Hi guys
Got an accounting question as I am trying to get my head around sales-lease accounting mechanics and the flow through 3FS:
Assuming:
- FV of $20m
- 10 years lease
- Lease interest 5%
- Lease payment / year 1.8m
- BV 15m
- D&A assuming 0.5m
- PV lease liability @ 5% (via NPV formula) = 13.9m = lease liability
First question, I see two different approaches calculating RoU assets i) assuming same amount as lease liability (13.9m), or ii) calculating as PV/FV x BV ($10.4m). From a practical perspective, which methodology be used?
Instantly:
IS
- Gain on sales (20-15m) = 5m -> for now I assume RoU = lease liability
- Tax = assuming 0
- NI = 5.0m
CF
- NI = 5.0m
- Gain on sales= -5m
- Cash inflow =20m
- C&c equiv. = 20m
BS
- Cash = 20m
- PPE = (15m)
- RoU = 13.9m
- Total asset= 18.9m
///
- Lease = 13.9m
- NI= 5.0m
- Total lease = 18.9m
Year end
IS
- Interest = -0.7m (based on 5%)
- D&A = -0.5m
- NI = -1.2m
CF
- NI = -1.2m
- D&A = +0.5m
- Lease = -1.8m
- C&c equiv = -2.5m
BS
- Cash = -2.5m
- RoU = 13.4 (13.9 – 0.5m D&A)
- Total asset= 10.9m
///
- Lease = 12.1 (- 1.8m lease principal)
- NI= -1.2m
- Total lease = 10.9m
Many thanks monkeys!
ROU asset is calculated taking the NPV of contractural rental obligations, discounted back at a secured rate equivalent to where the company can borrow on a coterminous basis. If a 10Y lease, where could they hypothetically borrow on a 10Y basis, etc. Not a science but needs to be defensible. This is how auditors and ratings agencies will account for the ROU.
What is the cap rate? Not following your FV vs. BV vs. PV. The sale price = year 1 rent / cap rate and that is what determines your gain.
you shouldn’t assume $0 tax liability. In this scenario if they have a $5 million gain they’re going to pay taxes on that gain
Sorry phone keeps posting before I can finish typing.
Is this an operating lease or a capital lease? You don’t have interest expense on a lease. And you can’t recognize D&A for an asset you don’t own. Rent expense is what flows through the IS.
If it’s SLB, it’s a capital (sales-type) lease by definition. Using a cap rate to determine the value of a lease is a financial calculation, not an accounting one (non-GAAP or IFRS-16).
This is not true. A sale/leaseback can be recognized by the lessee as an operating lease or a capital lease depending on whether it passes the 90% test, among other metrics (does it have a repurchase option, is there ongoing involvement that constitutes quasi-ownership, etc.).
A Capital lease is a designation for lessee recognition; a sales-type lease for lessor for recognition.
A cap rate is a valuation metric, yes, but it determines sale price and rent which impact gain recognition and income statement impact.
source: I structured sale/leasebacks in a prior life.
The above is correct, need to see if it qualifies as a sales leaseback in the first place...see below URL for a full walkthrough.
https://www.journalofaccountancy.com/issues/2020/jul/accounting-for-sal…
To the original poster, I think your answer is close but the interest component is non-cash and would presumably be baked into the $1.8mm lease payment. You'd have to use effective interest rate method so numbers may differ but using your stated assumptions above:
Your initial assumptions and YE I/S assumptions are right but when it comes to YE CF I would say you need to add back both the D&A and Implied Interest so its a wash and the cash outflow is the lease payment. As such, cash is down $1.8mm and, assuming the $13.4mm RoU asset and a net position of $11.6mm on the asset side, it would would be balanced on the liability/equity side as the lease would only be down by $1.1mm ($1.8mm payment but the liability increases by the implied interest so offset by $0.7) to $12.8mm with the net loss of $1.2mm balancing it out to $11.6mm.
I may be making it too complicated but that's what jumps to mind.
If it’s qualified as an operating lease, then it wouldn’t be a SLB for accounting purposes; it’d be known as a “failed-sale”
Meant to respond to the comment above yours***
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