Creating Effective Documentation

Creating Effective Documentation

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ABC Company (NAME OF COMPANY IN CASE)

 

Date: September 24, 2012 (DATE ASSIGNMENT DUE)

 

Prepared by: Really Smart Senior (YOUR NAME)

 

 

Reviewed by: Professor Robert Elya

 

 

ISSUE: Accounting for ABC’s sale-sublease-leaseback of solar equipment with customers and third party investors. (THIS TOPIC/ISSUE LINE SHOULD SUCCINCTLY DESCRIBE THE OVERALL ACCOUNTING ISSUE BEING ADDRESSED IN THE MEMO)

 

 

 

BRIEF BACKGROUND OF COMPANY (THIS SECTION IS DESIGNED TO PUT THE ISSUE IN CONTEXT) THIS SECTION SHOULD BRIEFLY DESCRIBE THE IMPORTANT INFORMATION ABOUT THE COMPANY THAT A READER OF MEMO WOULD FIND HELPFUL IN EVALUATING THE ISSUE, INCLUDING NATURE OF ITS BUSINESS, RELATIVE SIZE (TO PROVIDE DEGREE OF MATERIALITY OF ISSUE TO THE COMPANY’S OVERALL FINANCIAL STATEMENTS),PUBLIC/PRIVATE (TO DETERMINE SEC CONSIDERATIONS), AND AN INTRODUCTION TO THE OVERALL QUESTION BEING ADDRESSED

 

ABC Company is a publicly held alternative energy firm that develops and leases solar panel technology to residential, government and commercial markets. As of December 31st, 2011, ABC Company recognized $X billion in revenue for the sale, lease and installation of photovoltaic solar systems. Customers have the choice of either purchasing or leasing ABC’s solar panels. ABC Company is currently involved in a sale and leasing arrangement involving residents and third party investors.

 

 

KEY CONSIDERATIONS INVOLVED IN THE ACCOUNTING QUESTIONS (IN THIS SECTION YOU WILL BREAKDOWN THE OVERALL ACCOUNTING QUESTION INTO ITS COMPONENT PARTS THAT MUST BE ANSWERED TO ARRIVE AT YOUR OVERALL CONCLUSION)

 

1. Is the Host Customer Agreement, between ABC and the residents, an operating or capital lease?

2. Are the solar systems considered integral equipment and therefore subject to the additional sale-leaseback requirements associated with real estate?

3. What is the classification of the leaseback from NBA to ABC Company?

4. What is the accounting for the sale sublease leaseback transaction?

 

 

SUMMARY CONCLUSION ON ACCOUNTING QUESTIONS (IN THIS SECTION THERE IS A CONCISE RESPONSE TO THE QUESTIONS STATED ABOVE)

 

1. The host customer agreement between ABC Company and the residents is classified as an operating lease. The agreement fails to meet any one of the 4 criteria that determine the classification of a capital lease.

2.The solar systems are not considered integral equipment. This is based on the assumption that the removal of the solar panels is simple and not costly. Therefore, no additional sale-leaseback accounting requirement is necessary.

3. The leaseback between ABC Company and NBA is considered a capital lease. The seller/lessee’s option to repurchase and the buyer/lessor’s option to compel the lessee to repurchase are assumed to satisfy the transfer of ownership criterion.

4. Since the sublease (Host Customer Agreement) is considered an operating lease, the lessor (ABC Company) should continue to recognize the assets on their balance sheet and depreciate them appropriately. An actual sale does not take place between ABC Company and NBA and therefore the sale lease back is not subject to normal leaseback accounting. The transaction should be treated as a financing obligation.

 

 

AUTHORITATIVE AND INTREPRETIVE GUIDANCE CONSIDERED (IN THIS SECTION YOU SHOULD LIST ALL THE GUIDANCE YOU REVIEWED IN RESEARCHING THE ISSUES. LIST ALL, INCLUDING THOSE THAT YOU SUBSEQUENTLY DID NOT CONSIDER THE CORRECT ALTERNATIVE TO SUPPORT YOUR CONCLUSION. IT IS IMPORTANT TO LIST ALL BECAUSE IT SUPPORTS THAT YOU WERE OPEN TO DIFFERENT ALTERNATIVES IN DOING YOUR RESEARCH, IT WAS UNBIASED. IT ALSO ALLOWS THE READER TO QUICKLY UNDERSTAND ALL THE MATERIAL YOU REVIEWED IN ARRIVING AT YOUR CONCLUSIONS)

 

Refer to FAS no. 98

Refer to FAS no. 66

Refer to ASC 840-40-25-01 (Classification of a leaseback arrangement) ASC 840-10-25-01

Refer to ASC 840-40-25-13-a (Common examples of continuing involvement)

Refer to ASC 840-40-25-17-a (Integral Equipment as a form of continuing involvement)

Refer to ASC 360-20-15-07 (Determinants of Integral Equipment) ASC 360-20-55-58 and

ASC 360-20-55-59 (Examples of determining whether or not fixtures qualify as integral equipment)

Refer to ASC 360-20-40-37 (Transfer of risks and rewards to owner)

Refer to ASC 360-20-40-38 (Option or Obligation to Repurchase as a form of continuing involvement)

Refer to ASC 360-20-40-41 (Guarantees as a form of continuing involvement)

Refer to ASC 840-40-25-11 (Accounting for a sale lease-back that does not qualify for normal sale lease-back accounting treatment)

Refer to ASC 840-40-55-75 (Finance method example)

 

 

 

DETAILED DISCUSSION, ANALYSIS, EVALUATION OF ALTERNATIVES & REASONS FOR CONCLUSION (THE FOLLOWING SECTIONS ARE THE MAIN BODY OF THE MEMO, AND IS WHERE YOU ADDRESS EACH QUESTION, AND INCORPORATE THE SPECIFIC DETAIL FACTS/FACT PATTERN OF THE CASE INTO THE APPLICABLE GUIDANCE. IT IS WHERE YOU PUT FORTH YOUR LOGICAL THOUGHT PROCESS AND THE SUPPORT FOR THE CONCLUSION YOU REACHED RELATIVE TO EACH COMPONENT QUESTION, AND ALSO WHY OTHER POSSIBLE ALTERNATIVES YOU IDENTIFIED WERE NOT FOLLOWED IN ARRIVING AT YOUR CONCLUSION. THIS WILL AGREE TO THE CONCLUSIONS YOU REACHED ABOVE AND IN TURN SUPPORT YOUR OVERALL CONCLUSION)

 

 

QUESTION 1 Does the Host Customer Agreement match any one of the four criteria that determine whether or not the lease is a capital lease, as stated in ASC 840-10-25-01? Additional information concerning the economic life of the assets and the present value of the lease payments under the host customer agreement is not available. This makes it difficult to assess the implications of minimum lease payments by residents and whether or not the present value of those payments makes up 90% of the underlying asset’s fair value, at lease inception (ASC 840-10-25-01-d). For the sake of simplicity, we will assume that the lease between ABC Company and the residents does not meet the other three criteria pertaining to ASC 840-10-25-01.   No other alternative accounting treatments were identified that required consideration. Based on the following factors we concluded it is an operating lease: 1. 2. 3.

 

 

 

 

 

QUESTION 2

Under SFAS no. 98 and SFAS66, a lease transaction does not qualify as a sale lease-back transaction if there are any elements of continuing involvement as defined by ASC 840-40-25-17. Integral equipment would qualify as continuing involvement since risk and ownership are not completely transferred upon sale.

Assumptions must be made in order to determine whether or not the solar panels, which have been leased to the residents, are considered integral equipment. Integral equipment is defined as “Any physical structure or equipment attached to the real estate, or other parts thereof, that cannot be removed and used separately without incurring significant cost” (asc.fasb.org).

There is not enough information to determine whether or not the solar panels constitute integral equipment; however, examples from ASC 360-20-55-58 and ASC 360-20-55-59 illustrate that the combined cost of removal and installation (and any costs incurred that are necessary for getting the solar panels ready for subsequent use) must be greater than or equal to 10% of the fair value of the equipment at lease inception in order to be considered integral.

We will again make a simplifying assumption – that there is no significant cost or burden involving the removal of the solar panels from the roofs of the resident’s properties – however, this is a moot point since there are other elements of continuing involvement, as discussed in issue 3.

 

No other alternative accounting treatments were identified that required consideration.

Based on the following factors we concluded it is an operating lease:

1.

2.

3.

 

 

QUESTION 3

Step 1: Is the sale-leaseback classified as an operating lease or a capital lease?

There is limited information regarding the classification of the lease between ABC Company and NBA. We will assume that the Head Lease satisfies the transfer of ownership criterion as stated by ASC 840-10-25-01-a. Additional information, concerning the 4 criteria of lease classification is not available; we must assume that the lessor’s option to compel the lessee to repurchase the assets, and the lessee’s option to repurchase the assets are sufficient to satisfy this criterion. Therefore, the Head Lease is a capital lease.

Step 2: Does the Head Lease between ABC Company and NBA avoid qualifying as continuing involvement?

According to ASC 360-20-40-37, an arrangement where, the buyer/lessor fails to assume all of the risks and rewards of ownership upon transfer of the asset, is considered continuing involvement. The following two conditions are met in the lease contract between ABC Company and NBA. These contract provisions satisfy the elements of continuing involvement and therefore, require different accounting treatment than that of a normal sale leaseback transaction.

ABC Company has the option to repurchase the solar panels back from NBA upon expiration of the lease and NBA has the option to demand that ABC Company repurchase the assets between years 5-7 at the greater of $0 or fair market value.

Under ASC 840-40-25-13-a, a repurchase option, where either the seller/lessee has the option to repurchase the asset underlying the lease agreement, or the buyer/lessor can compel the lessee to repurchase the asset, constitutes continuing involvement.

Furthermore, the Head Lease states that ABC Company must make guaranteed payments of local utilities incentive rebates to NBA. These cash flows that ABC Company guarantees for a specified period of time should be considered a form of continuing involvement, as well, according to ASC 840-40-25-13-b.

Based upon the assumptions above, the sale leaseback transaction is not subject to normal sale leaseback accounting as specified by ASC 840-40-25-09. Therefore, accounting by the lessee cannot be considered a form of off balance sheet financing and ABC Company must continue to record the assets underlying the lease and sublease.

Under 840-40-25-11, a sale leaseback transaction where the seller/lessee maintains a degree of continuing involvement must account for the transaction using either the financing or deposit method. When there is no longer any continuing involvement between the two parties, ABC can recognize the transaction as a true sale, as well as, any related gains or losses associated with sale of the assets.

 

 

 

 

 

QUESTION 4

The Host Customer Agreement, between ABC Company (as sub-lessor) and the residents is an operating sublease. Despite the fact that they are not the true owners of the solar panels, ABC Company should continue to recognize the assets on their balance sheet because they retain risks and rewards of controlling the assets. As cash for the minimum lease payments are received, rent revenue should be credited for the same amount. With each period, the depreciation expense should be matched with rent revenue and accumulated depreciation should be credited.

ABC Company (as sub-lessee) should recognize the transaction with NBA using the finance method as stated in ASC 840-40-55-75. Since the transaction does not qualify as an actual sale, ABC must recognize the 26.2 million as a finance obligation (liability) on their balance sheet. They should continue to depreciate the asset, which falls in line with their concurrent treatment and recognition of the operating lease or Host Customer Agreement with the residents.

 

 

REQUIRED FINANCIAL STATEMENT DISCLOSURE (IF GAAP WOULD REQUIRE SPECIFIC DISCLOSURE RELATIVE TO THIS TRANSACTION IN THE FINANCIAL STATEMENTS YOU WOULD INDICATE WHAT THOSE DISCLOSURE REQUIREMENTS ARE, AND ALSO PERHAPS A DRAFT OF THE APPROPRIATE DISCLOSURE FOR THIS CASE.)

 

 

In accordance with ASC XXXX the following information should be disclosed in ABC’s financial statements relative to the transaction:

 

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