Sale and Leaseback Transactions

The FASB’s lead Project Manager introduced the key topics described in the agenda paper:

1. Determination whether a sale has occurred
2. Accounting for the sale/purchase
3. Accounting for the leaseback
4. Accounting for “off market” terms
5. Accounting for “failed” sales and leaseback transactions
6. Accounting for sale and leaseback transactions during transition

Determination of whether a sale has occurred

The Staff recommended that the Boards reconfirm that in order for a sale to occur in the context of a sale and leaseback transaction, the sale must meet the requirements for a sale under the new revenue recognition standard.

The Staff was divided on whether or not to include additional application guidance as well as on the recognition of gains or losses on the sale and leaseback transactions (full vs partial recognition).

The Staff proposes that any off market adjustment should be based on the difference between the sale price and the fair value of the underlying asset or the difference between the present value of the contractual lease payments and the present value of fair market value lease payments, whichever provides more readily determinable evidence.

A “failed” sale-leaseback transaction should be accounted for as a financing transaction by both parties to the transaction.

The Project Manager opened the discussion for the first two questions on determining whether or not a sale has occurred and whether or not to include additional application guidance.

There was extensive debate particularly by FASB members in relation to options and whether the existence of options to repurchase at fair value could prevent sale accounting. One FASB member asked the Staff if an option to buy back an asset at the prevailing fair value upon exercise of the option would be considered substantive. The Project Manager confirmed that this would be the case. The FASB member then followed up with an example to demonstrate that a decision taken in the revenue recognition standard might have been wrong. The facts under the example he presented were as follows:

• Fixed asset (building) with a remaining life of 40 years
• book value $500k
• sale price $1mn
• leaseback 10 years
• lease payments $42k p.a.

He indicated that, in accordance with the revenue standard, the entries would be to debit cash or receivable and credit a financing liability of $1mn. Assuming that the incremental borrowing rate was 7%, at the end of year 1 there would be an interest expense (debit) of $70k, credit cash $42k and the difference constituting a credit to liability. The liability would continue to grow up to over $1.3mn. He was asking Staff who he would have that liability to at the end of the ten year period. He wanted the Staff to explain why this accounting was believed to be appropriate. The Project Manager responded that in this instance there was no difference to the revenue recognition standard; the notion of a financial liability would arise because cash received of $1mn, but at that time there was an uncompleted sale. The FASB member indicated that he did not understand why a sale should not have occurred in the example presented. The FASB Chairman responded that there was no sale recognition because it would be similar to a “failed” sale. The FASB Vice-Chairman indicated that it was a financing arrangement because an entity was borrowing and using the asset as collateral. The Project Manager agreed with this assessment.

Another FASB member expressed concern for using revenue recognition guidance for leasing even though the revenue recognition standard clearly excludes leasing from its scope. He further indicated that in some cases an option was for a portion of the asset which had not been considered in the revenue standard. These issues should be dealt with in the leasing standard and not referred to the revenue standard. In a leaseback an entity would receive a different set of rights and they have to analyse whether there was a full gain or a partial gain.

Some FASB members considered it necessary to have application guidance in order to provide clarity and to deal with those particular cases for leasing that could not be dealt with through the revenue standard, even though some Staff members thought that there could be unintended consequences. These members believed they would be able to address this, for example by specifying that the application guidance was specific to sale and leasebacks.

Some FASB members then discussed the effect on whether control has passed of an option to repurchase at the then prevailing fair value (this was compared to being similar to a right of first refusal and the FASB members questioned whether it really was substantive) and a forward to repurchase at prevailing fair value (where there is an obligation to repurchase but the buyer/lessor is at risk of value changes). Those FASB members believed that the revenue guidance was not sufficient and that therefore additional application guidance would be need in the leasing standard.

The Project Manager explained that a sale and leaseback scenario should not be different to a situation where an entity sold to a customer and then purchased something from the same customer (i.e. being a seller and a purchaser with the same counterparty). He believed there was no reason for not using the revenue standard.

In contrast, most IASB members agreed with the Staff recommendation to refer to the revenue standard. One Board member indicated that these transactions (sale and leaseback) were usually negotiated together and that it was necessary to apply contract combination guidance, which was already included in the revenue standard. In general, IASB members disagreed with the comments raised by FASB members as regards adding additional application guidance. One IASB member said that it would not be appropriate to have revenue recognition guidance in another standard; if there was something wrong with the revenue standard, the guidance should be added in IFRS 15. Also, it would be awkward to reconsider whether or not a sale had occurred given the revenue standard had just been published. Several IASB members concurred with this.

One IASB member raised a concern regarding a situation when there is a put option in an environment that was deflationary: If an entity just followed IFRS 15, would that change current practice as IFRS 15 was based on a control notion? In the case of a put option, downside risk remained on the seller/lessee’s side. The IASB’s Technical Principal responded that this scenario assessed whether the buyer/lessor had a significant economic incentive to exercise the put option, and if so, that would be treated as a failed sale. If there was no significant economic incentive (for example, a put option at fair market value), then the put option would not prevent sale recognition.

Another Board member indicated that he was not sure whether a call option at fair value was substantive. If the price was fair value, then the price would be neutral when assessing whether or not there was an economic incentive to exercise the option. Another Board member responded that the existence of the option would give the holder a right to make the other party perform; for that reason, it was substantive and gave the holder of the option some control over what happens with the asset – if the option was at fair value, that would just mean there was no economic incentive, but that was about risks and rewards, whereas a sale was about transfer of control.

In response to the discussion by the FASB members, another Board member raised the question of whether a right-of-use asset under the leaseback was a portion of the asset transferred or whether it was a different asset. Once that question was answered, the revenue guidance should then be applied.

In relation to the second question, a Board member enquired whether the guidance would be general guidance or specific guidance. The Technical Principal responded that the guidance would be tailored to specific issues for sale and leaseback.

The IASB Chairman called a vote. On Question 1 of how to determine whether a sale had occurred, IASB members voted in favour of the Staff recommendations (a) (a sale would be determined based on the revenue recognition standard), (c) (if a seller had a substantive purchase option, a sale would not occur) and (d) (the presence of a leaseback did not preclude a seller from concluding that he had sold the underlying asset). Item (b) was directed to the FASB only. As regards Question 2, only two Board members were in favour of adding additional application guidance beyond the points covered in Question 1.

FASB members agreed with the Staff recommendations on the first question as regards items (a), (b) (a sale does not occur if the leaseback is a Type A lease for the seller-lessee) and (d). As regards item (c) the majority of the FASB members agreed that there was a need for deeper analysis, and Staff should conduct more research before the Board would make a decision. They also decided to hold back an answer on Question 2 on additional application guidance until they felt able to make a decision on the issue regarding purchase options.

Accounting for a sale/purchase

The FASB’s lead Project Manager introduced the questions 3 to 5 of the agenda paper. Question 3 asked whether, in the absence of “off-market” terms, the Boards prefer to account for the gain in the same manner as any other gain resulting from the sale of a nonfinancial asset (as was proposed in the 2013 ED) or to limit any gain recognised on the sale of an asset to the amount of the gain relating to the residual asset. Question 4 asked the Boards whether, if a sale occurred:

• The seller-lessee should recognise any loss on the sale in the absence of “off-market” terms in the same manner as any other loss incurred on the sale of a nonfinancial asset, and
• The buyer-lessor should account for the purchase of the underlying asset in accordance with other existing U.S. GAAP or IFRSs.

Lastly, Question 5 was asking whether the Boards agree that, if a sale/purchase was determined to have occurred, the seller-lessee and the buyer-lessor should account for the leaseback in the same manner as any other lease (that is, in accordance with the lessee and lessor guidance, respectively).

The FASB’s Vice Chairman indicated that the revenue standard did not deal with situations with partial gain scenarios. He expressed concerns that there would be structuring opportunities to recognise a gain when an entity was effectively leasing back the major part of the asset and that would lead him towards partial gain recognition, albeit that this would not sit comfortably with the revenue guidance. The Project Manager responded that the revenue recognition standard dealt with derecognition of the asset and the sales price but did not have the notion of a partial gain.

Several FASB members indicated that partial gain recognition would add complexity, and there was a conflict between the concept of transfer of control and partial gain recognition. One FASB member considered that partial gain recognition would require application guidance as it would be an interpretation that was not contemplated in the revenue standard. Another FASB member added that, to get to partial gain recognition, the ROU would have to be seen as a subset of the asset which was contrary to the decisions to date.

In contrast, most IASB members agreed with the Staff recommendation for partial gain recognition. One Board member pointed out that paragraph 47 clearly explained the rationale: The partial gain would properly reflect the economic reality of the transaction; it was a combination of two contracts that were entered into in contemplation of each other; and an entity had not sold the asset but only sold a portion that would not be used in the leaseback. Another Board member indicated that a leaseback represented a continuing involvement and partial recognition was hence appropriate. Another Board member said that, in substance, an entity had not sold the right of use (ROU) portion of the underlying asset, but transferred the residual, and it had actually obtained financing using the ROU asset as collateral. A number of IASB members also pointed out that partial gain recognition would not be inconsistent with IFRS 15 but would apply the revenue guidance to the residual transferred. However, the wording would need to be amended to refer to sale of the residual asset rather than the underlying asset.

The two Boards voted as follows: On Question 3, the two Boards ended up in opposite camps, as the IASB voted unanimously in favour of partial gain recognition whereas the FASB voted unanimously in favour of full gain recognition. On Questions 4 and 5, the Boards were fully aligned and both voted unanimously in favour of the Staff recommendations.

Accounting for “off-market” terms and failed sales

The FASB’s lead Project Manager introduced questions 6 and 7 to the Boards. Question 6 was focused at the accounting for “off-market” terms: If the sale price of the underlying asset was less than its fair value, the difference was, in effect, a prepayment of rent by the seller-lessee. If the sale price exceeded the fair value of the underlying asset, the excess would be recognised as an additional financial liability. Both parties would determine any potential “off-market” adjustment based on whichever benchmark provides more readily determinable evidence. Question 7 asked the Boards to confirm that a failed sale should be accounted for as a financing transaction.

One IASB member raised a concern that in some cases it would be difficult to determine the market price, as entities could participate in different markets. Another Board member raised the example of an airline buying 100 aircraft with a market price of 100m each, but due to the volume the airline got a 20% discount, so the net purchase price was 80m. If that airline then entered into a sale and leaseback transaction for one aircraft, what should be the fair value of the aircraft – 80m or 100m? Another IASB member responded by stating that he would expect to recognise the gain in relation to the residual transferred (e.g. if the aircraft was leased back for 80% of its life, then he would recognise a gain for the 20% transferred whereas if it was leased back for one week then the whole gain should be recognised). The Technical Principal responded that the Staff intended the starting point to be based off the 80m, and that this should not represent a significant change to current guidance in IFRSs or U.S. GAAP on off-market terms. The Technical Principal agreed to take this forward and follow up.

One FASB member said that the market price should be the most readily determinable. Another FASB member believed that some application guidance would be needed to check that both legs of the transaction are at fair value.

Both the IASB and the FASB  agreed unanimously with the Staff recommendation for Question 6.

As regards Question 7 both Boards agreed that there was a need for further clarification (in particular around purchase options at the prevailing fair value at exercise). A FASB member commented that, in a ‘failed sale’ scenario, the cash received upfront results in a CR that is a liability - and regardless of whether it was called financing or an outstanding performance obligation, interest would accrue on that liability either under the financial instruments guidance or the revenue standard. Another FASB member questioned how it could be a financing if the minimum lease payments were the only payments to be made, and they were less than the cash received on day 1. Both Boards agreed that the Staff should take another look at fair value purchase options and put any voting on hold.

Transition

The FASB’s lead Project Manager introduced the transition requirements. The Staff recommended that:

1. Entities should reassess whether there has been a sale in a sale and leaseback transaction only where the transaction was still being accounted for as a “failed sale” at the effective date (that is, those transactions previously accounted for as sales by the seller-lessee and purchases by the buyer-lessor would not be reassessed). (Question 8)
2. Any seller-lessee deferred gains or losses that resulted from “off-market” sales and leaseback terms should be recognized as an adjustment to the leaseback ROU asset (if a deferred loss) or accounted for as a remaining financial liability (if a deferred gain) at the beginning of the earliest period presented. (Question 9)
3. If the Boards decided to recognise the gain on a completed sale in a sale and leaseback transaction only to the extent of the portion related to the residual asset, the Staff proposed that entities apply this approach prospectively from the effective date of the final leases standard, but otherwise applying the sale and leaseback transition proposals as described in the paper. (Question 10)

There were no comments raised from FASB members. Several IASB members said that, in their view, transition requirements should be analysed in their entirety and not just for sale and leaseback transactions.

One IASB member said that application should be retrospective in all aspects and that they have to deal with the complexity of the standard as a whole and not just on this topic. Another Board member believed that transition guidance would be necessary for the standard as a whole and needed to consider the transition guidance for the revenue recognition standard. This Board member suggested giving relief, with an option to apply retrospectively.

Another IASB member agreed that transition should be consistent with the revenue recognition transition where reassessment was only required for open transactions. In the context of sale and leaseback transactions, only ‘failed sale’ transactions were open transactions from a revenue recognition perspective and, therefore, this Board member agreed with only reassessing transactions previously accounted for as failed sales.

When called for a vote both Boards agreed that transition should be discussed holistically as a whole package (IASB: 13 affirmative votes, FASB: unanimous).

Lessor disclosures

The IASB’s Practice Fellow introduced the agenda paper which outlines the disclosure requirements for lessors:

1. A lessor should disclose information about the nature of its leases, as well as information about significant assumptions and judgements made in applying the leases requirements in substantially the same manner as was proposed in the 2013 ED;
2. A lessor should disclose a table of lease income recognised in the reporting period;
3. A lessor should disclose information about how it managed its risk associated with the residual value of its leased assets;
4. A lessor should provide the property, plant and equipment disclosures required by IAS 16 Property, Plant and Equipment for assets under Type B leases;
5. A lessor should disclose a maturity analysis of the undiscounted cash flows that comprise the lessor’s lease receivable (for Type A leases) and a maturity analysis of the undiscounted lease payments to be received for Type B leases, separately from each other, for each of the first five years following the reporting date and a total of the amounts for the remaining years thereafter. For Type A leases only, a lessor should reconcile the undiscounted future cash flows that comprise the lessor’s lease receivables to the lease receivables recognised on the balance sheet;
6. For Type A leases a lessor should provide an explanation of the significant changes in the balance of its net investment in leases during the reporting period.

Several IASB members indicated agreement with the Staff recommendation. One Board member believed it should be pointed out that these requirements already existed in IAS 1 (significant assumptions and judgements) and IAS 17. Another Board member said that it would be important for disclosure requirements not to be boiler-plate type in nature as this would not provide valuable information. He further asked why the Staff was not requiring disclosure of the risks associated with the residual value. The IASB’s Technical Principal commented on concerns about requiring disclosures of estimated residual values, but maybe they could encourage it.

Another Board member stated that there was no requirement to disclose the length of the lease term as compared to the asset’s life, unless this was seen as included in the ‘general description’, but he thought it should be more prescriptive.

One Board member did not agree with the Staff recommendation because they were not changing lessor accounting, however, they would be adding more disclosures. Another Board member said that they should be analysing what was really missing in IAS 17, which was residual value disclosure.

No significant comments were raised by FASB members. One FASB member questioned whether there would be redundant information considering what public entities already disclosed in their MD&A. Another FASB member questioned the need for the disclosures for entities that were incidental lessors or where being a lessor was not significant part of the entity’s activity. That Board member also agreed with the previous comments made on the need for more robust residual value disclosures for entities with significant lessor activities.

When called to vote, both Boards approved items (i) to (iii) above (both unanimous).

On item (iv) above there were no substantial comments raised by FASB or IASB members. A FASB member questioned whether information for short term leases would be disclosed separately from leases on longer terms. The project manager stated that separate disclosure was not envisaged. Both Boards approved the Staff recommendation (IASB: 12 affirmative votes, FASB: unanimous).

On item (v) some IASB members expressed concern as to why lease receivables would be treated differently from any other financial receivables. They believed that the disclosures should be aligned with IFRS 7. The project manager responded that these disclosure requirements existed today and were useful for investors and the staff did not see any reason for removing it.

One FASB member indicated that maturity information would give insight about the discount rate, so that users could evaluate the entity’s business. Another FASB member asked whether the discount rate should be considered a significant assumption and be required to be disclosed. Several FASB members questioned why there were requirements to disclose in detail the first five years and then there was a lump sum; in some cases it would be appropriate to provide more long-term information in detail. One FASB member also reiterated the earlier point that he did not see the need for giving disclosures for Type A leases that go beyond those required for financial receivables.

When called to vote both Boards approved the Staff recommendation (though the IASB counted only eight affirmative votes; FASB: five in favour).

The Boards discussed item (vi) which recommended to eliminate the lease receivables and residual assets reconciliation proposed in the 2013 ED, and to instead require a lessor to provide an explanation of the significant changes in its net investment in leases during the reporting period.

One IASB member agreed with not having a full reconciliation, but proposed making clear that the ‘explanation’ of significant changes should include quantitative information. This Board member proposed an approach similar to the impairment considerations, where they had discussed not having a full reconciliation, but to disclose key figures.

There was an extensive debate between FASB members, and many indicated that they should hold the decision until they finish their impairment project. One FASB member summarised that this would not be required for Type A leases, but that Type A lease would be within the scope of the impairment project. There did not need to be any incremental disclosure beyond those that would be required under the impairment requirements. Another FASB member commented that the information regarding residual values should be provided.

The project manager explained that the proposal was to require a quantitative and qualitative explanation (similar to MD&A type information) of what caused the movement in the net investment balance from one day to another. This did not override any disclosures that would be required for financial instruments under the impairment project.

When called to a vote, the IASB members agreed with the Staff recommendation with a clarification that the requirement would include qualitative and quantitative data.

The FASB voted to put their decision for requiring a roll-forward of a lease receivable on hold until they finished the impairment project. They agreed on requiring qualitative and quantitative data though.