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Letters of credit for sale-leaseback transactions.




This month's column discusses a recent consensus reached by the Financial Accounting Standards Board emerging issues task force (EITF or task force) concerning letters of credit issued in conjunction with a sale-leaseback transaction.

EITF Abstracts, copyrighted by the FASB, is available in soft-cover and loose-leaf versions and may be obtained by contacting the FASB order department at 401 Merritt 7, P.O. Box 5116, Norwalk, Connecticut 06856-5116. Phone: (203) 847-0700

ISSUE NO. 90-20

This EITF issue, Impact of an Uncollateralized Irrevocable Letter of Credit on a Real Estate Sale-Leaseback Transaction, considers the effect of a letter of credit on sale-leaseback accounting under FASB Statement no. 98, Accounting for Leases: Sale-Leaseback Transactions Involving Real Estate. The facts are these:

A seller-lessee (Company A) enters into a real estate sale and leaseback transaction with an unrelated buyer-lessor (Company B). The agreement appears to meet all the provisions necessary to recognize a sale of the property under Statement no. 98. (Sale-leaseback accounting allows the seller-lessee to record a sale and remove the property and related liabilities from the balance sheet and allows a gain or loss.)

However, in connection with the leaseback, Company B requires Company A to provide an irrevocable letter of credit securing a portion or all of the lease payments in the event of a lease default. Company A will not pledge any assets or collateral to the letter of credit's issuer. A continuing involvement by Company A would preclude sale-leaseback accounting under Statement no. 98.

Accounting issue. The issue is whether the letter of credit constitutes a form of continuing involvement (other than the "normal leaseback") that would preclude the use of sale-leaseback accounting by Company A.

Arguments. Those who would preclude sale-leaseback accounting believe a letter of credit is evidence of seller-lessee continuing involvement. They further contend that any letter of credit provided by the seller-lessee constitutes additional collateral under paragraph 12(d) of Statement no. 98 because it gives the buyer-lessor another source of collection of the lease payments if there's a lease dispute or seller-lessee bankruptcy.

Those supporting sale-leaseback accounting believe a bank letter of credit is a common provision in lease agreements and falls under the concept of a normal leaseback. They contend that although paragraph 12(d) prohibits any form of commitment by the seller-lesse that exceeds its obligation to pay rent, an uncollateralized letter of credit does not extend the lessee's risk beyond the specified lease payments.

Consensus. The EITF concluded an uncollateralized, irrevocable letter of credit should not be considered a form of continuing involvement by the seller-lessee to preclude sale-leaseback accounting under Statement no. 98. However, the EITF stressed all written contracts existing between the seller-lessee and the issuer of a letter of credit must be considered to determine any underlying collateral arrangements that might constitute a form of continuing involvement and thereby preclude sale-leaseback accounting under Statement no. 98.

By MOSHE S. LEVITIN, CPA, senior technical manager, and LINDA A. VOLKERT, CPA, and GAIL KAHANER POLIN, CPA, technical managers, of the AICPA technical information division.
COPYRIGHT 1991 American Institute of CPA's
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Copyright 1991, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:Polin, Gail Kahaner
Publication:Journal of Accountancy
Date:Dec 1, 1991
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