Sale-leaseback contracts can be attracting companies trying to find a liquidity increase or a strategy to manage their financial obligation ratio.

However, for accountants, they can likewise be complicated to evaluate and determine whether a sale has taken location.

So how precisely does sale-leaseback accounting work?

This post covers whatever you require to understand about these transactions, consisting of the meaning of sale-leaseback, benefits and drawbacks, and accounting examples.

What is a sale-leaseback?

A sale-leaseback (a.k.a. sale and leaseback) deal takes place when the owner of a property sells it, then rents it back through a long-lasting lease. The original owner becomes the seller-lessee, and the buyer of the property ends up being the buyer-lessor.

While this deal does not affect the operational usage of the possession by the seller-lessee, it does have various accounting outcomes for both parties. The seller-lessee can continue utilizing the property, however legal ownership is transferred to the buyer-lessor.

Learn more about the responsibilities of lessors and lessees.

What is the function of a sale-leaseback?

The most typical reasons to get in a sale-leaseback arrangement are to raise capital, enhance the balance sheet, or gain tax benefits. The seller-lessee is usually seeking to release the cash kept in the worth of a residential or commercial property or possession for other functions but does not desire to compromise their capability to utilize the property.

Purchasers who participate in these contracts are usually institutional investors, renting companies, or finance companies pursuing an offer that has a safe and secure return as the buyer-lessor.

Sale-leasebacks are typically seen in industries with high-cost set properties, such as building, transport, property, and aerospace.

How does a sale-leaseback work?

In a sale-leaseback arrangement, ownership is moved to the buyer-lessor, while the seller-lessee continues to utilize the property. For example:

- An energy company can offer the properties that comprise their solar-power system to a funding company, then immediately lease it back to work and satisfy the demand of clients.


- Construction business can offer their property residential or commercial properties and after that immediately lease them back from the purchaser to establish them.


- Aviation business regularly offer their airplane to an aviation financing company and right away rent them back with no time out in their regular routine.


- Real estate business frequently have sale-leaseback programs that give house owners more flexibility than a standard home sale. Equity in the home can quickly be transformed into money by the seller-lessee, and mortgage brokers get to a broader consumer base as the buyer-lessor. These transactions are also called "sell and remain" arrangements.


Benefits and drawbacks of sale-leasebacks

Sale-leaseback deals have the flexibility to be structured in different ways that can benefit both parties. Obviously, there are also dangers associated with this type of arrangement that both parties need to evaluate, in addition to service and tax ramifications.

Mutual understanding of the advantages and drawbacks is a crucial element when specifying the contract. Let's have a look at the advantages and disadvantages for each party.

Pros for the seller-lessee:

- They get the choice to broaden their organization or buy new devices with the increase of money while keeping day-to-day access to the possession.


- It's a less costly way to obtain funds compared to loan financing, hence enhancing the balance sheet.


- They can invest money in other venues for a greater return, thus improving the earnings and loss declaration (P&L).


- Sale-leaseback enables the full deductibility of lease payments with the transfer of tax ownership to the buyer-lessor.


- There's restricted danger due to property volatility.


Cons for the seller-lessee:

- The owned asset is gotten rid of from the balance sheet.


- The right of use (ROU) possession increases, depending on the lease term and agreed-upon lease payments surpassing fair-market worth.


- They should recognize capital gains.


Pros for the buyer-lessor:

- Rental earnings over the life of the lease reinforces their financial position.


- They can make sure that lease terms are crafted to fit their requirements.


- They have more control over return on financial investment (ROI) based on the conditions laid out in the agreement.


- They can repossess the possession if the seller-lessee defaults on payments.


Cons to the buyer-lessor:

- They should renegotiate agreements if the seller-lessee defaults on lease payments.


- They're the main creditor/owner if the seller-lessee declare insolvency.


- There's a risk that the asset value may reduce faster than the forecasted market and end up being impaired.


How to figure out if a transaction qualifies as a sale-leaseback

To certify as a sale-leaseback, a transaction needs to meet a number of criteria. When evaluating the contract under ASC 842, entities need to apply ASC 606 (income from contracts with consumers) to determine whether the sale of a possession has actually occurred. There is a substantial amount of judgement that enters into this process, and it is good practice to have an auditor review the details and complexities of the offer.

Let's discuss the procedure action by step.

1. Determine if there's a contract

First, you must determine if there is a contract as discussed in ASC 606-12-25-1 through 8.

Essentially, any arrangement that creates legally enforceable rights and responsibilities usually satisfies the definition of a contract. Contracts can be oral, composed, or suggested by an entity's popular company practices.

2. Asses if there's a sale

Assess from an accounting viewpoint if there is a sale or a financing contract.

The primary question is if control has transferred from the seller to the purchaser, therefore satisfying the efficiency commitment. If the answer is yes, then a sale has actually taken place. Otherwise, the unsuccessful sale is dealt with as a financing plan.

ASC 842 references ASC 606-10-25-30 for a list of signs showing that control has been moved to the buyer-lessor. The 5 control signs are:

1. The reporting entity has a present right to payment; the buyer-lessor has a present obligation to pay the seller-lessee.


1. The customer has a legal title.


1. The customer has physical possession.


1. The customer has considerable risks and rewards of ownership.


1. The client has actually accepted the possession.


This is where judgment will be necessary to assess, primarily from the buyer-lessor's position, if control has been moved. It is not needed that all the indications be fulfilled to draw this conclusion. However, it is needed that both the seller-lessee and buyer-lessor perform this evaluation independently.

It is possible that while the actions to assess control equal for both celebrations, each can pertain to a different conclusion that would affect the occurrence of a competent sale.

For instance, celebrations could make differing assumptions relating to factors such as the economic life, reasonable worth of the property, or the discount rate that would impact the lease classification determination.

If the seller-lessee categorizes the lease as a financing lease or the buyer-lessor classifies the lease as a sales-type lease, then the test for control has failed. The transaction must then follow accounting treatment for a funding transaction. Despite the fact that the seller-lessee no longer lawfully owns the property, they would keep it on their books. The earnings would be thought about a financing liability.

Compliance for sale-leaseback transactions

Accounting for sale-leasebacks is fairly the same by the transition from ASC 840 to ASC 842.

If a transaction was previously represented as a sale-leaseback under ASC 840, it does not require to be reassessed to identify whether it would have also qualified as a sale (or purchase) under ASC 842. The lease part of any transaction that certified as a sale-lease back must be represented by both the lessees and lessors in accordance with shift requirements.

See ASC 842-10-65-1 for assistance on postponed gain or loss balances after shift depending upon the lease category.

Any deals that were accounted for as a failed sale-leaseback under ASC 840 should be reassessed under the new lease standard. Seller-lessees need to identify if a sale would have occurred either:

1. At any point on or after the start duration of the earliest period provided in the financial statement under ASC 842 (if a reporting entity chooses to change comparative periods).


1. At the efficient date (if a reporting entity elected to not change comparative durations).


If a sale would have occurred, the sale-leaseback ought to be represented according to the lease transition assistance in ASC 842-10-65-1 on a modified retrospective basis from the date a sale is figured out to have actually happened.

Buyer-lessors, however, do not require to review effective purchases formerly taped because the sale-leaseback model of ASC 840 did not use to lessors. In this scenario, buyer-lessors ought to represent the leaseback in compliance with regular lessor shift guidance.

How to account for sale-leasebacks under ASC 842

If the deal fulfills the requirements under ASC 842 to qualify as a sale-leaseback, then the seller-lessee will:

- Recognize the sale and any gain or loss-the distinction in between the money got and the book worth of the asset when the buy-lessor takes control of the property.


- Derecognize the property, removing it from the balance sheet.

- Calculate and acknowledge the associated lease liability and ROU asset for leaseback in accordance with ASC 842.


The buyer-lessor should likewise decide whether the transaction resulted in an organization mix according to ASC 805 or a property acquisition. A possession acquisition can be tape-recorded as per ASC 350: Residential Or Commercial Property, Plant & Equipment (PP&E). The evaluation of the asset need to be equivalent to the fair-market worth separate from the leaseback agreement. The contract should then be acknowledged as any other lease contract.

To sum up, ASC 842-40-25-4 gives the following assistance on how to represent the sale-leaseback.

The seller-lessee shall: - Recognize the deal price when the buyer-lessor gets control of the property

- Derecognize the hidden possession quantity.

The buyer-lessor will: - Represent the property purchase.

- Recognize the lease in accordance with ASC 842-30.

How to adjust for off-market terms

Accountants should take extra actions to adjust for off-market terms. Per ASC 842-40-30-1, the initial step is to identify whether the prices is at fair value using among the following approaches, depending on the details readily available:

- Comparison of the sale cost of the asset vs. the fair worth of the property.


- Comparison of today value of the lease payments vs. the present worth of market rental payment


If there is a difference, the sale-leaseback needs to be adjusted to reflect the fair-market worth of the possession according to ASC 842-40-30-2.

If the list price is below fair value, the difference is taped as prepaid lease. If the sale rate of the asset is above fair worth, the excess is considered additional financing, different from the lease liability, gotten from the buyer-lessor.

To sum up, if there is a balance between the sale price and the reasonable value, the seller-lessee requirements to change the effect of the deal:

Sale rate is lower than fair value: Make a modification to increase the sales cost through an increase (debit) to prepaid rent (reflected in the seller-lessee's preliminary measurement of the ROU asset).


Sale cost is greater than reasonable value: Make an adjustment to reduce the prices through an increase (credit) to extra funding liability.


Sale-leaseback accounting examples

Now that we understand the theory, let's go through a practical example of how sale-leaseback accounting works.

Suppose Blue Sky Airlines sells one of its Boeing aircrafts to ABC Aviation. Blue Sky Airlines is the seller-lessee and ABC Aviation is the buyer-lessor. Let's see what it looks like if the sale price is lower than fair value and higher than fair worth.

Price or lease payments are lower than fair worth

Let's say the seller-lessee offered the possession at a discount rate or less than market worth. Thus, they must recognize the difference and adjust for it with the right-of-use possession quantity for lease accounting.

- Asset sale quantity: $78.5 million.


- Fair-market value: $84 million.


- Lease duration: 18 years.


- Annual lease payment: $3 million.


- Rate of interest: 6%.


The ROU present worth of $3 million for 18 years at 6% rates of interest is $32,482,810. The distinction in the market value and prices is $5.5 M.

List price or lease payments are higher than fair value

Now, let's state the seller-lessee sold the asset at a premium or more than market price.

- Asset sale amount: $86 million.


- Fair market price: $84 million.


- Lease period: 18 years.


- Annual lease payment = $3 million.


- Rates of interest: 6%.


The ROU present worth of $3 million for 18 years at 6% rate of interest is $32,482,810. The difference in the market worth and list prices is $2 million.

Blue Sky Airlines will tape-record the following journal entries for this deal.

Note: PP&E is recorded at bring worth with the seller-lessee. Gain on the sale is the distinction in the price ($ 86M) and the bring worth ($ 80M) of the possession less the off-market adjustment ($ 2M).

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