1. Prepared by: Gabriela H. Schneider, CMA Northern Alberta Institute of Technology INTERMEDIATE ACCOUNTING Seventh Canadian Edition KIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK

2. Appendix 21A Other Lease Issues Appendix 21A Other Lease Issues

3. 15.Describe the lessee’s accounting for sale- leaseback transactions. 16.Explain the classification and accounting treatment accorded leases that involve land as well as buildings and equipment. Learning Objectives

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

5. 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)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 tightCan provide additional working capital when liquidity is tight

6. Lessee Accounting If the lease meets one of the three capital lease criteria, lessee accounts for the transaction leaseback as a capital leaseIf the lease meets one of the three capital lease criteria, lessee accounts for the transaction leaseback as a capital lease If the lease does not qualify as a capital lease, lessee accounts for the leaseback as an operating leaseIf the lease does not qualify as a capital lease, lessee accounts for the leaseback as an operating lease

7. Lessee Accounting Any gains or losses on the sale of the property leased back are amortized over the lease term in proportion to the amortization of the leased assets (if a capital lease), or in proportion to the rental payments (if operating lease)Any gains or losses on the sale of the property leased back are amortized over the lease term in proportion to the amortization of the leased assets (if a capital lease), or in proportion to the rental payments (if operating lease) If leased asset is land only, amortize straight- line over the lease termIf leased asset is land only, amortize straight- line over the lease term

8. Lessor Accounting If the lease meets one of the Group I criteria and both Group II, purchaser records the transaction as a purchase and a direct financing leaseIf the lease meets one of the Group I criteria and both Group II, purchaser records the transaction as a purchase and a direct financing lease Otherwise, transaction is a purchase and an operating leaseOtherwise, transaction is a purchase and an operating lease Criteria for sales-type lease would not be met in a sale-leaseback transactionCriteria for sales-type lease would not be met in a sale-leaseback transaction

9. Sale-Leaseback Illustration On Jan 1, 2005 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 backOn Jan 1, 2005 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: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 1/05 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

10. Accounting by Lessee Inc. January 1, 2005: Sale of Aircraft to Lessor Inc. Cash80,000,000 Accumulated Amortization 10,000,000 Accumulated Amortization 10,000,000 Aircraft (net)85,500,000 Unearned profit on Sale-Leaseback 4,500,000 Sale-Leaseback 4,500,000 January 1, 2005: Leaseback transaction Aircraft under Capital Lease 80,000,000 Obligations under Capital Lease 80,000,000

11. Accounting by Lessee Inc. January 1, 2005: First Lease Payment Obligations under10,487,443 Capital lease Cash10,487,433 2005 Executory Costs Executory CostsXXX Cash or A/PXXX

12. Accounting by Lessee Inc. December 31, 2005: Amortization Expense Amortization Expense5,333,333 Accumulated Amortization5,333,333 ($80,000,000 / 15 years) December 31, 2005: Amortization of Deferred Profit on Sale–Leaseback Unearned Profit on300,000 Amortization expense or Revenue 300,000 ($4,500,000 / 15 years)

13. Accounting by Lessee Inc. December 31, 2005: Interest Expense Interest Expense8,341,507 Interest Payable8,341,507 [($80,000,000 - $10,487,443) x 12%]

14. Accounting by Lessor Inc. January 1, 2005: Purchase of Aircraft from Lessee Inc. Aircraft80,000,000 Cash80,000,000 January 1, 2005: Leaseback transaction Lease Payments Receivable157,311,645 Aircraft80,000,000 Unearned Interest Revenue77,311,645 ($10,487,443 x 15 years = 157,311,645)

15. Accounting by Lessor Inc. January 1, 2005: First Lease Payment Cash10,487,443 Lease Payments 10,487,443 Receivable December 31, 2005: Interest Revenue Unearned Interest Revenue8,341,507 Interest Revenue8,341.507

16. Real Estate Leases Lessee has capital lease of land that will revert to lessor, if general rules followed:Lessee has capital lease of land that will revert to lessor, if general rules followed: –land recognized on balance sheet –no amortization –when lease term ends and land is returned: Dr. Loss XXX Cr. Land XXX Cr. Land XXX Therefore special rules needed

17. Real Estate Leases In this situation, and only land is leasedIn this situation, and only land is leased –Treat as operating lease by lessee and lessor In this situation and land is minor part of leased property, do not separate out land valueIn this situation and land is minor part of leased property, do not separate out land value In this situation and land is significant part of leased property, land portion is treated as an operating leaseIn this situation and land is significant part of leased property, land portion is treated as an operating lease

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