DCAA has issued guidance intended to clarify a recent FAR 31.205-16 change we reported on regarding recognition of gains and losses on disposing of assets associated with sale-and-leaseback transactions and how the change affects lease/rental cost limitations in FAR 31.205-11, Depreciation costs and 31.205-36, Rental costs.  The guidance provides two helpful examples, one for a gain and one for a loss, and shows actual deletions and additions to the relevant cost principles.

Recognition Date.  Whereas prior to the rule change there was no specific identification of a date for recognizing gains and losses under a sale-leaseback arrangement, the new coverage requires the gains or loss be recognized on the date the contractor becomes a lessee.  

Allowable Loss Limitation.  Since sale-and-leaseback transactions are usually made to raise capital, the government is concerned that recognizing losses based on the net amount realized rather than on the fair market value of the asset may put the government at risk of reimbursing costs of raising capital and artificially inflating the loss.  The revised rule requires that the allowable amount of a loss be limited to the amount by which the net book value (i.e. undepreciated balance of the asset) exceeds the fair market value of the asset.

Government Participation in Gains.  FAR 31.205-16 has always limited recognition of any gain associated with disposing of capital assets to the amount of depreciation costs it previously recognized where for costing purposes, gains and losses are “considered as adjustments of depreciation costs previously recognized.”  Hence the government’s participation in the gain (i.e. credit) does not extend to any appreciation in asset value in excess of its acquisition cost.

Limitation on Lease/Rental Costs.  The rental and depreciation cost principles continue to limit the rental and lease costs associated with a sale-and-leaseback transaction to the amount that would have been allowed had the contractor retained title to the asset.  To ensure the government reimburses only its equitable share of an asset’s original acquisition cost, the allowable rental/lease costs will be computed based on the adjusted net book value after recognition of the gain or loss.

Existing Leases Under Sale-and-Leaseback Arrangements.  The guidance recognizes that assets under currently existing leases resulting from prior sale-and-leaseback transactions would not have been subjected to the recognition of gains or losses nor the the current rental/lease cost limitations reflect such gains or losses.  Hence the guidance says auditors should advice ACOs that an advanced agreement may be beneficial (MRD 05-PAC-053(R).

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