Lessors and Discontinued Operations Subsequently Retained

Journal of Accountancy, November 1991 | Go to article overview

Lessors and Discontinued Operations Subsequently Retained


This month's column discusses recent consensuses reached by the Financial Accounting Standards Board emerging issues task force (EITF) concerning consolidation of special-purpose entity lessors by lessees and the accounting for discontinued operations of a business segment subsequently retained.

EITF Abstracts, copyrighted by the FASB, is available in soft-cover and loose-leaf versions and may be obtained by contacting the FASB order department at 401 Merritt 7, P.O. Box 5116, Norwalk, Connecticut 06856-5116. Phone: (203) 847-0700.

ISSUE NO. 90-15

This issue, Impact of Nonsubstantive Lessors, Residual Value Guarantees, and Other Provisions in Leasing Transactions, considers whether a lessee should consolidate a special-purpose entity (SPE) lessor in a transaction structured to be an operating lease.

An SPE is established to engage in certain types of transactions (for example, leasing) on behalf of a sponsor (lessee). Although the sponsor is not related to the SPE through ownership, the sponsor often has virtually all the risks and rewards of the SPE-held assets. For example, a lessee may bear the entire risk of loss and liability from operation of the SPE's property. The SPE often is thinly capitalized, whereby majority equity owners make only a nominal capital investment. An SPE lessor's activities often include these real or personal property leasing transactions:

* Sale-leasebacks: the sale of property by the owner and a lease of the property back to the seller.

* Build-to-order leases: property constructed by the lessor according to the lessee's specifications.

* Buy-lease: the lessor's purchase from a third party of an existing asset meeting a lessee's specifications.

In a typical arrangement, a company (lessee) enters into a lease transaction and classifies it as an operating lease based on a literal reading of FASB Statement no. 13, Accounting for Leases, as amended. However, certain characteristics of that transaction raise questions about whether operating lease treatment (as opposed to a financing or consolidation) is appropriate. These characteristics include.

* The lessee's residual value guarantees.

* The lessee's participation in both risks and rewards associated with ownership of the leased property.

* Purchase options available to the lessee.

* An SPE lessor lacking economic substance.

* Property constructed to the lessee's specifications.

* Lease payments adjusted for final construction costs.

Accounting issue. Should a lease with these characteristics be accounted for as an operating lease?

Background. The Securities and Exchange Commission expressed concern over some leases that were recorded as operating leases but were in substance a financing of the leased asset. According to the SEC, accounting for these transactions as operating leases could be misleading to users of financial statements because the risks and rewards of ownership assumed by the lessee are not acknowledged under this accounting method. The SEC staff considered certain factors to determine whether these lease trasactions are, in substance, financings: construction risk; the special-purpose nature of the property; the use of a thinly capitalized SPE; and transfer of substantially all risks and rewards of ownership to the lessee.

Arguments. Accounting alternatives proposed included.

* Sale-leaseback accounting.

* Consolidating SPE lessors with the related lessee.

Some believe the lessee should account for these transactions as a sale-leaseback under FASB Statement no. 98, Accounting for Leases: Sale-Leaseback Transactions Involving Real Estate. Certain risks (for example, the rist of loss), assumed by the lessee before the beginning of the lease term may be similar to the risks of direct ownership of the property before a sale-leaseback. …

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