, the present value of rentals of P4,591,000 is less than 90%
of the fair value of
Measurement of right of use asset
1. To record the purchase of the equipment:
Carrying amount 12,000,000
Equipment 5,000,000 Sale price at fair value 10,000,000
Cash 5,000,000

2. To record the annual rental: Cost of right of use asset

Cash 900,000 (1,290,000 / 10,000,000 x 12,000,000) 1,548,000

Rent income 900,000

3. To record annual depreciation of equipment: Loss to be recognized

Depreciation (5,000,000/8) 625,000 Sale price 10,000,000

Accumulated depreciation 625,000 Carrying amount 12,000,000

Illustration - Sale price at fair value with loss Total loss (2,000,000)

On January 1, 2020, an entity sold a building with remaining life of 25 Fair value 10,000,000
years and immediately leased it back for 3 years. Right retained by seller-lessee equal to lease liability 1,290,000

Sale price at fair value 10,000,000 Right transferred to buyer-lessor 8,710,000

Carrying amount 12,000,000
Annual rental payable at the end of each year 500,000
Implicit interest rate 8%
Present value of an ordinary annuity of Loss to be recognized
1 at 8% for three periods 2.58 (8,710,000/10,000,000 x 2,000,000) 1,742,000
Loss not to be recognized
Measurement of lease liability (1,290,000/10,000,000 x 2,000,000) 258,000

Present value of rentals (500,000 x 2.58) 1,290,000 Total loss 2,000,000

 Books of seller-lessee Transfer of asset is not a sale

1. Cash 10,000,000 IFRS 16, paragraph 103, provides that if the transfer of asset by the
Right of use asset 1,548,000 seller-lessee does not satisfy the requirements for the recognition of a
Loss on right transferred 1,742,000 sale:
Building 12,000,000
Lease liability 1,290,000 a. The seller-lessee shall continue to recognize the transferred asset and
shall recognize a financial liability equal to the transfer proceeds.
2. Interest expense 103,200
Lease liability 396,800 The entry is debit cash and credit lease liability for the transfer
Cash 500,000 proceeds.

3. Depreciation (1,548,000/3) 516,000 The rental or lease payment is accounted for as part payment of interest
Accumulated depreciation 516,000 expense and part payment of the principal lease liability.

The interest is computed based on the implicit interest rate using the
Books of buyer-lessor effective interest method.

1. Building 10,000,000 b. The buyer-lessor shall not recognize the transferred asset but shall
Cash 10,000,000 recognize a financial asset equal to the transfer proceeds.

2. Cash 500,000 The entry is debit lease receivable and credit cash.
Rental income 500,000
The rental or lease payment from the seller-lessee is accounted for as
3. Depreciation (10,000,000/25) 400,000 part collection of interest income and part collection of the principal
Accumulated depreciation 400,000 lease receivable.