Sub-leases of real estate – IFRS 16 Best short read

Sub-leases of real estate

New classification guidance means that more sub-leases are finance leases under IFRS 16 than previously, impacting the financial position and financial performance of intermediate landlords.

A sub-lease is a transaction in which a lessee (or ‘intermediate lessor’) grants a right to use the underlying asset to a third party, and the lease (or ‘head lease’) between the original lessor and lessee remains in effect. (IFRS 16.3)

A company applies IFRS 16 to all leases of right-of-use assets in a sub-lease. The intermediate lessor accounts for the head lease and the sub-lease as two different contracts.

Sub-leases of real estate

An intermediate lessor classifies the sub-lease as a finance lease or as an operating lease with reference to the right-of-use asset arising from the head lease. That is, the intermediate lessor treats the right-of-use asset as the underlying asset in the sub-lease, not the item of property, plant or equipment that it leases from the head lessor. (IFRS 16.B58)

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Landlord Lease modifications

Landlord Lease modifications / Rental modifications

Accounting for lease modifications has become a hot topic due to the COVID-19 pandemic, with many tenants seeking rent concessions and other changes to lease agreements.

Unlike IAS 17, IFRS 16 provides detailed guidance on the lessor accounting for lease modifications, with separate guidance for modifications to finance leases and operating leases.

A lease modification is a change in the scope of a lease, or the consideration for a lease, that was not part of its original terms and conditions. Common examples are:

  • decreasing the scope of the lease by removing the right to use one or more underlying assets;
  • decreasing the scope of the lease by shortening the contractual lease term; and
  • changing the consideration in the lease by increasing or decreasing the lease payments.

Changes that result from renegotiations of the original contract are lease modifications.

The exercise of an option included in the original lease contract is not a modification. There is no lease modification when a lessor reassesses the lease term if:

  • the lessee exercises an option not previously included in the lessor’s determination of the lease term;
  • the lessee does not exercise an option previously included in the lessor’s determination of the lease term;
  • an event occurs that contractually obliges the lessee to exercise an option not previously included by the lessor; or
  • an event occurs that contractually prohibits the lessee from exercising an option previously included by the lessor (see Changes in the lease term).

The following diagram summarises the accounting for lease modifications by a lessor/landlord.

Original lease is a finance lease

Change to contractual terms and conditions

Original lease is an operating lease

Increase in scope of lease by adding right of use for one or more underlying assets and at stand-alone price for increase

All other contract modifications.

Classification at inception if modification had been in effect then as:

Operating lease

Finance lease

Separate lease

Not a separate lease

Apply IFRS 9

Modifications to operating leases

Food for thought – When does a lessor account for a lease modification?

Similar to a lessee, a lessor accounts for modifications to operating and finance leases on the effective date of the modification. This is the date when both parties agree to the lease modification. (IFRS 16.79–80, IFRS 16.87)

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Sales outside ordinary activities – best way of combining IFRS 15 IAS 16 IAS 38 and IAS 40

Sales outside ordinary activities

Certain aspects of IFRS 15 apply to the sale or transfer of non-financial assets – e.g. intangible assets and property, plant and equipment – that are not an output of the entity’s ordinary activities.

Under IFRS 15, the guidance on measurement and derecognition applies to the transfer of a non-financial asset that is not an output of the entity’s ordinary activities, Sales outside ordinary activitiesincluding:

When an entity sells or transfers a non-financial asset that is not an output of its ordinary activities, it derecognises the asset when control transfers to the recipient, using the guidance on transfer of control in the respective standard IAS 16, IAS 38 or IAS 40 (see Transfer of control).

The resulting gain or loss is the difference between the transaction price measured under IFRS 15 (using the guidance in Step 3 of the model) and the asset’s carrying amount. In determining the transaction price (and any subsequent changes to the transaction price), an entity considers the guidance on measuring variable consideration – including the constraint, the existence of a significant financing component, non-cash consideration and consideration payable to a customer (see Step 3 – Determine the transaction price).

The resulting gain or loss is not presented as revenue. Likewise, any subsequent adjustments to the gain or loss – e.g. as a result of changes in the measurement of variable consideration – are not presented as revenue.

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Landlord Lease payments

Landlord Lease payments

Distinguishing between fixed and variable lease payments will impact the profile of a landlord’s earnings.

1. Overview

At commencement, a lessor identifies the lease payments, which include: (IFRS 16.70)

  • fixed payments, including in-substance fixed payments, less any lease incentives;Landlord Lease payments
  • variable lease payments that depend on an index or a rate;
  • the exercise price of a purchase option if the lessee is reasonably certain to exercise that option;
  • payments of penalties for terminating the lease, if the lease term reflects the assessment that the lessee will exercise an option to terminate the lease; and
  • the full amount (regardless of the likelihood that payment will be due) of any residual value guarantees provided to the lessor by the lessee, by a party related to the lessee or by a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee.

Real estate leases will often include some or all of the following:

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Landlord lease definition

Landlord lease definition

Identifying a lease of real estate is usually straightforward – but some scenarios will require judgement.

1 Overview

A lease is a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration. (IFRS 16.B9)

The key factors to consider when applying the lease definition are as follows.

Landlord lease definition

2 Applying the definition to real estate

Types of properties common in real estate leases include:

  • land and buildings;
  • office space: e.g. a floor of a building;
  • retail space;
  • specified spots in a car park; and
  • residential property.

When applying the lease definition to real estate arrangements, it will usually be clear whether the arrangement meets the lease definition criteria.

Key factors to consider when applying the lease definition are as follows.

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Sale-and-leaseback of real estate – IFRS 16 Best complete read

Sale-and-leaseback of real estate

New guidance on ‘failed sales’ means that some sale-and-leaseback transactions are accounted for as pure financing transactions by both landlords and tenants.

In a sale-and-leaseback transaction, a company (the seller-tenant) transfers an underlying asset to another company (the buyer-landlord) and leases that asset back from the buyer-landlord. (IFRS 16.98–103)


To determine how to account for a sale-and-leaseback transaction, a company first considers whether the initial transfer of the underlying asset from the seller-tenant to the buyer-landlord is a sale. The company applies IFRS 15 to determine whether a sale has taken place. This assessment determines the accounting by both the buyer-landlord and the seller-tenant.


Transfer to buyer-landlord is a sale

* Adjustments are required if the sale is not at fair value or the lease payments are off-market. A company is not required to assess both, however – only whichever one is more ‘readily determinable’.

Transfer to buyer-landlord is not a sale


Transfer to buyer-landlord is a sale

* Adjustments are required if the sale is not at fair value or the lease payments are off-market. A company is not required to assess both, however – only whichever one is more ‘readily determinable’.

Transfer to buyer-landlord is not a sale

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Leased investment property

Leased investment property

It is mandatory rather than optional for landlords to apply IAS 40 to account for leased investment property, requiring landlords to disclose fair value information for all leased investment property.

A company applies IAS 40 to account for a right-of-use asset if the underlying asset would otherwise meet the definition of investment property. (IAS 40.2, IAS 40.30, IFRS 16.48, IFRS 16.56)

Under IAS 40, a company chooses as its accounting policy either the fair value model or the cost model for measuring its investment property. The company applies the policy to all of its investment property – i.e. it applies the same policy to owned and leased investment property. However, in either case the company complies with the disclosure requirements of IAS 40 – including disclosures of the fair value of the investment property. (IFRS 16.34, IFRS 16.56, IAS 40.30)

Leased investment propertyIf a lessor enters into an operating lease of investment property, then it continues to recognise the investment property. In contrast, if a lessor enters into a finance lease of investment property, then it derecognises the investment property and instead recognises a net investment in the lease, which is accounted for under IFRS 16.

An intermediate lessor classifies a sub-lease as a finance lease or an operating lease with reference to its right-of-use asset under the head lease rather than the underlying asset – see Sub-lease. (IFRS 16.B58)

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Separate lease and non-lease components for real estate under IFRS 16

Separate lease and non-lease components

Many real estate leases contain multiple lease and non-lease components, which landlords need to identify and account for separately.

1 Overview

IFRS 16 requires a landlord to separate the lease and non-lease components of a contract. (IFRS 16.12, IFRS 16.BC135(b))

In practice, real estate contracts may contain:

  • one or more lease components: e.g. the right to use land and/or a building; and
  • one or more non-lease components: e.g. maintenance, cleaning and provision of utilities.

For lessors, identifying components and allocating consideration will determine the split of lease income vs revenue from contracts with customers. These amounts are often presented and have to be disclosed separately. For example, a real estate company will need to distinguish lease income from revenue for other property related services – e.g. common area maintenance (CAM). (IFRS 15.110, IFRS 15.114, IFRS 16.90)

The key steps in accounting for the components of a contract are as follows.

Identify separate lease components (go here)

Identify non-lease components (go here)

Allocate consideration (go here)

Reallocate consideration on lease modification (go here)

2 Typical lease components in real estate contracts

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Landlord Lease term – IFRS 16 Best complete read

Landlord Lease term

New guidance on lease term could impact the period over which operating lease incentives are recognised in profit or loss, particularly for renewable and cancellable leases.

1 Overview of landlord lease term

Determining the lease term is a critical estimate that is significant for the lessor. The lease term may affect the lease classification. For operating leases, it impacts the period over which lease incentives are recognised.

The lease term is the non-cancellable period of the lease, together with:

  • optional renewable periods if the lessee is reasonably certain to extend; and
  • periods after an optional termination date if the lessee is reasonably certain not to terminate early. (IFRS 16.18)

To determine the lease term, a lessor first determines the length of the non-cancellable period of a lease and the period for which the contract is enforceable. It can then determine – between those two limits – the length of the lease term.

The lessor determines the lease term at the commencement date.

The lease term starts when the lessor makes the underlying asset available for use by the lessee. It includes any rent-free periods. (IFRS 16 Definition, IFRS 16.B36)

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Landlord accounting model – IFRS 16 best replacement for IAS 40

Landlord accounting model

Landlords continue to classify leases as finance or operating leases, and continue to classify many real estate leases as operating leases.

1 Overview

The lessor follows a dual accounting approach for lease accounting. The accounting is based on whether significant risks and rewards incidental to ownership of an underlying asset are transferred to the lessee, in which case the lease is classified as a finance lease. This is similar to the previous lease accounting requirements that applied to lessors.

What are the impacts of IFRS 16 on lessors?

Much of the guidance in IFRS 16 on lessor accounting is a ‘carry forward’ from IAS 17 Leases – literally a cut-and-paste. This reflects feedback from financial statement users and other stakeholders that lessor accounting was not ‘broken’.

However, there are a number of changes in the details of lessor accounting. For example, lessors apply the new:

  • definition of a lease (see this page);
  • guidance on separating components of a contract (see this page);
  • guidance on lease term (see this page);
  • guidance on lease modifications (see this page);
  • guidance on sub-lease (see this page); and
  • guidance on sale-and-leaseback (see this page).

The same definition of ‘lease term’ applies to both lessees and lessors. IFRS 16 includes guidance on when extension options and termination options are taken into consideration when determining the lease term. Additional guidance has been issued about determining the lease term – an estimate that could significantly impact the overall lease accounting.

In addition, IFRS 16 includes specific guidance on separating the components of a contract and accounting for lease modifications by lessors.

The new guidance may significantly impact the accounting for sub-leases and sale-and-leaseback transactions.

2 Lease classification

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