Sale-Leaseback Costs and Gain on Exchange of Assets

Article excerpt

ISSUE NO. 89-16

The EITF was asked to address how to consider executory costs in calculating the profit to be deferred in a sale-leaseback transaction.

A sale-leaseback transaction is a common financing tool that's been around for over two decades. It's been used primarily to infuse badly needed cash into a company and to reduce debt.

In a typical transaction, a company sells, then leases back all or part of its property such as its office building, warehouse or equipment. This perhaps allows it to uncover value hidden in the real estate itself or to increase earnings if monthly lease payments are less than financing costs. In many cases. the company's debt-to-equity ratio is improved.

Why is this issue so important? Most lease transactions provide for the payment by one of the parties of executory costs such as insurance, maintenance and taxes in connection with the leased property. In many cases, such costs aren't significant relative to the total cost of the lease and won't be material in the accounting. However, in a long-term lease of real estate, the FASB staff determined the executory costs could be as high as 30% of the lease's cost. Thus, the accounting for such costs could be a significant issue.

Relevant literature. FASB Statements nos. 13, Accounting for Leases, and 28, Accounting for Sales with Leasebacks, generally require any profit or loss in a sale-lease-back transaction to be deferred.

Statement no. 13 specifically excludes executor costs from the definition of minimum lease payments when determining how to classify a lease (that is, whether the lease should be recorded as a capital lease or as an operating lease). Accordingly, executory costs are excluded from the operating lease amount or the capital lease amount.

Statement no. 28, which amended Statement no. 13 for sale-leaseback accounting, does not address executory costs specifically. Regarding deferral of profit, Statement no. 28 says, for an operating lease, profit may be deferred up to the present value of the minimum lease payments. For a capital lease, profit may be deferred up to the recorded lease amount.

What are the alternatives? The EITF considered three approaches for how executory costs could affect the amount of profit to be recognized or deferred in a sale-leaseback deal.

Under the first approach, executory costs would be excluded in all cases. The second approach would include executory costs if they are included in minimum lease payments under Statement no. 13. The third approach includes executory costs in all circumstances.

Supporters of the first approach point to Statement no. 13, which specifically excludes such costs from minimum lease payments in recording a capital lease, and Statement no. …