890 SECTION 3 Financial Instruments and Liabilities Since the lease term is equal to the expected useful life of the warehouses (>75%), the leaseback must be recorded by the lessee as a capital lease. 30 There typically is interdependency between the lease terms and the price at which the asset is sold. We view the sale and the leaseback as a single transaction. Look closely at the 2017 entries to see the net effect of recording the sale-leaseback this way. Amortizing the deferred gain over the lease term as a reduction of depreciation expense decreases depreciation each year to $60,000. 31 Interest expense is $76,685. If Teledyne had not sold the warehouses ($600,000 book value) and had borrowed $900,000 cash by issuing an installment note, the 2017 effect would have been virtually identical: December 31, 2017 Interest expense 10% 3 ($900,000 2 133,155) ............................... 76,685 Note payable (difference) ................................................................ 56,470 Cash (installment payment) .......................................................... 133,155 Depreciation expense ($600,000 ÷ 10 years) ................................... 60,000 Accumulated depreciation ......................................................... 60,000 The deferred gain is reported in the balance sheet as a valuation (contra) account, offsetting the leased asset. The 2017 balance sheet effect of the sale-leaseback transaction and a $900,000 installment note are compared in Illustration 15–22 . Once again, the effect is virtually identical. Sale- December 31, 2017 Deferred gain on sale-leaseback ($300,000 ÷ 10 years) ................... 30,000 Rent expense .............................................................................. 30,000 Those of you with a healthy sense of skepticism will question whether the leaseback portion of our sale-leaseback situation could qualify as an operating lease. After all, the 10-year lease term is equal to the 10-year remaining useful life. But when you remember that neither the third (75% of economic life) nor the fourth (90% recovery of fair value) capital lease classification 30 The fourth criterion also is met. The present value of lease payments ($900,000) is 100% (> 90%) of the fair value of the warehouses ($900,000). Meeting any one of the four criteria is sufficient. 31 If depreciation is over the useful life of the leased asset rather than the lease term because ownership is expected to transfer to the lessee, amortization of the deferred gain also would be over the useful life. If a leaseback of land is a capital lease, the amortization of the deferred gain is recorded as revenue. Leaseback Retain Asset; Borrow Cash Assets Leased asset $900,000 $950,000 Less: Accumulated depreciation (90,000) (410,000) Less: Deferred gain ($300,000 2 30,000) (270,000) $540,000 $540,000 Liabilities Lease payable ($900,000 2 133,155 2 56,470) $710,375 Note payable ($900,000 2 133,155 2 56,470) $710,375 Illustration 15–22 Comparison of a Sale-Leaseback and a Purchase Accounting by the buyer/lessor is no different in a sale-leaseback transaction than another lease transaction. That is, it records a lease in accordance with the usual lease guidelines. Operating Leases If the leaseback portion of the previous sale-leaseback transaction were classified as an operating lease, the gain still would be deferred but would be recognized as a reduction of rent expense rather than depreciation. There is no leased asset to depreciate. 32 32 The deferred gain would be reported as a liability since it could not be offset against a leased asset. Depreciating the book value of the warehouses over their remaining useful life produces depreciation equal to the net depreciation recorded in a sale-leaseback.
Spiceland_Inter_Accounting8e_Ch15
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