1. Chapter 20 Appendix 20A Chapter 20 Appendix 20A Other Lease Issues Prepared by: Dragan Stojanovic, CA Rotman School of Management, University of Toronto

2. 2 Sale-Leaseback Transactions Transaction in which the property owner (seller—lessee) sells the property to another party (purchaser—lessor) and immediately leases it back from the new owner Example: company buys land and constructs a building, sells it to a property investor and then leases it back

3. 3 Advantages of Sale-Leasebacks If equipment purchase has already been financed, a sale-leaseback can allow the seller to refinance at lower rates (if rates have decreased) Can provide additional working capital when liquidity is tight

4. 4 Lessee Accounting If the lease the capital or finance lease criteria, lessee accounts for the transaction leaseback as a capital or finance lease If none of the capital lease criteria is met, lessee accounts for the leaseback as an operating lease

5. 5 Lessee Accounting Under PE GAAP, any gains or losses on the sale of the property leased back are amortized on the same basis as depreciation of the leased assets (if a capital lease), or in proportion to the rental payments (if operating lease) Under IFRS, any gains or losses on the sale of the property leased back are amortized over the leased term (if a capital lease), or recognized in income (if operating lease and fair value used)

6. 6 Lessee Accounting If asset is impaired, seller writes it down to FV and recognizes full loss in the year If leased asset is land only, amortize straight- line over the lease term

7. 7 Lessor Accounting Lessor applies regular lease standards

8. 8 Sale-Leaseback Illustration On Jan 1, 2011 Lessee Inc. sells a used Boeing 747 with a cost of $85.5 million and a book value of $75.5 million to Lessor Inc for $80 million and immediately leases it back Conditions are: –15 year lease term with equal rental payments of $10,487,443 at beginning of each year (Table A-5; i=12%; n=15) –FV = $80 million on Jan 1/11 and 15 year economic life –Lessee pays all executory cost –Lessee amortizes similar owned assets straight-line over 15 years –Annual payments assure Lessor 12% return which is also Lessee’s incremental borrowing rate

9. 9 Accounting by Lessee Inc. January 1, 2011: Sale of Aircraft to Lessor Inc. Cash80,000,000 Accumulated Amortization 10,000,000 Aircraft 85,500,000 Deferred profit on Sale-Leaseback 4,500,000 January 1, 2011: Leaseback transaction Aircraft under Capital Lease 80,000,000 Obligations under Capital Lease 80,000,000

10. 10 Accounting by Lessee Inc. January 1, 2011: First Lease Payment Obligations under Capital lease 10,487,443 Cash10,487,433 2011 Executory Costs Executory CostsXXX Cash or A/PXXX

11. 11 Accounting by Lessee Inc. December 31, 2011: Amortization Expense Amortization Expense5,333,333 Accumulated Amortization5,333,333 ($80,000,000 / 15 years) December 31, 2011: Amortization of Deferred Profit on Sale–Leaseback Deferred Profit on Sale-Leaseback300,000 Amortization expense300,000 ($4,500,000 / 15 years)

12. 12 Accounting by Lessee Inc. December 31, 2011: Interest Expense Interest Expense8,341,507 Interest Payable8,341,507 [($80,000,000 - $10,487,443) x 12%]

13. 13 Accounting by Lessor Inc. January 1, 2011: Purchase of Aircraft from Lessee Inc. Aircraft80,000,000 Cash80,000,000 January 1, 2011: Leaseback transaction Lease Payments Receivable157,311,645 Aircraft80,000,000 Unearned Interest Income77,311,645 ($10,487,443 x 15 years = 157,311,645)

14. 14 Accounting by Lessor Inc. January 1, 2011: First Lease Payment Cash10,487,443 Lease Payments Receivable10,487,443 December 31, 2011: Interest Revenue Unearned Interest Income8,341,507 Interest Income 8,341,507

15. 15 Real Estate Leases If only land is leased, lessee accounts for the lease as a capital lease if lease transfers ownership of property (or, under PE GAAP, bargain purchase option exists) If title is not expected to be transferred and land is minor part of leased property, treat as single unit

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