TENTH CANADIAN EDITION INTERMEDIATE ACCOUNTING PREPARED BY: Lisa Harvey, CPA, CA Rotman School of Management, University of Toronto 1 CHAPTER 20 Appendix 20A Other Lease Issues Kieso Weygandt Warfield Young Wiecek McConomy

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 Copyright John Wiley & Sons Canada, Ltd. 2

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 Copyright John Wiley & Sons Canada, Ltd. 3

Seller-Lessee Accounting If the lease meets the capital or finance lease criteria, seller-lessee accounts for the transaction as a sale and the lease as a capital or finance lease If none of the capital or finance lease criteria are met, lessee accounts for the transaction as a sale and the lease as an operating lease Copyright John Wiley & Sons Canada, Ltd. 4

Seller-Lessee Accounting Under IFRS, any gains or losses on the sale of the property leased back are amortized over the leased term (if a finance lease) or recognized in income (if operating lease and selling price = FV) Under ASPE, 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) Copyright John Wiley & Sons Canada, Ltd. 5

Lessee Accounting If the selling price is less than fair value, the seller-lessee must write down the asset to FV and recognize the full loss in the year –If the lease payments are below market rate to compensate for this impairment, the loss is deferred and amortized If leased asset is land only, amortize straight-line over the lease term Copyright John Wiley & Sons Canada, Ltd. 6

Purchaser-Lessor Accounting Lessor applies regular lease standards Copyright John Wiley & Sons Canada, Ltd. 7

Sale-Leaseback Illustration Given: On Jan 1, 2015 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 FV = $80 million on Jan 1/15 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 –Present value of MLP is $80 million (Table A-5; i=12%; n=15) Copyright John Wiley & Sons Canada, Ltd. 8

Accounting by Lessee Inc. January 1, 2015: Sale of Aircraft to Lessor Inc. Cash80,000,000 Accumulated Depreciation 10,000,000 Aircraft 85,500,000 Deferred Profit on Sale-Leaseback 4,500,000 January 1, 2015: Leaseback Transaction Aircraft under Lease 80,000,000 Obligations Lease 80,000,000 Copyright John Wiley & Sons Canada, Ltd. 9

Accounting by Lessee Inc. January 1, 2015: First Lease Payment Obligations under Lease 10,487,443 Cash10,487, Executory Costs Operating Expense XXX Cash or Accounts PayableXXX Copyright John Wiley & Sons Canada, Ltd. 10

Accounting by Lessee Inc. December 31, 2015: Depreciation Expense Depreciation Expense 5,333,333 Depreciation Amortization5,333,333 ($80,000,000 / 15 years) December 31, 2015: Depreciation of Deferred Profit on Sale–Leaseback Deferred Profit on Sale-Leaseback 300,000 Depreciation expense 300,000 ($4,500,000 / 15 years) Copyright John Wiley & Sons Canada, Ltd. 11

Accounting by Lessee Inc. December 31, 2015: Interest Expense Interest Expense8,341,507 Interest Payable 8,341,507 [($80,000,000 - $10,487,443) x 12%] Copyright John Wiley & Sons Canada, Ltd. 12

Accounting by Lessor Inc. January 1, 2015: Purchase of Aircraft from Lessee Inc. Aircraft Acquired for Lease 80,000,000 Cash80,000,000 January 1, 2015: Leaseback Transaction Lease Payments Receivable157,311,645 Aircraft Acquired for Lease 80,000,000 Unearned Interest Income77,311,645 ($10,487,443 x 15 years = 157,311,645) Copyright John Wiley & Sons Canada, Ltd. 13

Accounting by Lessor Inc. January 1, 2015: First Lease Payment Cash 10,487,443 Lease Receivable 10,487,443 December 31, 2015: Interest Revenue Unearned Interest Income 8,341,507 Interest Income 8,341,507 Copyright John Wiley & Sons Canada, Ltd. 14

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 Copyright John Wiley & Sons Canada, Ltd. 15

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