Read about ASC 842 & other lease accounting topics
Read about ASC 842 & other lease accounting topics
A sale and leaseback agreement is a transaction where the seller of an asset becomes the lessee and the purchaser becomes the lessor. Nothing changes in the before and after picture of a sale and leaseback agreement except the ownership. The entity that sold the asset continues to operate and holds full control over it. However, they are no longer the asset’s owner. These agreements were created to help entities generate cash flow while mitigating debt.
In this blog, we’ll explore ownership in a sale and leaseback agreement, some examples of it in action, and we’ll help you understand whether you should enter into a sale and leaseback agreement.
A sale and leaseback agreement is made between two entities where the owner of an asset sells said asset to a purchaser. Once the asset is sold, the entity who sold the asset then leases it back from the purchaser, hence the term “leaseback”.
In general, this sort of agreement is made for high-value fixed assets like real estate or aerospace equipment.
Builders or companies with very expensive assets often use sale and leaseback agreements. They enter into these agreements because they can use the proceeds from selling the asset while still using or operating the asset over the lease term.
There are a few advantages of sale and leaseback agreements. First and foremost, it can be a good way to access capital (cash). When a company needs cash, the first thought might be to take out a bank loan. Because a loan’s interest rates are determined by the health of the business, this can be an expensive way to access capital. If the business owns real estate or equipment, a sale and leaseback agreement allows them to get cash at what is often a lower total cost.
A sale and leaseback agreement offers an alternative to loans that can allow a company to generate capital as almost as swiftly as taking out a loan. Leasebacks can also provide additional tax deductions and enable a company to expand its business by providing them with an easy way to generate funds. They also limit the volatility risk of owning an asset.
Buyer-lessors also benefit from sale and leaseback agreements. They get a guaranteed lease, a fair return on investment, and a stable income stream for a specified period of time.
For an example of a sale and leaseback agreement, we can look back at a transaction Sears made in 2015. In this transaction, Sears sold 235 of its storefronts to Seritage Growth Properties, then began immediately leasing the properties back from Seritage to continue operations. This helped Sears in two ways: it generated about $2.7 billion in cash for the company and offloaded some pressing liabilities from its balance sheet.
Furthermore, this transaction benefited Seritage Growth Properties by giving them the right to recapture space in Sears’ stores and rent it out to other tenants.
It is not uncommon to see sale and leaseback agreements between businesses and investors (the buyer-lessor) like MBFCs, mutual funds, pension funds, and hedge funds.
Identifying whether a sale has taken place in a sale and leaseback transaction can be tricky, but there are a few things to keep in mind. First, entities must use ASC 606 to determine whether the sale of an asset has occurred and whether there is a contract. If a contract is present, the next step is determining whether a sale has occurred.
To determine whether a sale has occurred in a sale and leaseback transaction, it’s important to measure whether the buyer-lessor has access to the use of, control, and substantially all of the remaining benefits of the asset. Some determinants of control include the transferring of legal title, physical possession, risk and reward cost of ownership, asset acceptance, and the requirement to pay for the asset.
Under ASC 842, the buyer-lessor and seller-lessee must individually determine whether control of the asset has been transferred between the two parties. Both parties may determine that a sale has happened or not happened, but they can also disagree, i.e., one party determines a sale happened while the other doesn’t and vice versa. This can occur when entities calculate lease classifications differently due to varying presumptions, including discount rate or fair value of the asset.
Entering into a sale and leaseback agreement does not automatically mean a sale has occurred. If the buyer-lessor classifies the sale and leaseback agreement as a sales-type lease or the seller-lessee classifies the leaseback as a finance lease, then the transaction will be a financing transaction, not a sale.
Also, if a seller-lessee can repurchase an asset from the buyer-lessor, this would stop the transaction from being a sale unless the purchasing option’s exercise price and the asset's fair value are equivalent and additional assets that are substantially similar to the transferred asset are readily available.
If a sale and leaseback transaction does not qualify as a sale, the buyer-lessor will qualify the lease as a sales-type lease and the seller-lessee will classify it as a finance lease respectively.
This change in standard practice has made it easier to determine whether control has passed from a seller-lessee to a buyer-lessor when assets are under construction.
However, individuals and companies preparing financial statements for complicated leasing agreements might find it difficult to apply the provisions to their statements. Thus, it is important to stay afloat of the best practices in the industry.
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A sale and leaseback agreement in real estate is when an entity sells its real estate to a purchaser for cash and then begins leasing the same property back from the new owner.
A failed leaseback is one where the transaction must be classified as a financing transaction rather than a sale. In this situation, the seller-lessee does not derecognize the transferred asset and depreciates the asset as if it were the legal owner. Any sales proceeds received from the buyer-lessor will be accounted for as a financial liability.
A leaseback transaction is one in which an owner of an asset sells that asset to an entity, then begins leasing that asset back from the party they sold it to for the long term.
A leaseback arrangement is an arrangement where the owner of an asset sells and subsequently leases back an asset from an entity they sold it to. This type of arrangement often frees up financial capital for entities that were tied up in nonliquid assets.
A leaseback of assets is a situation where an asset is sold to a party and then leased back from the entity that sold the asset. While the ownership of the asset is changed in this situation, the use of the asset should still be fully in control by the entity known as the seller-lessee.
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