CHAPTER 15 sALEAND LEASEBACK TECHNICAL KNOWLEDGE To define a sale and leaseback. To recognize a sale and leaseback on the part of the lessee. To recognize a sale and leaseback on the part of the lessor. To know the recognition of a transfer of asset that 48 not a sale. 473SALE AND LEASEBACK 4 sale and leaseback is an arrangement whereby o an asset to another party and then immediate] set back from the new owner ne party 1 lease the a. Thus. the seller becomes a seller-lessee and the buyey, buyer-lessor \ sale and leaseback transaction may occur when thy eller-lessee is experiencing cash flow or financing problem or because there are tax advantages in such an arrangement in the less jurisdiction Moreover, the seller-lessee would like to avoid the burden of paying the executory costs attendant to the asset, such as r , Insurance and taxes. Transfer of the asset-is a sale IFRS 16, paragraph 100, provides that the transfer ofan asset must satisfy the requirements for the recognition of sale in order to be accounted for as sale and leaseback. The important consideration in a sale and leaseback transaction is the recognition of two separate and distinct transactions. However, it is important to note that there is no physical transfer of asset, irst — there is a sale, Second - there ie a lease agreeme ‘nt for the same asset in which the seller is the lessee and the buyer is the lessor However, the lease rent a nd the sale price are usually interdependent and negotiat ed as a package. 474| tion ~ Sale pri : guste i Price at fair value the beginning of the ¢ st nery With A remainin atch is equal to the fair y, w “rent year, 8 life of 10 alue of the entity immediately leased the ithe prevailing annual rental of f » an entity sold a years for P2,000,000 machinery machiner 300,000. chinery had a carr: pe mac y ‘ying amount of ocumulated depreciation of P1,200,000. y back for 1 year P 1,800,000, net of pooks of seller-lessee To record the sale: Cash 26 2,000,000 Accumulated depreciation 1,200,008 Machinery 3,000,000 Gain on right transferred 200,000 2, To record annual rental: 300,000 Rent expense a The seller-lessee used the operating Jease model because the lease is short-term or one year. Books of buyer-lessor 1. To record the purchase: 2,000,000 <4 2,000,000 Cash 2 To record the annual rental: = 100,000 100,000 Rent income nery: | 3 To record depreciation of the machi 200,0 7 200,000 Depreciation ‘Accumulated depreciation (2,000,000/10) 475Illustration — Sale price at fair value 2021, an entity sold an equipment wig, Jo years and immediately leased it bach ling market rental. On January 1, remaining life of 10 yea for 4 years at the prevai 6, Sale price atfairvalve 8.000a Carrying amount of equipm 500, Anseal ental payable at the end of each year 800,00 Implicit interest rate tio oft Present value of an ordinary annuity of i ‘at 10% for four periods 0 Measurement of lease liability The seller-lessee shall account for the leaseback as a finance lease. The lease liability is measured at the present value of rental payments. Present value of rentals (800,000 x 3.17) 2,536,000 Table of amortization Date Payment 10% interest Principal Present value V/1/2021 2,536,000 12/31/2021 800,000 253,600 546,400 1,989,600 12/31/2022 800,000 198,960 601,040 1,388,560 12/31/2023 800,000 138,856 661,144 727,416 12/31/2024 — 800,000 72,584 727,416 vd Measurement of right of use asset IFRS 16, paragraph 100, provides that 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 in relation to the right of use retained by the seller-lessee. Simply stated, the cost of right of use asset is equal toa fraction whose numerator is the present value of lease liability and whose denominator is the fair value of the asset multiplied by the carrying amount of the asset, Carrying amount 4,500,000 Sale price at fair value 6,000,000 Cost of right of use asset (2,636,000 / 6,000,000 x 4,500,000) 1,902,000 476ail or loss to be recognized A hh 100 provides that the gg 10 O PF ace " Bain or loss that pertains Mine right retained by the seller-fe €@ is nol recognizec ight retained by the gel T-leg: te ial lease liability in relati u asset jain or loss that pertain: Te lessor 1s recognized, See is the proportion of ‘on to the fair value of the 8 to the right transferred to the the right transferred to the buyer-lessor is the fair value of asset minus the initial lease liability. sale price at fair value 6,000,000 Carrying amount of equipment 4,500,000 Total gain Fair value of equipment 6,000,000 Right retained by seller-lessee equal to lease liability 2,536,000 Right transferred to buyer-lessor 3,464,000 Gain to be recognized (3,464,000 /6,000,000 x 1,500,000) 866,000 Gain not to be recognized (2,536,000 / 6,000,000 x 1 500,000) 634,000 Total gain 1,500,000 Books of seller-lessee The seller-le ssee shall apply the finance lease model in accounting fo: r the sale and leaseback transaction. | To record the sale and leaseback: Cash 6,000,000 Right of use asset 1,902,000 quipment 4,500,000 ase liability 2,536,000 Gain on right transferred 866,000 * To record the annual rental for the first year: Interest 10% x 2,536,000) 253,600 Lay phe ¢ x2, Ba ‘ase liabi ; Cash 800,000 3, . : To record the annual depreciation of right of use asset: Depreciation (1,902,000 /4years) 475,500 Accumulated depreciation 475,500 477Books of buyer-lessor Paragraph 100 provides that the buyer-lessor shall account for the purchase of the asset applying lessor accounting standard. Accordingly, the buyer-lessor shall apply the operating lease model because the lease term is 4 years or only 40% of the useful life of the underlying asset. Moreover, the present value of rentals. of P2,536,000 is less than 90% of the fair value of P6,000,000. 1 p To record the purchase of the underlying asset: Equipment 6,000,000 Cash 6,000,000 . To record the annual rental: Cash 800,000 Rent income 800,000 . To record annual depreciation of equipment: Depreciation (6,000,000 / 10: years) 600,000 Accumulated depreciation 600,000 478juustration ~ Sale price above fair value January 1, 2021, an entity sold a building with remaining jife of 20 years and immediately leased it back for 5 years, gale price 20,000,000 ot value of building 18,000,000 Exnying amount of building 10.800,000 jnnual rental payable at the end of each year 1,500,000 jmplicit interest rate 12% present value of an ordinary annuity of Tat 12% for five periods 3.60 Lease liability (1,500,000 x 3.60) 5,400,000 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 adjustment to measure the sale price at fair value. Any excess sale price over fair value shall be accounted for os additional financing provided by the buyer-lessor to seller-lessee. Sale price 20,000,000 Fair value of building 18,000,000 Excess sale price over fair value 2,000,000 Present value of lease liability 5,400,000 Additional financing equal to excess sale price (2,000,000) Present value of lease liability related to rentals 3,400,000 Carrying amount of building 10,800,000 Fair value of building 18,000,000 Cost of right of use asset (3,400,000 / 18,000,000 x 10,800,000) Fair value of building arrying amount of building Adjusted total gain Pair ieee of buildin: retained by seller-lessee equal to lease lability, excluding excess sale price Right transferred to buyer-lessor Gain Cain Adju to be recognized (14,600,000/ 18,000 x7 Not to be recognized ( 3,400,000 / 18,000 x sted total gain 479 aBooks of seller-lessee 1. To record the sale and leaseback: Cash 20,000,000 Right of use asset 2,040,000 arn Building $100,000 Lease liability 5,400,090 Gain on right transferred 840,000 . To record the annual rental for the first year: Interest expense (12% x 5,400,000) 648,000 Lease liability 852,000 Cash 1,500,000 . To record the annual depreciation of right of use asset; Depreciation (2,040,000/5 years) 408,000 Accumulated depreciation 408,000 Books of buyer-lessor The buyer-lessor shall apply the operating lease model because the lease term is 5 years or only 25% of the 20-year useful life of the underlying asset. Moreover, the present value of lease liability related to rentals of P3,400,000 is less than 90% of the fair value of the 1. wo asset of P18,000,000. To record the purchase of the building: Building 18,000,000 Financial asset 2,000,000 Cash 20,000,000 . To record the annual rental related lease: Cash Rent income ee 944,444 To vecord the annual rental related to financing: Cash Financial asset ee 566 Interest income 340,000 } To record depreciation of building Depreciation (18,000,000 / 2¢ ‘Accumulated depreciata aa 480allocation of the annual rental e annual rental of P1,500,000 is partly rental income and partly payment of the financial asset. Present value Fraction _ Allocation Rental income 3,400,000 3,400/5,400,000 944,444 Financial asset 2,000,000 2,000/5,400,000 __ 555,556 qotal present value 5,400,000 000 Amortization related to financial asset Date Payment 12% interest Principal Present value V/1/2021 2,000.000 12/31/2021 555,556 240,000 315,556 1,884,444 12/31/2022 556,556 202,138 353,423, 1,331,021 1231/2023 555,556 159,723 395,833 935,188 12/31/2024 585,556 112,222 443,384 491,854 12/31/2025 555,556 «63,702 491,854 a December 31, 2021 Payment 585,556 Interest income for 2021 (12% x 2,000,000) (240,000) Principal payment 315,556 Present value — January 1, 2021 _ 2,000,000 Principal payment (315,556) Present value — December 31, 2021 1,684,444 481Illustration — Sale price below fair value On January 1, 2021, an entity sold an equipment with remaining life of 8 years and leased it back for 5 years Sale price 5,000,000 Fair value of equipment 6,000,000 Carrying amount of equipment 4,800,000 Annual rental payable at the end of each year 900,000 Implicit interest rate 8% Present value of an ordinary annuity of Lat 8% for five periods 3.99 Measurement of lease liability Present value rentals (900,000 x 3.99) Table of amortization Date Payment 8% interest Principal Present value V/1/2021 - 3,591,000 12/31/2021 900,000 287,280 612,720 2,978,280 12/31/2022 900,000 238,262 661,738 2,316,542 12/31/2023 900,000 185,323, 714,677 1,601,865 12/31/2024 — 900,000 128,149 771,851 830,014 12/31/2025 — 900,000 69,986 830,014 -peasurement of right of use asset ragraph 101, provide, 8 g 16, paragraph 101, provides that if the PRS Jaal the fair value of the as mye adjustment to measure the me , the seller-lesse ale price at ir value. ifthe sale price is below fair value, the difference is accounted as prepayment of rental. value of equipment 6,000,000 Fair val Sale price 5,000,000 Excess fair value over sale price 000,000 Present value of rentals (900,000 x 3.99) 3,591,000 Excess fair value — prepayment of rental Total lease liability : Carrying amount of equipment 4,800,000 Fairvalue of equipment 6,000,000 Cost of right of use asset (4,591,000 / 6,000,000 x 4,800,000) Gain to be recognized Fair value of equipment 6,000,000 ‘arrying amount of equipment. 4,800,000 Total gain 00,000 Feir value of equipment 6,000,000 tht retained by seller-lessee equal to lease hability including the excess fair value 4,591,000 Ry “ht Wransferred to buyer-lessor 1,409,000 Gai | “into be recognized | Gai(t' 409.000 / 6,000,000 x 1,200,000) 281,800 ‘ant to be recognized 4,591,000 6,000,000 x 1,200,000) 918,200 Tote Bain, 483 aeBooks of seller-lessee je and Ieaseback 1. To record the sali 5,000,000 2,800 Cash Right of use asset 4,800,000 Equipment 3,591,000 Lease liability oat Gainon right transferred 800 To record the annual rental for the first year: 37,280 Interest expense 28 280 Lease liability , sino Cash 3. To record the annual depreciation of right of use asset: Depreciation (3,672,800/5 years) 734,560 ‘Accumulated depreciation 734,560 Books of buyer-lessor The buyer-lessor shall apply the operating lease model because the lease term of 5 years is less than 75% of the 8-year useful life of the underlying asset. Moreover, the present value of rentals of P4,591,000 is less than 90% of the fair value of 6,000,000. 1. To record the purchase of the equipment: Equipment 5,000,000 Cash 5,000,000 2. To record the annual rental: Cash Rent income oe 900,000 3. To record annual depreciation of equipment: Depreciation (5,000,000/ 9,000,000 / 8 Accumulated depreciation 620,000 625,000 484ustration ~ Sale price ; : mh Price at fair value with loss ondanuary 1, 2021 jife of 25 year AN entity sold ab and immediate uilding with remaining ly leased it back for 3 years gale price at fair value Carrying amount of building o po pert 00,000 Annual rental payable at the end ofe Implicit interest rate present value of an ordinary annuity of 1 at 8% for three periods ach year ao cae 2.58 Measurement of lease liability Present value of rentals (500,000 x 2.58) Table of amortization Date Payment 8%interest Principal Present value vv2021 1,290,000 12/31/2021 500,000 103,200 396.800 893,200 12/31/2022 500,000 71,456 428.544 464.6: 12/31/2023 500,000 35.344 464,656 - Measurement of right of use asset 12,000,060 Carrying a: t of building ee 10,000,000 Sale price at fair value Cost of right of use asset (1,290,000 / 10,000,000 x 2,000,000) 1.548.000 "485Loss to be recognized Sale price Carrying amount of building Total loss Fair value of building Right retained by seller-leasee equal to lease liability Right transferred to buyer-lessor Loss to be recognized (8,710,000 / 10,000,000 x 2,000,000) Loss not to be recognized (1,290,000 / 10,000,000 x 2,000,000) Total loss Books of seller-lessee 1. Cash 10,000,000 Right of use asset 1,548,000 Loss on right transferred 1,742,000 Building Lease liability 2. Interest expense 103,200 Lease liability 396,800 Cash 3. Depreciation (1,548,000 /3) 516,000 Accumulated depreciation Books of buyer-lessor 1. Building 10,000,000 Cash 2. Cash 500,000 Rental income 3. Depreciation (10,000,000 / 25) 400,000 Accumulated depreciation 486 10,000,000 12,000,000 (2,000,000) 10,000,000 12,000,000 1,290,000 500,000 516,000 10,000,000 500,000 400,000gransfer of asset is not a sale ¢ 16, paragraph 103, pr irs 3, provides that if the je . asset by the seller-lessee does not satiaf the a i vs for the recognition of a sale. die oan The seller-lessee shall continue to recognize the transferred asset and shall recognize a financial liability equal to the transfer proceeds. : The entry is debit cash and credit lease liability for the transfer proceeds. The rental or lease payment is accounted for as part payment of interest expense and part payment of the principal lease liability. The interest is computed based on the implicit interest rate using the effective interest method. b. The buyer-lessor shall not recognize the transferred asset but shall recognize a financial asset equal to the transfer proceeds. The entry is debit lease reeivable and credit cash. The rental or lease payment from the seller-lessee is accounted for as part collection of interest income and part collection of the principal lease receivable 487