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SALES AND LEASEBACK
If the sale and lease are separate transactions: Scenario 1. Scenario 2. Scenario 1: ABC sold its building to XYZ in exchange for P1,000,000 with a book value of P800,000. Before recording such transaction as “sale”, ABC may apply the criteria provided by PFRS 15 (Revenue from Contracts with Customers) whether such event would qualify as a sale transaction: Risks and rewards have been transferred from the seller to the buyer. Using the example above, the new owner, will now enjoy the benefits attached to the building, such as the using it for their own operations. Aside from the benefits, various potential threats and uncertainties that may adversely affect the value, performance, or future cash flows associated with asset is to be managed by the new owner. Example of this is physical deterioration of the building. The seller has no control over the goods sold. Collection of payment is reasonably assured. The amount of revenue can be reasonably measured. Costs of earning the revenue can be reasonably measured. If all of the criteria are present in a transaction, it is considered to be SALE. The journal entry to be recorded in a sale transaction would involve:
- SALE TRANSACTION JOURNAL ENTRY ON SELLER’S BOOK Cash 1,000, Building 800, Gain on sale 200, To record the sale of building.
JOURNAL ENTRY ON BUYER’S BOOK
Building 1,000, Cash 1,000, To record the purchase of building. A common reason why a company would sell their asset is to generate immediate cash. Scenario 2: XYZ leased the building it purchased to DEF for 3 years, wherein a monthly rental of P20,000 will be paid. In this case, the lessee (DEF) is of not the same identity as the seller of the building (ABC was the seller of the building). The lease contract is a separate and distinct transaction, thus, what we have discussed in Lessee and Lessor Accounting will apply.
- LEASE TRANSACTION JOURNAL ENTRY ON LESSEE’S BOOK (As discussed previously, the default method is Finance Lease.) ROU-A(20Kx12x6) 720, LL 720,
JOURNAL ENTRY ON LESSOR’S BOOK
[Assuming none of the criteria was present (TT;CPO;>75%;>90%), Operating Lease will apply.)] Cash 20, Rent income 20, If the sale and lease transaction are NOT separate transactions: If the identity of the lessee is also the seller of the identified asset, PFRS 16 sets out specific guideline that needs to be considered. Sales and leaseback is a transaction in which one party sells an asset to another party and then immediately leases it back from the new owner. The diagram below visualizes what sales and leaseback is: In this scenario, the SELLER of the asset transfers the ownership of the building to the BUYER (which is the Sale Transaction), and the new owner would allow the seller to lease the same building (which is the Lease Transaction).
This transaction would usually happen if the seller is in need of immediate cash and the buyer have no plans yet of utilizing the asset it bought. Assuming that the building was also the primary location of operations for the seller, the lease agreement can also be advantageous for them instead of purchasing another office space. On the other hand, instead of letting the building be in an idle state, the buyer will be willing to enter a lease agreement with the seller so that the building can have its own cash inflow (in the form of rental payments). (NOTE: It is not required to physically transfer the asset from the seller’s premises towards the buyer’s. There is a concept of symbolic or constructive delivery in our law which means that there is still a transfer of control or ownership without the need for physical transfer. Example of this is giving the keys of an apartment to a buyer, or transferring of land title documents.) ACCOUNTING FOR THE BUYER-LESSOR Accounting for the buyer-lessor is simpler compared to the seller-lessee. As the buyer, the journal entry for the purchase of the asset will be: [Dr.] Asset XX (at purchase price) [Cr.] Cash XX As the lessor, only LESSOR ACCOUNTING will be simply followed. Lessor shall identified first if the lease qualifies as operating lease or finance lease (use TT- CPO->75%LT->90%PVLP criteria). If Operating Lease, common accounting questions will be: Gross Rental Income = Rental Payments made during the year (but will be adjusted to account the rental payments evenly if there are free rentals or changes in rentals) Net Rental Income = Rental Payments received during the year less Depreciation Expense (since the new owner of the asset is the buyer-lessor, the same shall be the bearer of the loss on depreciation or depreciation expense ) If Finance Lease, is shall be further classified if Direct Financing or Sales-type Lease. Our discussion for this types of leases will apply.
ACCOUNTING FOR THE SELLER-LESSEE
Originally, all rights of the seller to the asset would cease upon sale, which is evidenced by the journal entry recorded (derecognition of the building and at the same time recognition of gain on sale). However, PFRS 16 identifies that, because there is a lease transaction after the sale, and the seller-lessee previously controls the underlying asset before that asset is transferred to the buyer-lessor, a concept of “rights retained” and “rights transferred” on the part of the seller-lessee exists. For that reason, the journal entry would not be simply combining the pro-forma entries for sale and lease into one compounded entry. JOURNAL ENTRY ON SELLER’S BOOK Cash 1,000, Building 800, Gain on sale 200, JOURNAL ENTRY ON LESSEE’S BOOK ROU-A(20Kx12x6) 720, LL 720, COMPOUNDED ENTRY (INCORRECT) Cash 1,000, ROU-A 720, Building 800, LL 720, Gain on sale 200, Just because the debits and credits balanced, it would not automatically mean that journal entry is correct. For accounting purposes, the amounts do not report accurate figures. This is because the right-of-use asset and gain on sale are two of the accounts that will be affected because of the concepts of rights retained and rights transferred. Because of the sale transaction, rights transferred by the seller-lessee to the buyer-lessor would include right to ownership and residual value risk. (legal owner si buyer-lessor, so in case maghataas an value san asset in the future, sa iya la an benefit; another scenario is that, pwede gamiton as collateral ni buyer-lessor an asset although naka-lease iton since siya an real owner) On the other hand, because of the lease transaction, the rights retained by the seller-lessee includes the right to control the use of the identified asset, operational control, and renewal options (following an concept san right-of-use asset, makaka-decide si Lessee kun ano an iya pag-gagamitan san asset; habang nasa iya pa an asset, sa iya liwat an benefit)
As mentioned, rights retained is generally, equal to the lease liability, but is adjusted if the selling price is not equal to the fair value of the asset. The adjustments will be discussed below: SP = FV Based on our example, no fair value was mentioned. It can be assumed that the selling price approximates the actual value of the asset if it is to be traded in the market. If SP=FV, there is no accounting issue in determining the rights retained. Sa POV ni seller-lessee, an iya rights retained over the asset is equivalent to the present value of lease payments, or an iya Lease Liability. Na-mention naton sa una nga dapat an imo right is equivaluent sa imo obligation. SP > FV Assuming that the fair value of the building upon sale is P900,000. Sa POV ni buyer-lessor, dapat an iya babaydan P900,000 la kay asya man an ungod na value san asset. Pero an iya ginbayad, still at P1,000,000. Diri iton “loss” sa iya part, but instead, an sobra nga P100,000 will be considered as additional financing or ginpautang liwat niya kan seller- lessee. Kun mas hataas an selling price compared sa fair value, an difference will be deducted from the original lease liability to determine the actual rights retained. Rights retained = Lease liability less Additional Financing SP < FV Assuming that the fair value of the building upon sale is P1,200,000. Sa POV ni seller-lessee, dapat an iya na-receive na bayad is P1,200,000 kay asya an ungod na value san building. Pero an difference na P200,000 is not a direct “loss”, instead, an pag-treat san kulang baga san advance rental nala niya kan lessor or prepayments. Kun mas guti an selling price compared sa fair value, the difference will be added to the original lease liability to determine the actual rights retained. Rights retained = Lease liability plus Prepayment From the compound journal entry, the accounts that are related to the SALE TRANSACTION are cash, building, and gain on sale and leaseback. For cash, there is no accounting issue for this because it is just the amount received in exchange of the asset (simply the selling price). For building (or the underlying asset), there is no accounting issue for this because it is just the carrying amount of the asset on our books. For gain on sale and leaseback, there will be a small complexity on this. Supposed to be, gain (in general) would represent the difference of cash received and carrying amount of the asset. However, tungod nga kita an previous owner san asset na aton liwat gin-rerentahan yana, mayda na concept san “rights transferred”, and an gain na igre-recognize is limited only up to that amount. 𝐺𝑎𝑖𝑛 𝑜𝑛 𝑠𝑎𝑙𝑒 & 𝑙𝑒𝑎𝑠𝑒𝑏𝑎𝑐𝑘 = 𝑇𝑜𝑡𝑎𝑙 𝐺𝑎𝑖𝑛/𝐿𝑜𝑠𝑠 𝑜𝑛 𝑠𝑎𝑙𝑒 ×
Total gain/loss on sale is determined by subtracting the carrying amount from the fair value of the asset. Supposed to be, that would be the amount to be recorded if the sale transaction is separate. However, because there is an immediate lease, the gain to be recognized is not at that full amount, instead, only up to the extent of the rights transferred over the fair value of the asset
To summarize the accounting for seller-lessee, you may refer to this table: SP = FV SP > FV SP < FV Initial Lease Liability Lease Payment X PV Factor SP less FV -- Additional Financing Prepayment Rights Retained = Lease Liability = LL less AF = LL plus PRP ROU-A CA X (Rights Retained ÷ FV of Asset) Gain or Loss on Rights Transferred Step 1: Total G/L = FV less CV Step 2: Rights Transferred = FV less RR Step 3: Gain to be recognized = Total G/L X (RT ÷ FV of Asset) APPLICATION Problem 1: SP=FV At the beginning of the current year, ABC. Co. sold a machine with remaining useful life of 5 years and immediately leased it back for 2 years at the prevailing market rental. The following information is provided: Selling price of the machine 3,000, Fair value of the machine 3,000, Carrying amount of the machine 2,250, Present value of rentals 1,268,
- At what amount shall the lease liability be initially measured in the books of seller-lessee?
- At what amount shall the right-of-use asset be initially measured in the books of seller- lessee?
- How much gain should be recognized in the books of the seller-lessee?
- Prepare the journal entries in the books of the seller-lessee. Answers:
- Lease Liability = present value of rentals = 1,268,
- Right-of-use asset = 951, 𝑅𝑂𝑈 − 𝐴 = 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑡ℎ𝑒 𝐴𝑠𝑠𝑒𝑡 ×
(Since SP=FV, there will be no adjustment to the lease liability in determining rights retained) 𝑅𝑂𝑈 − 𝐴 = 2,250,000 ×
- Gain on sale and leaseback = 433, 𝐺𝑎𝑖𝑛 𝑜𝑛 𝑠𝑎𝑙𝑒 & 𝑙𝑒𝑎𝑠𝑒𝑏𝑎𝑐𝑘 = 𝑇𝑜𝑡𝑎𝑙 𝐺𝑎𝑖𝑛/𝐿𝑜𝑠𝑠 𝑜𝑛 𝑠𝑎𝑙𝑒 × 𝑅𝑖𝑔ℎ𝑡𝑠 𝑇𝑟𝑎𝑛𝑠𝑓𝑒𝑟𝑟𝑒𝑑 𝐹𝑎𝑖𝑟 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡ℎ𝑒 𝐴𝑠𝑠𝑒𝑡 OR 𝐺𝑎𝑖𝑛 𝑜𝑛 𝑠𝑎𝑙𝑒 & 𝑙𝑒𝑎𝑠𝑒𝑏𝑎𝑐𝑘 = (𝐹𝑉 − 𝐶𝐴) × 𝐹𝑉 − 𝑅𝑅 𝐹𝑎𝑖𝑟 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡ℎ𝑒 𝐴𝑠𝑠𝑒𝑡 𝐺𝑎𝑖𝑛 𝑜𝑛 𝑠𝑎𝑙𝑒 𝑎𝑛𝑑 𝑙𝑒𝑎𝑠𝑒𝑏𝑎𝑐𝑘 = ( 3 𝑀 − 2.25𝑀) × 3 𝑀 − 1.268𝑀 3 𝑀 = 750𝐾 × 1.732𝑀 3 𝑀 = 433,
- Cash 3,000, Right-of-use asset 951, Machine 2,250, Lease liability 1,268, Gain on sale and leaseback 433, Cash (selling price of the machine) Right-of-use asset (represents the portion of rights retained on the asset) Building (carrying amount of the machine) Lease liability (present value of rentals) Gain on sale and leaseback (represents the gain on sale but only a portion of the actual rights transferred)
