CHAPTER 15 Leases 889 2. The seller-lessee pays periodic rent payments to the buyer-lessor to retain the use of the asset. What motivates this kind of arrangement? The two most common reasons are: (1) If the asset had been financed originally with debt and interest rates have fallen, the sale-leaseback transaction can be used to effectively refinance at a lower rate. (2) The most likely motivation for a sale-leaseback transaction is to generate cash. Capital Leases Illustration 15–21 demonstrates a sale-leaseback involving a capital lease for warehouses. The sale and simultaneous leaseback of the warehouses should be viewed as a single borrowing transaction. Although there appear to be two separate transactions, look closer at the substance of the agreement. Teledyne still retains the use of the warehouses that it had prior to the sale and leaseback. What is different? Teledyne has $900,000 cash and a noncancelable obligation to make annual payments of $133,155. In substance, Teledyne simply has borrowed $900,000 to be repaid over 10 years along with 10% interest. From the perspective of substance over form, we do not immediately recognize the $300,000 gain on the sale of the warehouses but defer the gain to be recognized over the term of the lease (or the useful life of the asset if title is expected to transfer outright or by the exercise of a BPO). Recording a saleleaseback transaction follows the basic accounting concept of substance over form. The gain on saleleaseback is deferred and recognized over the lease term as a reduction of depreciation expense. Teledyne Distribution Center was in need of cash. Its solution: sell its four warehouses for $900,000, and then lease back the warehouses to obtain their continued use. The warehouses had a carrying value on Teledyne’s books of $600,000 (original cost $950,000). Other information: 1. The sale date is December 31, 2016. 2. The noncancelable lease term is 10 years and requires annual payments of $133,155 beginning December 31, 2016. The estimated remaining useful life of the warehouses is 10 years. 3. The annual rental payments (present value $900,000) provides the lessor with a 10% rate of return on the financing arrangement. * Teledyne’s incremental borrowing rate is 10%. 4. Teledyne depreciates its warehouses on a straight-line basis. December 31, 2016 Cash ......................................................................................... 900,000 Accumulated depreciation ($950,000 2 600,000) .................... 350,000 Warehouses (cost) ............................................................... 950,000 Deferred gain on sale-leaseback (difference) ...................... 300,000 Leased warehouses (present value of lease payments) ............. 900,000 Lease payable (present value of lease payments) ................. 900,000 Lease payable .......................................................................... 133,155 Cash .................................................................................... 133,155 December 31, 2017 Interest expense 10% 3 ($900,000 2 133,155) ....................... 76,685 Lease payable (difference) ....................................................... 56,470 Cash (rental payment) .......................................................... 133,155 Depreciation expense ($900,000 ÷ 10 years) ........................... 90,000 Accumulated depreciation ................................................. 90,000 Deferred gain on sale-leaseback ($300,000 ÷ 10 years) .......... 30,000 Depreciation expense ........................................................ 30,000 *$133,155 3 6.75902 5 $900,000 ($899,997.31 rounded) Re nt payments (fr om T ab le 6 ) n 5 10, i 5 10% P vrea slue en t Illustration 15–21 Sale-Leaseback
Spiceland_Inter_Accounting8e_Ch15
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