A fixed-price repurchase option turns the sale into a loan: the gain disappears, the debt is the full price and the rent becomes debt service.
When a sale and leaseback fails the sale test under ASC 842, typically because the seller keeps a fixed-price repurchase option, the seller-lessee keeps the building on its balance sheet, keeps depreciating it, books no gain and records the cash received as a financial liability. On an illustrative $50,000,000 sale with $3,000,000 of annual rent and a $55,000,000 repurchase option after ten years, the liability accretes at 6.73 per cent from $50,000,000 to $55,000,000; year 1 shows $3,366,478 of interest and $1,000,000 of depreciation instead of an $18,000,000 gain and $3,000,000 of rent.
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ASC 842 asks whether the transfer is a sale under the revenue standard's control criteria. A repurchase option held by the seller-lessee generally prevents sale accounting unless the exercise price is fair value at the time of exercise and alternative assets, substantially the same, are readily available in the market. A fixed-price option on a headquarters building passes neither test, so the transaction is a financing: the buyer-lessor has lent the seller $50,000,000 secured on a building the seller never stopped controlling.
Failed sale: keep the asset at its carrying amount; record a financial liability equal to the cash received
Each year: interest = opening liability × effective rate; liability = opening + interest − rent paid
Effective rate, where repurchase at the fixed price is expected: the rate at which the liability reaches the repurchase price at the option date. In Excel: =RATE(10, 3000000, -50000000, 55000000) returns 6.73%.
| Input | Value |
|---|---|
| Sale price, at fair value | $50,000,000 |
| Carrying amount: land, building | $8,000,000, $24,000,000 |
| Building's remaining useful life | 24 years |
| Leaseback rent, paid annually in arrears | $3,000,000 |
| Lease term | 10 years |
| Fixed-price repurchase option at the end of year 10 | $55,000,000 |
| Seller-lessee's incremental borrowing rate | 6.50% |
Step 1, no derecognition. The building stays on the balance sheet at $32,000,000 and continues to depreciate at $24,000,000 / 24 = $1,000,000 a year. The $18,000,000 difference between price and carrying amount is not a gain.
Step 2, the liability. The $50,000,000 received is a financial liability. Rent paid is debt service.
Step 3, the rate. At the 6.50 per cent borrowing rate the liability would reach $53,373,606 by year 10, leaving a $1.6 million step on exercise. Solving for the rate that lands the liability on the $55,000,000 repurchase price gives 6.73 per cent. Where repurchase is expected, accreting to the option price is the common approach; the rate and its basis are a judgement to agree with the auditor.
Step 4, the schedule. Interest exceeds the rent every year, so the liability grows:
| Year | Opening | Interest at 6.73% | Rent paid | Closing |
|---|---|---|---|---|
| 1 | 50,000,000 | 3,366,478 | 3,000,000 | 50,366,478 |
| 2 | 50,366,478 | 3,391,152 | 3,000,000 | 50,757,630 |
| 5 | 51,620,716 | 3,475,600 | 3,000,000 | 52,096,316 |
| 10 | 54,341,229 | 3,658,771 | 3,000,000 | 55,000,000 |
| Ten years | 35,000,000 | 30,000,000 |
Total interest is $35,000,000: the $30,000,000 of rent plus the $5,000,000 by which the repurchase price exceeds the cash received. That is the true cost of the financing, and the accounting now shows it.
| Line | Failed sale | Successful sale |
|---|---|---|
| Gain on sale | 0 | 18,000,000 |
| Rent in operating expenses (EBITDA) | 0 | 3,000,000 |
| Interest expense | 3,366,478 | 0 |
| Depreciation of the building | 1,000,000 | 0 |
| Liability on the balance sheet | 50,000,000 | 21,566,491 |
Failure costs the seller three things it usually wanted from the deal. The $18,000,000 gain disappears, since under ASC 842 a successful sale at fair value recognises the whole gain at once. Reported debt is $50,000,000 instead of an operating lease liability of $21,566,491, the rent discounted at 6.50 per cent, which most leverage covenants treat more kindly. And pre-tax profit in year 1 is $1,366,478 lower, excluding the gain, because interest and depreciation exceed the rent. The one line that improves is EBITDA, which no longer carries the $3,000,000 of rent.
At year 10, if the option is exercised, paying $55,000,000 extinguishes the liability with no gain or loss. If it lapses, control passes then: the building, carried at $22,000,000 after ten years of depreciation, and the liability both come off, and the difference, $33,000,000, is recognised as a gain.
| Case | Effective rate | Year 1 interest, $ |
|---|---|---|
| Repurchase at $50,000,000 | 6.00% | 3,000,000 |
| Repurchase at $55,000,000 | 6.73% | 3,366,478 |
| Repurchase at $60,000,000 | 7.42% | 3,709,571 |
| Rent $2,500,000, repurchase at $55,000,000 | 5.77% | 2,883,510 |
| Rent $3,500,000, repurchase at $55,000,000 | 7.70% | 3,850,093 |
With the option priced at the sale price, the rent is the interest and the liability stays flat at $50,000,000. Every million of premium in the option price, or of extra rent, raises the effective rate, and the accounting simply reports the financing cost the contract already contains.
ASC 842 and IFRS 16 diverge here. Under IFRS 16 a successful sale and leaseback recognises only the gain on the rights transferred, not the whole gain; under ASC 842 a successful sale at fair value recognises all of it. Both standards treat a failed sale as a financing.
Accreting the liability at the incremental borrowing rate without looking at the repurchase price. At 6.50 per cent the liability reaches $53,373,606, and exercising the option then produces a charge on the gap in year 10 that belonged in the ten years of interest before it. The opposite mistake is treating any repurchase right as fatal: an option at fair value on an asset for which substantially similar substitutes are readily available can still allow sale accounting, although for a specific building that second test is rarely met, and the drafting of that one clause decides which of the two columns above the seller reports.
The lessee-side accounting arithmetic of the book's portfolio is in the free workbook for this book and the sale-leaseback model template; the IFRS 16 version of the gain is in how the gain is calculated under IFRS 16.
Failing the revenue standard's control transfer test, most often through a seller-lessee repurchase option, unless the option is at fair value and substantially similar assets are readily available. A fixed $55,000,000 buyback on a $50,000,000 sale fails, so the seller keeps the building and books a $50,000,000 financial liability instead of an $18,000,000 gain.
Practice starts from the seller-lessee's incremental borrowing rate and adjusts it where needed; when a fixed-price repurchase is expected, the rate is often solved so the liability reaches the option price. On the worked deal that is 6.73 per cent against a 6.50 per cent borrowing rate, which would leave the liability at $53,373,606 rather than $55,000,000.
Yes, compared with a successful one. The rent is treated as debt service, so the $3,000,000 a year leaves operating expenses and appears as $3,366,478 of interest in year 1, with the building's $1,000,000 depreciation continuing. EBITDA rises by the rent; pre-tax profit falls by $1,366,478 before the lost gain.
This article is one calculation from Sale and Leaseback. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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