Sale-leaseback agreements can be interesting business trying to find a liquidity boost or a strategy to manage their debt ratio.

However, for accountants, they can likewise be complex to evaluate and identify whether a sale has occurred.

So how exactly does sale-leaseback accounting work?

This post covers everything you need to understand about these transactions, consisting of the significance of sale-leaseback, advantages and disadvantages, and accounting examples.

What is a sale-leaseback?

A sale-leaseback (a.k.a. sale and leaseback) transaction takes place when the owner of an asset sells it, then leases it back through a long-term lease. The initial owner becomes the seller-lessee, and the purchaser of the property ends up being the buyer-lessor.

While this deal does not affect the functional use of the property by the seller-lessee, it does have various accounting results for both celebrations. The seller-lessee can continue utilizing the asset, however legal ownership is transferred to the buyer-lessor.

Discover more about the duties of lessors and lessees.

What is the function of a sale-leaseback?

The most common factors to go into a sale-leaseback arrangement are to raise capital, improve the balance sheet, or acquire tax advantages. The seller-lessee is generally seeking to free the cash kept in the value of a residential or commercial property or property for other functions however does not wish to compromise their capability to use the property.

Purchasers who get in into these contracts are usually institutional financiers, leasing companies, or financing companies pursuing an offer that has a secure return as the buyer-lessor.

Sale-leasebacks are typically seen in markets with high-cost set properties, such as construction, transportation, real estate, and aerospace.

How does a sale-leaseback work?

In a sale-leaseback arrangement, ownership is transferred to the buyer-lessor, while the seller-lessee continues to use the possession. For instance:

- An energy company can sell the possessions that comprise their solar-power system to a funding company, then immediately rent it back to function and satisfy the need of customers.

• Construction business can offer their realty residential or commercial properties and after that quickly rent them back from the buyer to develop them.
  - Aviation business frequently offer their aircraft to an air travel funding organization and instantly lease them back without any time out in their regular routine.
  
• Realty companies typically have sale-leaseback programs that provide house owners more flexibility than a standard home sale. Equity in the home can rapidly be converted into cash by the seller-lessee, and mortgage brokers gain access to a broader consumer base as the buyer-lessor. These transactions are likewise referred to as “sell and stay” plans.
  Advantages and disadvantages of sale-leasebacks
  
  Sale-leaseback transactions have the versatility to be structured in various manner ins which can benefit both parties. Naturally, there are likewise risks associated with this kind of arrangement that both parties must assess, in addition to company and tax implications.
  
  Mutual understanding of the benefits and drawbacks is an essential aspect when specifying the contract. Let’s take an appearance at the pros and cons for each celebration.
  
  Pros for the seller-lessee:
  
  - They get the alternative to expand their business or buy brand-new equipment with the increase of money while preserving day-to-day access to the property.
  
• It’s a cheaper method to get funds compared to loan funding, therefore enhancing the balance sheet.
  
• They can invest money in other places for a higher return, therefore enhancing the revenue and loss statement (P&L).
  
• Sale-leaseback permits the complete deductibility of lease payments with the transfer of tax ownership to the buyer-lessor.
  
• There’s limited danger due to property volatility.
  Cons for the seller-lessee:
  
  - The owned asset is gotten rid of from the balance sheet.
  
• The right of usage (ROU) asset increases, depending upon the lease term and agreed-upon lease payments surpassing fair-market worth.
  
• They must acknowledge capital gains.
  Pros for the buyer-lessor:
  
  - Rental earnings over the life of the lease reinforces their financial position.
  
• They can guarantee that lease terms are crafted to fit their requirements.
  
• They have more control over roi (ROI) based upon the conditions described in the contract.
  
• They can repossess the property if the seller-lessee defaults on payments.
  Cons to the buyer-lessor:
  
  - They need to renegotiate contracts if the seller-lessee defaults on lease payments.
  
• They’re the main creditor/owner if the seller-lessee apply for personal bankruptcy.
  
• There’s a risk that the property value might reduce faster than the projected market and end up being impaired.
  How to identify if a deal certifies as a sale-leaseback
  
  To qualify as a sale-leaseback, a deal should meet several criteria. When evaluating the agreement under ASC 842, entities should use ASC 606 (revenue from contracts with clients) to identify whether the sale of an asset has taken place. There is a substantial quantity of judgement that goes into this procedure, and it is great practice to have an auditor evaluation the information and complexities of the offer.
  
  Let’s go over the process step by action.
  
  1. Determine if there’s an agreement
  
  First, you must identify if there is a contract as described in ASC 606-12-25-1 through 8.
  
  Essentially, any agreement that creates legally enforceable rights and responsibilities usually satisfies the definition of a contract. Contracts can be oral, written, or implied by an entity’s customary service practices.
  
  2. Asses if there’s a sale
  
  Assess from an accounting perspective if there is a sale or a funding agreement.
  
  The primary concern is if control has transferred from the seller to the buyer, for that reason satisfying the performance obligation. If the answer is yes, then a sale has actually happened. Otherwise, the unsuccessful sale is dealt with as a financing arrangement.
  
  ASC 842 recommendations ASC 606-10-25-30 for a list of indications showing that control has been moved to the . The five control indications are:
  
  1. The reporting entity has a present right to payment