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Dear Stephen,
Could you please explain on accounting treatment of Example 8 written in BPP’s Text Book:
Questions:
Fradin, an international hotel chain, is currently finalising its FS for the year ended 30 June 20X8, and is unsure how to account for the following transactions
On 01 July 20X7 (T??c la? ?âu n?m), it sold one of its hotels to a third party institution and is leasing it back under a 10-year lease. The sale price is $57mil and the fair value of the asset is $60mil.
The lease payment is $2.8mil/year in arreas commencing on 30 June 20X8.
The present value of lease payment is $20mil and the implicit interest rate in the lease is 6.6%.
The purchasers can cancel the lease agreement and take full control of the hotel with 6 months’ notice.
The hotel had a remaining economic life of 30 years at 01 July 20X7 and a carrying amount (under the cost model) of $48mil.
Answer:
The carrying amount of the hotel asset of $48mil should be derecoginized.
The right of use asset should be then recognized: =48*20/60 = 16
The excess of fair value of the assets and carrying amount should be treated as prepayment: 60 – 57 = 3mil (I don’t understand why this should be treated as prepayment). This make the right of use asset to be additionally recorded at $3mil => $19mil.
A gain on sale is recognized: 60 – 48 =12
Gain in relation to rights retained: 12*20/60 = 4 (I don’t understand what is rights retained and gain in relation to rights retained)
Gain relating to the rights transferred is (balancing figures): 8 (I don’t understand what is rights transferred and gains in relation to rights transferred).Appreciate your help in explaining the above.
When I teach from the BPP book I simplify the example. Simplification is that selling price of 57 is also the FV of the asset.
So:
Dr Cash 57
Dr Right of Use asset (20/57×48) 17
Cr PPE 48
Cr Liability 20
Cr P&L 6 (balancing figure)
Bear in mind that SBR is words not numbers in the real exam – what you need to explain is that they no longer own the old asset (PPE) but the they do now have the right to use it for 10 years, hence they have a right of use asset.And that is plenty!
@stephenwidberg said:
When I teach from the BPP book I simplify the example. Simplification is that selling price of 57 is also the FV of the asset.
So:
Dr Cash 57
Dr Right of Use asset (20/57×48) 17
Cr PPE 48
Cr Liability 20
Cr P&L 6 (balancing figure)
Bear in mind that SBR is words not numbers in the real exam – what you need to explain is that they no longer own the old asset (PPE) but the they do now have the right to use it for 10 years, hence they have a right of use assetAnd that is plenty!
Thank you for your understanding. Now I understand that regarding sales and lease back, we would separate into two transactions for clearer understanding:
1/ Sales: As performance obligation is satisfied, risk and rewards are transferred to the clients, we DErecognize the asset.
2/ When we lease back, we should recognize the right-of-use asset corresponding to 10 years and the gain from the sale (FV – Carrying amount) should be separated into two part: Gain related to right transfer and gain related to right retained.
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