Leases: Lessee Perspective — Selected Topics (Portfolio 5118)

BNA Tax and Accounting Portfolio 5118, Leases: Lessee Perspective—Selected Topics (Accounting Policy and Practice Series), explains and analyzes specific financial accounting leasing issues from the perspective of the lessee.

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This Portfolio is part of the Accounting Policy and Practice Series, an essential resource including more than 70 accounting Portfolios and the latest news and developments.


BNA Tax and Accounting Portfolio 5118, Leases: Lessee Perspective—Selected Topics (Accounting Policy and Practice Series), explains and analyzes specific financial accounting leasing issues from the perspective of the lessee. The Portfolio extensively analyzes sale-leaseback transactions, including lessee motivations for entering into these types of leases and the rules applicable to both classification and reporting. The Portfolio also comprehensively discusses build-to-suit structures and analyzes lessee involvement in these transactions and the ways in which that involvement affects financial reporting.
The Portfolio analyzes the effects of changes in lease provisions on existing leases and the accounting for subleases. The work also discusses additional topics of interest to lessees, including rating agencies' treatments of operating leases, tax-exempt municipal leasing, and leasing fractional shares of aircraft. Lastly, the Portfolio describes new approaches to lease accounting that U.S. and international standards setters are considering and suggests how parties to leases might plan for these changes.
The third in a subseries of Portfolios on accounting for leases, this work augments. Other titles in the subseries will focus on leasing from the lessor's perspective. The FASB and the International Accounting Standards Board (IASB) are collaborating to revise and converge their standards on Accounting for Leases. This Portfolio will be updated as necessary to reflect any new rules or principles. For a summary of the most recently proposed rules and their potential impact on lessee accounting, see APP 5114, Accounting for Leases: Fundamental Principles at Section I.D.
This Portfolio may be cited as BNA Tax and Accounting Portfolio 5118, Sebik & Starczewski, Leases: Lessee Perspective—Selected Topics (Accounting Policy and Practice Series).


Joseph P. Sebik, C.P.A.

Joseph P. Sebik, B.A., Accounting, Queens College of the City University of New York (1977); graduate credits towards MBA; Controllership, St. Johns University; Certified Public Accountant, New York State (1980); member of the Accounting Committee of the Equipment Leasing Association (ELA) since 2000; recurring speaker at ELA Accounting Conferences; author of numerous articles on leasing; member of the AICPA; over 20 years of lease accounting and financial reporting experience with Price Waterhouse, IBM Credit Corporation, Citicorp Global Equipment Finance, JPMorgan Capital, Citi Bankers Leasing (a division of Citigroup Inc.), and ICON Capital Corp.

Lisa Marie Starczewski, Esq.

Lisa Marie Starczewski, J.D. (summa cum laude), Villanova University School of Law; B.A. (magna cum laude), Smith College. Starczewski served as Editor-in-Chief of the Villanova Law Review (1987–88) and has practiced law with Morgan, Lewis & Bockius and Schnader, Harrison, Segal & Lewis. She taught at Villanova University School of Law. Ms. Starczewski has coauthored two other Accounting Policy and Practice Portfolios: 5101, Revenue Recognition: Fundamental Principles; and 5114, Accounting for Leases: Fundamental Principles. She has also authored numerous Tax Management Portfolios (published by BNA), including 714 T.M., Partnerships—Allocation of Liabilities; Basis Rules; 565 T.M., Installment Sales; 752 T.M., Corporate Alternative Minimum Tax; 587 T.M., Noncorporate Alternative Minimum Tax; 503 T.M., Deductions: Overview and Conceptual Aspects; and 504 T.M., Deduction Limitations: General. She has received the Tax Management Distinguished Author Award and is a member of the Tax Management U.S. Income Advisory Board.

Table of Contents

Detailed Analysis

I. Purpose, Role, and Scope of Portfolio

II. Sale-Leaseback Transactions-Lessee Perspective

A. Accounting for Sale-Leaseback Transactions-In General

1. Sale-Leaseback Defined

2. Accounting by Seller-Lessee

a. In General

b. Criteria for Sale-Leaseback Accounting

c. Real Estate and Integral Equipment

3. Recognizing Gain From Sale

4. Organization of Section II

B. Reasons for Entering Into Sale-Leasebacks of Equipment

1. Transaction Size

2. Liquidity

3. Avoiding Tax Losses and Alternative Minimum Tax

4. Using Capital Losses

5. Creating Tax Deductions

6. Improving Financial Ratios

C. Types of Real Estate Assets

D. Types of Real Estate Leases and Investors

1. Categories of Real Estate Investors

2. Traditional "Box" Investors

3. Tax and Finance Oriented Investors

E. Sale-Leasebacks Involving Real Estate (and Integral Equipment)

1. Restriction on Classification as Operating Lease

2. Scope of FAS 98

a. In General

b. Determining Whether Equipment Is Integral Equipment

(1) In General-EITF Issue 00-13

(2) Practical Effect of EITF Issue 00-13

3. Eligibility, Presentation, and Disclosure

a. Criteria for Seller-Lessee to Apply Sale-Leaseback Accounting

(1) Definition of a "Normal Leaseback"

(2) Buyer-Lessor's Initial and Continuing Investment

(3) Absence of "Continuing Involvement"

(a) Application of the General Rule

(b) Analysis of Lessee Continuing Involvement-Special Issues

(i) Lessee Participation in Lessor's Interest Savings on Refinancing

(ii) Options to Repurchase Property After a Sale-Leaseback

(iii) Right of First Refusal and Right of First Offer

(iv) Lessee Indemnification of Environmental Risks

(v) Default Remedies Resulting in the Lessee Providing Additional Collateral or a Reversion of the Asset to Lessee as a Result of Non-Performance Related Covenants

(vi) Economic Obsolescence Clause as a Form of Lessee Continuing Involvement

(vii) Partial Sales of Real Estate

b. The Effect of FAS 98 on To-Be-Built Facilities

c. Presentation and Disclosure Requirements

4. Build-To-Suit Structures

a. Construction Phase Mechanics of a Build-To-Suit Structure

(1) Lessee Involvement as Construction Agent-In General

(2) Financing During Construction Period

(a) Construction Risks

(b) Construction Financing

b. Inception of Lease and Accountant's Present Value Measurement

c. Preconstruction Involvement-EITF Issue 96-21

(1) Construction Period Lease Payments

(2) Costs Incurred by Lessee Prior to Entering Into a Lease Agreement

d. Lessee Involvement in Asset Construction: EITF Issue 97-10

(1) Basic Rules

(2) Tests for Determining Whether Lessee Is Considered Owner During Construction Period

(a) Lessee's Maximum Guarantee Is 90% or More of Total Project Costs

(b) Lessee's Maximum Guarantee Is Less Than 90% of Total Project Costs-Automatic Indicators of Substantive Ownership

(3) Table Summarizing Indemnification/Guarantee Provisions in EITF Issue 97-10

F. Sale-Leaseback Accounting

1. Major Leaseback-Leaseback of Substantially All of the Use of the Sold Property

2. Minor Leaseback-Leaseback of Only a Minor Amount of the Use of Sold Property

3. Intermediate Leaseback-Leaseback of More Than a Minor Amount But Less Than Substantially All of the Sold Property

III. Effect of Changes in Lease Provisions

A. In General

B. Reasons for Changes in Lease Provisions

C. Determining Whether a Change to a Lease Agreement Results in a New Agreement

1. Change in Lessee's Incremental Borrowing Rate

2. Change in Lessee's Estimate of Economic Useful Life

3. Change Formalizing Original Lease Provision

4. Change in Indices-Based Payments

5. Change in Minimum Lease Payments Without Extension or Renewal of Lease Term

D. Accounting for Changes in Lease Provisions Generally

E. Accounting for Changes in the Lease Provisions of a Capital Lease

F. Accounting for Changes in the Lease Provisions of an Operating Lease

G. Changes in Leases During Construction of a Build-To-Suit

1. Issues and Challenges

2. Inception of the Lease in a Build-To-Suit

3. Occasions Typically Requiring Lease Classification

IV. Subleases and Similar Transaction

A. Structure and Basic Accounting Treatment of Subleases

1. Accounting by Lessor

2. Accounting Criteria for Lessees

B. Reasons for Subleasing

1. Changes in Asset Needs/Avoiding Termination Charges

2. Disposal of Segment of a Business

3. Sublease of a Portion of Leased Asset

4. Lessee Profit Opportunity

C. Accounting and Reporting for Subleases

1. Summary of Accounting by Lessee

a. Fact Patterns

b. Original Lessee Ceases to Be Primarily Liable

c. Original Lessee Remains Primarily Liable

d. Accounting by New Lessee

2. Original Lessee Is Relieved of the Primary Obligation

a. Original Lease Is a Capital Lease of Equipment

b. Original Lease Is a Capital Lease of Real Estate or Integral Equipment

c. Original Lease Is an Operating Lease

3. Original Lessee Is Not Relieved of the Primary Obligation Under the Original Lease

a. Original Lease Is a Capital Lease Under Paragraph 7(a) or 7(b) of FAS 13

b. Original Lease Is a Capital Lease Under Paragraph 7(c) or 7(d) of FAS 13

(1) In General

(2) Sale-Leaseback Sublease Exception

c. Original Lease Is an Operating Lease

D. Other Subleasing Issues

1. Economic Compulsion

2. Losses on Subleases

3. Partial-Term Subleases

V. Additional Topics of Special Interest to Lessees

Introductory Material

A. Rating Agencies' Positions on Operating Leases

1. In General

2. The Adjustment for Operating Leases

a. Standard & Poor's Adjustment

b. Moody's Adjustment for Operating Lease Capitalization

c. Fitch's Approach to Capitalizing Operating Leases

3. Summary of Rating Agency Approaches

B. Leasing to Municipalities, Tax-Exempt Entities, Not-for-Profit U.S. Entities, and Non-U.S. Taxpayers

1. Limitation on the Use of Accelerated Depreciation

2. Tax-Exempt Municipal Leases

a. General Structure

b. Use of Tax-Exempt Municipal Leases

c. Characterization of the Lease by the Tax-Exempt Entity

d. Types of Lessors

e. Tax-exempt Leasing to U.S. Non-Profit Organizations

C. Leases Involving Fractional Shares of Aircraft

1. Use of Fractional Share Ownership Programs

2. Structure of a Fractional Share Program

3. Typical Documentation

4. Accounting Considerations

a. Query: Can Fractional Shares Be Leased?

b. Alternative Approach

VI. Anticipated Lease Accounting Rule Changes and Possible Ramifications

Introductory Material

A. Historical Background

1. Pronouncements Preceding FAS 13

2. FAS 13: Risk and Rewards Model

3. Critique of FAS 13: Risk and Rewards Model

B. G4+1 Reports and the "New Approach"

C. The Effect of the Sarbanesâ€"Oxley Act and the 2005 SEC Report on Leasing

D. Input From Public Accounting Firms

E. Joint Project of the IASB and FASB

1. Scope of the Project

2. Alternative Lease Accounting Methods

a. Right of Use/Asset and Liability Approach

b. Whole-Asset Approach

c. Risk and Rewards Approach

d. Executory Contract Approach

e. Variable Interest Approach

3. Questions Arising Under the Convergence Project

F. Planning for Change and Predicted Impacts

1. Small Ticket Leasing

2. Middle Market Leasing

3. Big Ticket Leasing

a. Generally

b. Synthetic Leases

c. Tax Leases

4. Indicative Balance Sheet Presentations

Working Papers

Working Papers


Worksheet 1 Glossary of Terms

Worksheet 2 Moody's Multiples of Current Rent Expense by Industry

Worksheet 3 FitchRatings Country Specific Multiples

Worksheet 4 Basic Fractional Share Structure Illustration

Worksheet 5 Sample Sale-Leaseback Disclosure-Savvis, Inc.

Worksheet 6 Sample Reclassification Disclosure-Southwest Airlines

Worksheet 7 Sample Build-to-Suit Disclosure-Electronic Arts, Inc.

Worksheet 8 Sample Contractual Relationship in a Build-to-Suit

Worksheet 9 Comparison of New Approaches to Lease Accounting

Worksheet 10 Sample Disclosure for Loss on Sublease-The Gap, Inc.




Internal Revenue Code

Treasury Regulations

Revenue Procedures and Revenue Rulings

Financial Accounting Standards Board

FASB Statements

FASB Interpretations

FASB Technical Bulletins

FASB Staff Positions

Memorandum of Understanding

Project Updates

Emerging Issues Task Force

EITF Issues

AICPA Professional Standards

International Accounting Standards Board



FASB Board Meeting Handouts

International Accounting Standards Board

Books, Articles, Speeches, and Letters

BNA Portfolios

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