The accounting for a sale and lease back transaction will depend on whether the leased back asset qualifies as a finance lease or an operating lease?
1. If a sale and leaseback transaction results in a finance lease, any excess of the sale proceeds over the carrying amount should not be recognized immediately as income by a seller/lessee. Instead, the excess is amortized to profit or loss over the lease term. It is inappropriate to show a profit on disposal of an asset which has then, in substance, been re-acquired by the entity under a finance lease as the lessor is providing finance to the lessee with the asset as security.
If, on the other hand, the sale proceeds from ‘the sale and leaseback transaction’ is less than the carrying amount, then the apparent ‘loss’ need not to be taken immediately by the seller/lessee to income, unless there has been an impairment under IAS 36 [IAS 17.64]. There may be an obvious reason why the sale proceeds are less than the carrying amount! For example, the fair value of a second-hand vehicle or item of plant and machinery is frequently lower than its book value, especially soon after the asset has been acquired by the entity. This fall in fair value after acquisition has no effect on the asset’s value-in-use. The lessor is providing finance to the lessee with the asset as security. This means that in the absence of impairment, a deficit (sales proceeds lower than carrying amount) will be amortized to profit or loss in the same manner as the excess over the lease term.
Methods for accounting in practice:
It is worth mentioning that lessees use two alternative accounting methods in accounting for a sale and leaseback arrangement that gives rise to a finance lease. Both methods achieves the same impact on profit or loss within each reporting period of the lease term; i.e., they do not result in charging the gain or loss on the sale transaction immediately to profit or loss, but rather amortize it to profit or loss over the lease term. The main difference is that:
o one method results in derecognizing the asset at its carrying amount and then re-recognizing it at the cash proceeds (assuming they equal to NPV of minimum lease payments); and
o the other method results in neither derecognizing the asset from the books nor recognizing the gain or loss in the books upon entering into the transaction. Amortization of the gain or loss, in this second method, is made indirectly through depreciating the previous carrying amount of the asset. the amount of depreciation in that case would equal to the net effect of amortization of gain or loss and depreciation of the revalued asset in the first method.
The first method, described as (gross presentation), requires the asset to be derecognized from the books at its previous carrying amount with a corresponding debit to cash for the value of sale proceeds.
It requires the entity to re-recognize the asset at the amount of the sale proceeds (i.e. fair value or, if lower, NPV of minimum lease payments) with a corresponding credit to lease obligation. Thus, gain or loss will be recognized in the books as deferred income and will be subsequently amortized to profit or loss along with depreciation of the new value of the asset.
The second method, described as (net presentation), does not require derecognition of the sold asset, but the asset is rather retained in the books at its previous carrying amount while the sale proceeds is recognized as an increase in cash against a lease obligation.
This method will not result in recognizing a gain or loss on sale at all, and amortization of the unrecognized gain or loss will be made indirectly through depreciation of the carrying amount of the asset (which is NOT the amount used to re-recognize the asset in the first method).
2. If a sale and leaseback transaction results in an operating lease, and it is clear that the transaction is established at fair value (transaction price = FV), any gain or loss shall be recognized immediately – because there has in effect been a normal sale transaction.
However, if the sale price is below fair value, any gain or loss shall be recognized immediately except that, if the loss is compensated for by future lease payments at below market price, then such loss shall be deferred and amortized in proportion to the lease payments over the period for which the asset is expected to be used.
On the other hand, if the sale price is above fair value, the excess over fair value shall be deferred and amortized over the period for which the asset is expected to be used [refer to IAS 17.61]
One last thing, if the fair value at the time of a sale and operating lease back transaction is less than the carrying amount of the leased asset, a loss equal to the amount of the difference between the carrying amount and fair value shall be recognized immediately [IAS 17.63]
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