“I am convinced this deal would not have happened without Century’s honesty, hard work, and their willingness to think outside the box as different issues arose.”

- Chris Ayers, NAI Olympia Partners

Financial Statement Impact

When structuring a sale/leaseback transaction, most companies prefer that the transaction be presented in the financial statements as an “operating lease” as opposed to a “capital lease.” The financial advantages of an operating lease are discussed in the “Sale/Leaseback Benefits” section. The distinction between these two types of leases is governed by Generally Accepted Accounting Principles (GAAP) as outlined in FASB statement No. 13 as amended.

There are five basic tests that a sale/leaseback transaction must pass in order to qualify as an operating lease. The following questions are answered by examining the terms of the lease agreement, with an answer of “No” to all required for the lease to be treated as an “operating lease.”

  1. Does the lease transfer ownership of the real estate from the landlord to the tenant?
  2. Does the lease provide for a bargain purchase option less than fair market value?
  3. Does the beginning of the lease term fall within the last 25% of the total estimated economic life of the real estate?
  4. Is the lease term, excluding renewal options, greater than 75% of the estimated economic life of the real estate?
  5. Is the present value of the minimum lease payments greater than or equal to 90% of the fair market value of the real estate?

When a sale/leaseback is structured as a “capital lease,” both the real estate asset and the associated debt are added to the balance sheet. Only the building portion of the real estate asset (not land) is depreciated, usually over 40 years, and deducted as an expense from the income statement. Also, only the interest portion of cash payments to the lender is deducted as an expense from the income statement.

However, when the sale/leaseback is structured as an “operating lease,” the real estate asset and the associated debt are omitted from the balance sheet. Footnote disclosure of future minimum rental payments in the aggregate and for each of the five succeeding fiscal years is required. The full rental payments are deducted over the term of the lease as expense from the income statement.

Century Equities can structure the sale/leaseback transaction and assist you through the maze of accounting requirements in order to ensure that the transaction takes advantage of the financial statement presentation afforded by an operating lease.