Leases: Lessor Perspective–Recording the Lease, written by Joseph P. Sebik, C.P.A. and Lisa Marie Starczewski, Esq., explains, analyzes and illustrates the recording of leases from the lessor's perspective. This Portfolio also discusses the disclosure requirements relevant to leases.

This Portfolio explains and illustrates in detail how a lessor should record a sales-type lease, a direct financing lease, an operating lease and a leveraged lease.

In addition, this Portfolio discusses

• the effect of FAS 166 and its related issues
• criteria for classifying sales-type leases
• recording and accounting for operating leases
• accounting for floating rate leases
• sales or participations of lease receivables
• limitations on finance income recognition for lease receivables sold
• and much more!

Leases: Lessor Perspective–Recording the Lease allows you to benefit from:

• Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area.
• Invaluable practice documents including tables, charts and lists.
• Guidance from world-class experts.
• Real-world and in-depth analysis that lets you explore various options.
• Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more.
• Alternative approaches to both common and unique tax scenarios.

This Portfolio is included in the Accounting Policy & Practice Series, a comprehensive series of titles which explain, explicate, and offer commentary on a wide range of accounting and financial management topics, including revenue recognition, income taxes, leasing, business combinations, debt instruments, risk management, internal controls and more.

Background Information:

In June 2009, the FASB issued Financial Accounting Statement No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140. This new statement is effective for transfers of financial assets entered into Jan. 1, 2010 for calendar year companies.

The new standard on derecognition of financial assets restricts when an entity may transfer a portion of a financial asset and account for the transferred portion as being sold.
Existing guidance permits transferors to report transfers of portions or components of financial assets as sales while transferring those portions at rates that are different than the rate in the underlying lease.

Under the new standard, a transfer of a portion of a financial asset may be reported as a sale only when three additional conditions are met, namely (1) when the transferred portion is a pro-rata portion of an entire financial asset, (2) when no portion is subordinate to another, and (3) when other restrictive criteria are met.

Previously under FAS 140, a portion of a financial asset could be transferred or sold separately by sale of a participating interest and the rate of interest payable on that portion sold could be different from the rate of the underlying lease, thus enabling the seller to enhance their yield on the remaining portion owned by them. For instance, if a direct financing lease provided the lessor with an implicit interest rate of 10%, but a portion of the lease receivable could be sold to a third party investor for an 8% yield, the selling lessor could retain the 2% difference and thus enhance their yield further on the 10% base yield in the lease. Under FAS 166, this structure of sale would prevent the lease receivable from being derecognized from the seller's balance sheet and the proceeds of the sale would be treated as debt.

This restriction appears to eliminate the possibility of enhancing the yield on retained interests in leases by selling off portions of the rent cash flows at lower rates.

Additionally, since it is anticipated that lessor leveraged lease accounting will be eliminated when the new lease accounting rules are issued and implemented in the 2011-2012 time frame, and selling lease receivables was considered a possible means to accomplish the derecognition as a substitute for leveraged lease treatment offsetting of non-recourse debt against the lease receivables, this type of restriction for derecognizing the sale of a lease receivables will further affect the capital markets commonly used by larger structured leases.

Lessors should carefully follow the development and implementation of FAS 166 to determine whether any means develop to derecognize portions of lease receivables as a means of enhancing existing yields on leases.

Detailed Analysis

I. Introduction and Scope of Portfolio

A. Effect of FAS No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140

B. Other Issues

II. Recording a Sales-Type Lease

A. Criteria for Classification as a Sales-Type Lease

B. Accounting for the Financing Portion

C. Accounting for the Sales Portion

D. Entry to Record the Sales-Type Lease

E. Accounting for Future Executory Costs Included in the Lease Payments

F. Captive Leasing Companies and Sales-Type Leases

G. Classification of a Renewal or Extension of an Existing Lease as a Sales-Type Lease

H. Effect of Investment Tax Credit on a Sales-Type Lease

1. Background

2. Discussion

I. Lease Renewals or Extensions Resulting From Equipment Upgrades During the Lease Term

J. Effect of Fair Value Subjectivity on Certain Sales-Type Leases

K. Sales-Type Lease With a Bargain Purchase Option

L. Determining How to Record a Lease When Multiple Lease Options Exist

III. Recording a Direct-Finance Lease

A. Background

B. Initial Direct Costs

C. Treatment of Syndication or Underwriting Fees When a Portion of a Direct-Finance Lease Is Retained

IV. Issues Applicable to Both Sales-Type Leases and Direct-Finance Leases

A. In General

B. Effect of a Permanent Decline in the Residual Value Estimate

C. Limitations Affecting the Evaluation of Residual Values

1. In General

2. Limitation of Forecasted Renewals on Setting Residual Values

3. Limitation on Accounting for Any Upward Adjustment of Residual Value

4. Limitation on Recording Residual Values in Excess of Asset's Fair Value

D. Sales or Participations of Lease Receivables

1. Background

2. Direct Sale Versus Participation

3. Use of the Term "Assignment" When Describing a Sale of a Lease

4. Basis of Accounting for the Sale or Assignment of a Lease

a. Non-Tax Leases

b. Tax-Oriented Leases

5. Basis of Accounting for the Sale or Assignment of a Lease Receivable

a. Legal Isolation

b. Right to Pledge the Asset

c. No Effective Control by the Seller

d. Conclusion

6. Limitation on Finance Income Recognition for Lease Receivables Sold

7. Lessor's Retained Interests in the EBOs of Tax Leases Sold

8. Income Recognition Issues When Selling Floating Rate Leases

9. Examples

E. Accounting for Floating Rate Leases

F. Use of a Titling Trust for Sales or Assignments of Certain Leased Assets

G. Accounting for a Purchase of an Existing Lease or Portfolio of Leases

H. Early Termination of a Lease by a Lessee and Subsequent Re-Lease

I. Sales of Residual Interests Prior to Lease Termination

J. Sale or Pledge of Finance Lease Receivables (Without Recourse) - Proceeds Exceed Cost (Money-Over-Money Transactions)

1. Overview of Transaction

2. Transaction Documented as Sale of Receivables

3. Transaction Documented as a Non-Recourse Borrowing

K. Revenue Recognition on Sales With a Guaranteed Minimum Resale Value Associated With a Financing-Type of Lease

V. Recording an Operating Lease

A. Background

B. Accounting for an Operating Lease

C. Real Estate Exception

D. Recording the Operating Lease

1. Basic Operating Lease

2. Operating Lease With Skipped or Uneven Rent Payments

3. Real Estate "Sales-Type Lease" Classified as an Operating Lease - Carrying Value Is Less Than Fair Value

4. Real Estate "Sales-Type Lease" Classified as an Operating Lease - Carrying Value Is More Than Fair Value

5. Treatment of Certain Contingent Rents Under Operating Leases

6. Sale of Operating Lease Receivables - Without Recourse

7. Sale of Operating Lease Receivables (Without Recourse) - Proceeds Exceed Cost (Money-Over-Money Transactions)

8. Sale of an Asset Subject to an Operating Lease With Seller Retaining Substantial Risks of Ownership

9. Revenue Recognition on Assets Sold (to Dealers), Repurchased and Placed Into an Operating Lease

VI. Accounting for the Acquisition of a Residual Interest

Working Papers

TABLE OF WORKSHEETS

Worksheet 1 Example of Finance Income Recognition

Worksheet 2 Extracts From IBM's 2007 Annual Report

Worksheet 3 Extracts From Xerox Corporation's 2007 Annual Report

Worksheet 4 Amortization of Lease Not at or Near End of Lease Terms

Worksheet 5 Allocation of Initial Direct Costs