Financial Accounting and Reporting-CPA Practice Exam

In US GAAP, recognition of profits for a sale-leaseback depends on what primary factor?

1. The financial health of the lessee

2. Whether it's a capital or operating lease

3. The economic environment

4. Market demand for the asset

The correct answer is: Whether it's a capital or operating lease

The recognition of profits for a sale-leaseback transaction under US GAAP primarily hinges on whether the lease is classified as a capital lease or an operating lease. This distinction is crucial because it affects how the transaction is recorded in the financial statements. In a sale-leaseback arrangement, the seller-lessee sells an asset and simultaneously leases it back from the buyer-lessor. If the lease is classified as a capital lease, it indicates that the risks and rewards of ownership have not effectively been transferred. In such cases, any profit on the sale may not be fully recognized upfront on the income statement since the asset remains on the seller-lessee's balance sheet as a capital asset. Conversely, if the lease qualifies as an operating lease, meaning the lessee does not retain significant risks and rewards associated with ownership, the seller-lessee can recognize the profit on the sale more fully in the current period. Therefore, the classification of the lease directly determines the accounting treatment of the transaction and, consequently, the recognition of profits. It's important to note that while factors such as financial health of the lessee, economic environment, and market demand for the asset may have implications in other contexts, they do not play a direct role in the specific accounting treatment under