Universal Weather and Aviation
Capital Lease Policy
#2-3.0016
Approved on:
November 3, 2010
Table of Contents
Policy .................................................................................................................................. 1
1.0 Purpose ......................................................................................................................... 1
2.0 Scope ............................................................................................................................ 1
3.0 Responsibility ............................................................................................................... 1
4.0 Policy ............................................................................................................................ 1
4.1 Leases ....................................................................................................................... 2
4.2 Lease Classification by Lessee ................................................................................. 3
4.3 Lease Classification by Lessor ................................................................................. 4
4.4 Capital Lease Accounting by Lessee ........................................................................ 5
4.5 Capital Lease Accounting by Lessor ........................................................................ 7
4.6 Accounting for Sale-Leasebacks .............................................................................. 9
5.0 Definitions .................................................................................................................... 9
6.0 References .................................................................................................................. 13
7.0 Exhibits ....................................................................................................................... 13
Exhibit 1 ........................................................................................................................... 14
Policy Title: Capital Lease Policy
Process Owner: Manager, Financial Reporting
Approval Date: November 3, 2010
Revision Date:
Policy 2-3.0016
Approved by: Corporate Controller
Effective Date: November 3, 2010
Revision No.:
Policy
1.0 Purpose
This policy will establish the guidelines for the accounting and the determination of what
is a capital lease versus what is an operating lease.
2.0 Scope
This policy applies to the Directors, officers, and employees of the Company and its
majority owned subsidiaries or joint ventures.
3.0 Responsibility
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Universal Weather and Aviation’s Corporate Manager, Financial Reporting is
responsible for the development, maintenance and compliance to the guidelines set
forth within this policy.
Universal Weather and Aviation’s local finance managers/Regional Controllers
are responsible for the maintenance and enforcement of the guidelines set forth
within this policy and it’s customization to their specific local market conditions
and statutory requirements.
Any variations/exceptions to this policy must first be communicated to the
Corporate Controller who will validate all variations prior to submission to the
Chief Financial Officer for final approval for policy changes.
4.0 Policy
The determination of a capital lease versus an operating lease and the subsequent
accounting is a complex issue which involves a significant degree of thought and
consideration. Leasing arrangements involve transfers of various risks and rewards that
allow a sharing of financial, operating, and tax characteristics of leased property.
As such, Universal must exercise care when considering leasing as there are far reaching
implications to such a decision. For example, Capital Leases are included in our
calculation of “Funded Debt” within our credit agreement. This calculation determines
the rate of interest we are required to pay on our borrowings under our line of credit.
Therefore, an increase in funded debt will increase our interest expense over time
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4.1 Leases
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Universal will adhere to the guidelines as set forth by Generally Accepted
Accounting Principles (GAAP) in the classification of whether a lease is a capital
lease or an operating lease. The FASB's guidelines for classifying and reporting
leasing transactions are based on the economic characteristics of the lease
agreement at the inception of the lease. A lease that transfers most all the risks
and benefits incident to the ownership of the leased property should be accounted
for as an asset and consequently a capital lease and as a sale or financing by the
lessor. All other leases are classified as operating leases.
The transfer of risks and benefits must be evaluated at the beginning of the lease
to determine the lease's appropriate classification. Universal’s Corporate
Manager, Financial Reporting should determine which party bears the risks of
changes in property values, which ends up with ownership of the leased property,
what is the residual, economic value at the end of the lease term, and what
guarantees (of residual value and others) are provided by the lessee. Generally,
lease agreements in which substantially all the risks are retained by the lessor are
classified as operating leases. This process is important, since lease classification
affects several critical indicators or measures of financial performance and health
of both lessee and lessor companies.
Leasing arrangements which do not meet the capitalization criteria identified and
discussed below shall be classified as operating leases. Operating leases are not
recorded as assets and are held as an “off balance sheet” liability. Normally,
rental on an operating lease is charged to expense over the lease term as it
becomes payable.
When accounting for an operating lease, the “rented” asset and the corresponding
long-term liability are not recorded; instead, rent expense is debited periodically
and cash (or a short-term accrued liability) is credited.
Rent expense, lease rental payments, lease payments are all synonymous terms
meaning the same thing e.g. the amount of funds one has to pay to procure to
utilization of a leased asset.
All leases must first be reviewed by the Legal Department and the Chief Financial
Officer or Corporate Controller before a commitment is made. Additionally, all
leases are subject to the Company’s Delegation of Authority and Capital
Expenditure policies and limitations (Policies 2-3.0001 & 2-3.0301 respectively).
Headquarters’ accounting department should review all lease agreements for
proper accounting (capital vs. operating leases).
Additionally, before committing to a lease agreement, Universal’s Corporate
Treasurer must be notified of the determination as to whether or not the lease may
be capitalized to make sure a minimal impact on our debt covenants.
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4.2 Lease Classification by Lessee
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A lease agreement must be evaluated at the beginning of the lease to classify the
lease along the lines required by SFAS No. 13. SFAS No. 13 delineates the
conditions under which the lessee must assume these risks and the benefits that
have been transferred. Lease agreements that do not meet these conditions are
classified as operating leases.
Lease agreements that meet one or more of the following criteria must be
classified as capital leases:
o The lease transfers ownership of the property to the lessee at the end of the
lease term.
o The lease contains a bargain purchase option.
o The lease term is equal to 75 percent or more of the estimated economic
life of the leased property (this criterion is not applicable when the lease
term begins within the last 25 percent of the economic life of the asset).
o The present value of the minimum lease payments (MLP) (excluding
executory costs) equals or exceeds 90 percent of the excess of the fair
value of the leased property to the lessor. The discount rate used should
be the lessee's incremental borrowing rate or the rate implicit in the lease,
whichever is lower.
The establishment of these criteria allow for an evaluation of whether benefits and
risks are transferred by a lease agreement.
o The first condition involves the transfer of ownership that would
effectively transfer all of the benefits and risks of the leased property to
the lessee.
o Similarly, the existence of a bargain purchase option implies an identical
transfer. Thus, the first two criteria satisfy the economic concepts
underlying the classification of a lease as a capitalized lease.
o The third criterion implies that lease terms covering at least 75 percent of
the estimated economic life of the leased property transfer substantially all
the risks and benefits of ownership. (This criterion cannot be used in lease
classification if the inception of the lease falls within the last 25 percent of
the total estimated economic life of the leased property.) This criterion
presumes that a substantial portion of the benefits and risks of use occur
during the initial 75 percent of the economic life. As such, this requires
capitalization of the leased property.
o The last criterion reflects the lessor's return on investment in the lessee's
payment for the leased property. When the present value of the minimum
leas payments (MLPs) equals or exceeds 90 percent of the fair value of the
leased property at the inception of the lease, the lessor will have earned a
fair return on investment. The lessee has effectively paid for the lease and
is required to treat the leased property as it would an acquisition. The
interest rate used to determine the present value, the MLP, contingent
rentals, and the residual value are among the critical factors in the
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application of this rule, and they should be evaluated carefully in the lease
classification process.
If a lease agreement meets any one of these four criteria at the inception of
the lease, it must be classified as a capitalized lease (i.e., the lessee should
recognize a leased asset and the obligation under capital leases). Reference
the Lease Calculation Template for assistance in making this determination (See
K:\finance\General Accounting\International Offices - Monthly Close\2 Entity
Book Templates, Notes, etc\Leases and Notes).
FASB Interpretation No. 31 mandates that the classification of the lease made at
the inception of the lease should not be changed in the event of a business
acquisition unless the provisions of the lease agreement are changed.
4.3 Lease Classification by Lessor
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The economic characteristics of the lease agreement must be evaluated at the
inception of the lease by the lessor to classify the lease under one of the following
categories:
o Operating leases
o Sales-type leases
o Direct-financing leases
o Leveraged leases
Leases that do not meet the criteria for a capital lease as reported by the lessee,
nor meet either of the following two criteria would be classified as an Operating
lease by the lessor.
o Collectability of MLPs is reasonably predictable.
o No significant uncertainties surround the amount of the non-reimbursable
costs yet to be incurred by the lessor under the provisions of the lease
agreement.
A lease agreement that meets any one of the above noted criteria for capital leases
by lessees and also meets both of the following criteria must be classified as a
sales-type or a direct-financing lease by the lessor:
o Collectability of MLPs is reasonably predictable.
o No significant uncertainties surround the amount of the non-reimbursable
costs yet to be incurred by the lessor under the provisions of the lease
agreement.
Distinguishing a sales-type lease from a direct financing lease relates to the
existence of a manufacturer's or dealer's profit (or loss). The lessor's profit or loss
is the difference between the fair value of the leased property at the inception of
the lease and the manufacturers or dealer's cost or carrying amount. Directfinancing leases do not incorporate a profit or loss, but reflect an interest
component earned by the lessor for the underlying financing transaction.
Generally, direct-financing leases are arranged by leasing intermediaries. In a
sales-type lease, the profit or loss must be recognized by the lessor at the
inception of the lease.
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o The accounting procedures under these two types of leases are equivalent
except for the treatment of initial direct costs. These costs may be
expensed as incurred in sales-type leases, whereas they must be amortized
to income over the life of the lease under direct-financing leases
Financing leases, which are financed principally with nonrecourse borrowings at
lease inception and which meet certain criteria, are accounted for as leveraged
leases. Leveraged lease contracts receivable are stated net of the related
nonrecourse debt service, which includes unpaid principal and aggregate
remaining interest on such debt. Unearned income represents the excess of
anticipated cash flows (including estimated residual values after taking into
account the related debt service) over the Company's investment in the lease.
4.4 Capital Lease Accounting by Lessee
The following example depicts how a typical lease would be viewed, the determination as
to whether or not it is a capital lease and the subsequent accounting for a capital lease by
the lessee.
Lease Provisions:
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The lease term is six years and is non-cancelable.
The fair value of the machinery at the inception of the lease is $240,000, it has an
estimated economic life of six years, and it has no residual value.
There is no bargain purchase option, and the lessor retains ownership at the end of
the lease.
The lessor's implicit rate is 10 percent, and the lessee has been informed of this
implicit rate.
The lessee's incremental borrowing rate is 11 percent.
The lessee depreciates similar machinery on a straight-line basis.
The lease requires annual payments of $54,096.12 at the beginning of each year.
This annual payment includes $4,000 for maintenance and insurance (executory
costs).
The lease should be accounted for as a capital lease because the lease term is equal to the
estimated economic life and the present value of the MLPs exceeds 90 percent of the fair
value of the machinery. (Only one condition needs to be met to classify it as a capital
lease.) The annual MLPs are $50,096.12, and their present value should be computed as
follows:
Capitalized Asset and Liability Amount
= ($54,096.12 !"#$%&&&'"(")*+,+-."/012+"34"0-"5--26.7"82+"0."9&:"43*";")+*63<,
= $50,096.12 × 4.79079 = $240,000
The lessor's implicit rate must be used, since it is lower than the lessee's incremental
borrowing rate and it is known to the lessee.
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The amortization schedule reflects the application of the effective interest method and
allocates each annual payment to executory costs, interest, and a reduction of the balance
of the lease obligation. No interest is recorded on the first payment of January 1, 2010,
since it is the inception of the lease and as such no interest has been incurred. The interest
component in years 2 through 6 is computed by applying the interest rate to the unpaid
obligation. The reduction in lease obligation is determined annually by the difference
between the payment (net of executory costs) and the interest computed as in the previous
calculation.
The balance sheet should reflect the capitalized lease asset and the obligations under
capital leases, showing the short- and long-term components. Each period should reflect
the amount of the obligation expected to be reduced by the next payment as a short-term
obligation.
Journal Entries
Debits
1. At inception, January 1, 2010
Capitalized lease asset
Obligations under capital leases:
Short-term
Long-term
2. First lease payment, January 1, 2010
Executory expenses
Obligation under capital leases
Cash
3. Recognition of accrued interest, December 31, 2010
Interest expense
Interest payable
4. Lease payment, January 1, 2011
Executory expenses
Interest payable
Obligations under capital leases
Cash
5. Amortization of leased asset, December 31, 2010
Depreciation expense
Accumulated depreciation—leased asset
6. December 31, 2015
Accumulated depreciation—leased asset
Capitalized leased asset
Credits
$240,000.00
$ 50,096.12
189,903.88
4,000.00
50,096.12
54,096.12
18,990.39
18,990.39
4,000.00
18,990.39
31,105.73
54,096.12
40,000.00
40,000.00
Debits
$240,000.00
Credits
240,000.00
(5) This entry will be made each year, since the company uses the straight-line method for depreciation.
The lease payment entries will follow the amortization schedule and the format depicted in (4) above.
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Lessee Company
Lease Amortization Schedule
Date
Jan. 1,
2010
Jan. 1,
2010
Jan. 1,
2011
Jan. 1,
2012
Jan. 1,
2013
Jan. 1,
2014
Jan. 1,
2015
Annual lease
payment
Executory
costs
Interest on unpaid
obligation
Reduction of lease
obligation
Balance of lease
obligation
$240,000.00
$ 54,096.12
$ 4,000.00
0
$ 50,096.12
189,903.88
54,096.12
4,000.00
$18,990.39
31,105.73
158,798.15
54,096.12
4,000.00
15,879.81
34,216.31
124,581.84
54,096.12
4,000.00
12,458.18
37,637.94
86,943.90
54,096.12
4,000.00
8,694.39
41,401.73
45,943.17
54,096.12
$324,576.72
4,000.00
$24,000.00
4,553.95 a
$60,576.72
45,542.17
$240,000.00
0
4.5 Capital Lease Accounting by Lessor
The accounting for sales-type leases is illustrated using the assumptions from the above
example (lessee accounting) but with changes and additional assumptions.
Assumptions:
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The machinery cost $150,000 to manufacture.
The unguaranteed residual value is $5,000.
Initial direct costs of $5,000 are incurred at inception.
The normal selling price is $242,822.35.
The collectability of lease payments is reasonably predictable, and no additional
costs are expected.
The lessor's gross investment in the lease is:
MLPs (net of executory costs):
$50,096.12 × 6
Unguaranteed residual value
Gross investment in leased property
=
$300,576.72
5,000.00
$305,576.72
The net investment should be computed as follows:
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Present value of an annuity due of $50,096.12 for 6 periods at 10% (50,916.12 × 4.79079)
Present value of $5,000 at end of 6 years at 10% a year ($5,000 × .56447)
Journal Entries
Debits
1. At inception
Gross investment in leased property
Cost of sales (cost less present value of unguaranteed residual value)
Sales revenue (present value of minimum lease payments)
Machinery
Unearned interest income
2. Initial direct costs
Cash
3. Cash
Gross investment in leased asset
Executory cost
4. Unearned interest income
Interest income
= $240,000.00
= $2,822.35
$242,822.35
Credits
$305,576.72
147,177.65
$240,000.00
150,000.00
62,754.37
5,000.00
5,000.00
54,096.12
50,096.12
4,000.00
19,272.62
19,272.62
Lessor Company
Lease Amortization Schedule for Sales-Type Leases
Beginning of year
Amortization of
End-of-year present
present value of net
Annual
unearned interest
Reduction in
value of net
Year
investment
Payments
incomea, b
net investment
investment
1
$242,822.35
$50,096.12
$19,272.62
$30,823.50
$211,998.85
2
211,998.85
50,096.12
16,190.27
33,905.85
178,093.00
3
178,093.00
50,096.12
12,799.69
37,296.43
140,796.56
4
140,796.56
50,096.12
9,070.04
41,026.08
99,770.48
5
99,770.48
50,096.12
4,967.44
45,128.68
54,641.80
6
54,641.80
50,096.12
454.32
49,641.80
5,000.00d
$300.576.72
$62,754.38
$237,822.34
d
Represents the unguaranteed residual value.
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4.6 Accounting for Sale-Leasebacks
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At this writing, the sale-leaseback of any property or equipment is expressly
prohibited by the Delegation of Authority Policy (No. 2-3.0001). The process
supporting these types of transactions have been included as Exhibit 1, but
are for information purposes only should a future situation warrant the need
to account for this type of transaction.
5.0 Definitions
Bargain Purchase Option
A bargain purchase option gives the lessee the right to purchase leased property
for a specified amount, which at the inception of the lease is sufficiently lower
than the expected fair value of the property at exercise date to virtually guarantee
the exercise of the option.
Bargain Renewal Option
A bargain renewal option gives the lessee the right to renew the lease agreement
at a specified rental payment, which at the inception of the lease is sufficiently
lower than the expected fair rental at the exercise date to virtually guarantee the
exercise of the option.
Cancelability
Leases should be regarded as non-cancelable when cancellations are only possible
under the following conditions:
o The permission of the lessor is required.
o A contingency considered remote at the inception of the lease occurs.
o A cancellation penalty is incurred of an amount that at inception provides
reasonable assurance that the lease will be continued.
Contingent Rentals
SFAS No. 29, “Determining Contingent Rentals,” defines contingent rentals as
increases or decreases in lease payments due to changes in factors determining
lease payments occurring subsequent to the inception of the lease.
Minimum lease payments (MLPs) are based on factors that exist and are
measurable at the inception of the lease; these are the factors that should be
included in the MLPs. Examples include payments based on construction cost or
consumer price indices and on the prime interest rate. Subsequent changes in
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these factors change lease payments. However, these changes are considered
contingent rentals and are included in income determination as they are accrued.
Changes in minimum lease rentals due to changes in construction or acquisition
cost of leased property or changes in costs during construction or preconstruction
phases are not contingent rentals but rather components of MLPs. (See “fair value
of leased property,” as amended by SFAS 23, “Inception of the Lease.”) Finally,
the portion of rental payments due only to the passage of time are excluded from
contingent rentals.
Estimated Economic Life of Leased Property
SFAS No. 13, paragraph 5(g) defines the estimated economic life of leased
property as the remaining period during which the property, given normal
maintenance and repairs, may be economically usable for its intended function at
the inception of the lease. The economic life is not limited by the lease term and
should be estimated by methods used to determine the depreciable life of similar
property.
Estimated Residual Value of Leased Property
The estimated residual value is the estimated or expected fair value of the leased
property at the end of the lease term (i.e., the expected market value at the end of
the lease term) and is equivalent to the expected salvage value at the end of the
depreciable life of similar property.
Executory Costs
The executory costs include costs of insurance, maintenance, and taxes on the
leased property. Lessee payments for guarantees of residual value from unrelated
third parties are also executory costs. Executory costs, whether paid by lessee or
lessor, are not components of MLPs. Lessor's profit, if any, on executory costs is
treated similarly.
Fair Value of Leased Property
The fair value of leased property is generally the selling price of the property if it
were sold in an arm's-length transaction between unrelated parties. The fair value
of the leased property may be known or determinable through negotiation or
inquiry in the marketplace. However, it need not be equal to the normal selling
price and should always be determined in the context of existing market
conditions at the inception of the lease.
Inception of the Lease
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The inception of the lease is the date of the lease agreement or the date of the
commitment if it is earlier. A commitment is a written agreement specifying all
the principal terms of the lease agreement, and it should be signed by all the
interested parties. The classification of the lease is determined at the lease's
inception, as defined above.
Implicit Interest Rate
The interest rate implicit in the lease agreement is the discount rate at which the
present value of the MLPs and the unguaranteed residual value accruing to the
lessor is equal to the fair value of the leased property to the lessor at the inception
of the lease. The implicit interest rate is essentially the lessor's rate of return
(ROR) on the lease and is the rate charged by the lessor to a given lessee.
Incremental Borrowing Rate
The incremental borrowing rate at the inception of the lease is the rate at which
the lessee would be able to borrow funds required to purchase the property to be
leased. The terms should be substantially similar for all the alternatives. The
lessee may obtain information on the borrowing rate externally from financial
intermediaries or develop it internally by computing the expected borrowing rate
for similar term transactions.
Initial Direct Costs
SFAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated With
Originating or Acquiring Loans and Initial Direct Costs of Leases,” defines initial
direct costs to include only the incremental costs incurred in negotiating
transactions and costs incurred by the lessor for completed leases. SFAS No. 91
excludes advertising, promotional, administrative, and other indirect costs of
leasing activities from the computation of initial direct costs.
Lease Incentives
Examples of lease incentives are a lessor's direct payments to a lessee and a
lessor's assumption of a lessee's costs or losses from an existing lease.
Lease Term
The lease term includes the fixed non-cancelable term and periods covered by the
following provisions where applicable:
o Bargain renewal options
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o Ordinary renewals during which the lessee's guarantee of the lessor's debt
is directly or indirectly related to the leased property
o Renewals assured by the existence of significant termination penalties (at
the inception of the lease)
o Ordinary renewals during periods preceding the date at which bargain
renewal options are exercisable
o Renewals at the option of the lessor
SFAS No. 13 specifies that the lease term cannot extend beyond the date a
bargain purchase option is exercisable. SFAS No. 98 amends the SFAS No. 13
definition of the lease term to include all renewal periods during which there will
be a loan outstanding from the lessee to the lessor.
Minimum Lease Payments
MLPs constitute one of the most significant determinants of required accounting
for leases. For the lessee, MLPs include the following:
o The minimum rental payments specified over the lease term
o Guarantees of residual value of leased property at the end of the lease term
regardless of whether the guarantee constitutes a purchase of the leased
property, since the guarantee make certain s that the lessee bears the risk
of the changes in value of the leased property (If the lessee is required to
purchase the leased property at the termination of the lease, the purchase
price is regarded as the lessee guarantee. Finally, the lessee may be
required to make up any deficiency in the residual value below a stated
amount. In that case, the stated amount constitutes the guarantee that
should be included in the MLPs.)
o Payments required upon failure to renew or to extend leases at the
expiration of the lease term regardless of whether the payments constitute
a purchase of the leased property
o Payments required under bargain purchase options
MLPs exclude contingent rentals, lessee guarantees of lessor debt, and executory
costs. This definition of MLPs should be used in computing present values and
the implicit interest rate defined previously.
The lessor's definition of MLPs includes all of the above factors plus any
guarantees of minimum rental payments or residual values beyond the lease term
by an unrelated third party, provided that the third party is financially capable of
discharging the obligations under the guarantee.
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Related Parties
SFAS No. 13 defines related parties in leasing transactions to include parent
companies and their subsidiaries, joint ventures and partnerships, and investor
companies and their investees. These relationships constitute related parties if the
parent or investor exercises significant influence over the operating and financial
policies of the investee.
Significant influence may be implied through guarantees of indebtedness,
extensions of credit, ownership of debt or equity securities, and common
ownership or common boards of directors or officers. This definition is
significant, since guarantees by third parties related to the lessee are considered
lessee guarantees.
Lease
A lease is an agreement conveying the right to use specific property, plant or
equipment (land and/or depreciable assets) for a stated, fixed period of time. All
new lease agreements must be reviewed by the Legal Department.
Lease Renewal
A lease renewal is a lease agreement which has been extended past its initial
period or revised for whatever reason and mutually agreed to by both parties. It
still requires the appropriate level of approval, but does not require Legal review
unless terms and conditions have been modified or if the original lease had not
been reviewed.
6.0 References
Delegation of Authority No. 2-3.0001
Capital Expenditures No. 2-3.0301
7.0 Exhibits
Exhibit 1
Accounting for Sale-Leasebacks
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Exhibit 1
Accounting for Sale-Leasebacks
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Sale-leaseback transactions are the sales of property by the owner and a lease of
the property back to the seller. SFAS No. 28 identifies three categories of
leasebacks based on the percentage of present value to the fair value of the asset
sold.
SFAS No. 28 prescribes the accounting on the basis of the substance of the use of
the asset after the sale. If the use of the asset continues after the sale, the saleleaseback is essentially a financing transaction and no profit or loss on the
transaction should be recognized. Thus, the extent of the continuing use after sales
is the critical factor in determining the accounting for the transaction. The extent
of use is based on the present value of “reasonable” rentals as a proportion of the
fair value of the asset sold and leased back. (“Reasonable” rentals are defined
with reference to the current property.)
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Minor Leasebacks
o The accounting for sale-leasebacks is determined by the relationship
between the present value of reasonable rentals and the fair value of the
asset sold. If the present value is less than 10 percent of the fair value of
the asset, the leaseback is considered “minor.” This criterion relates to the
90 percent of fair value recovery test in the classification of leases, and the
leaseback is considered substantially equivalent to a sale of the property.
The sale and leaseback should be treated as two separate transactions and
any gain (loss) on the transaction must be recognized in full in the current
accounting period. These procedures cannot be used if the lease rentals are
not reasonable, and the gain (loss) should not be recognized in the current
accounting period. Essentially, a proportionate amount of the gain (loss)
must be deferred and amortized over the lease term in proportion to
amortization of the leased property if the leaseback can be classified as a
capital lease. If it is classified as an operating lease, the deferral is
amortized in proportion to the rental payments.
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More than Minor but Less Than “Substantially All”
o When the present value of rentals exceeds 10 percent but is less than 90
percent of the fair value of the asset sold, the sale-leaseback is accounted
for as a single transaction.
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o When the sale results in a profit and the leaseback meets the criteria for a
capital lease, all or part of the gain must be deferred and amortized in
proportion to the amortization of the leased property. The amount of the
gain to be deferred is given by the carrying value of the property (the fair
value of the property or the present value of the MLPs, whichever is
lower). The excess gain must be recognized in the current accounting
period. For operating leases, the gain to be deferred is the present value of
the MLPs, and it should be amortized in proportion to the rental payments
under the operating lease. Excess gains are recognized currently.
o When the sale-leaseback results in a loss, a portion of the loss (fair value
less the un-depreciated cost) must be recognized currently. The excess loss
(selling price less fair value) is deferred. This excess loss is amortized in
proportion to the amortization of leased property for capital leases and in
proportion to rental payments for operating leases.
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“Substantially All” Leasebacks
o A leaseback falls into this category when the present value of the MLPs is
equal to or exceeds 90 percent of the fair value of the property sold. The
entire gain (loss) must be deferred and amortized to income as described
in the previous section.
Universal Weather and Aviation
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