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

A lessor classifies a lease as either a finance lease or an operating lease, as follows:

  • leases that transfer substantially all of the risks and rewards incidental to ownership of the underlying asset are finance leases; and
  • all other leases are operating leases. (IFRS 16.62–63)

The lease classification test is essentially unchanged from IAS 17.

Generally, the presence of the following indicators, either individually or in combination, leads to a lease being classified as a finance lease:

  • transfer of ownership to the lessee either during or at the end of the lease term;
  • existence of a purchase option that is reasonably certain to be exercised;
  • the lease term is for a major part of the economic life of the underlying asset;
  • the present value of the lease payments amounts to substantially all of the fair value of the underlying asset at inception of the lease; and
  • the underlying asset is specialised.

Lease classification is made at the inception date and is reassessed only if there is a lease modification. Changes in estimates (e.g. changes in estimates of the economic life or of the residual value of the underlying asset), or changes in circumstances (e.g. default by the lessee), do not give rise to a new classification of a lease for accounting purposes. (IFRS 16.66)

However, if the contract includes terms and conditions to adjust the lease payments for particular changes occurring between the inception date and the commencement date, then, for the purpose of classifying the lease, the effect of any such changes is deemed to have taken place at the inception date. (IFRS 16.B54)

Food for thought – What is the typical classification of real estate leases?

Typically, landlords classify leases of real estate as operating leases, because the underlying asset – the real estate – generally has a long useful life and significant residual value.

However, a lease of real estate may be classified as a finance lease. This may be the case, for instance, if the lease term is very long or the underlying property is of a specialised nature or for structured transactions. In addition, sub-leases of real estate are now more likely to be classified as finance leases – see Sub-leases.

Food for thought – Are there special rules on the classification of leases of land?

No. The classification of a lease of land is assessed based on the general classification guidance. An important consideration is that land normally has an indefinite economic life. However, the fact that the lease term is normally shorter than the economic life of the land does not necessarily mean that a lease of land is always an operating lease; the other classification requirements are also considered. (IFRS 16.B55, IFRS 16.BCZ241–BCZ24)

For example, in a 99-year lease of land with fixed lease payments, the significant risks and rewards associated with the land are transferred to the tenant during the lease term, and on lease commencement the present value of the residual value of the land would be negligible. It follows that a long lease term may indicate that a lease of land is a finance lease.

There is no bright-line threshold for the lease term above which a lease of land would always be classified as a finance lease, and assessing classification can require the use of significant judgement in some cases.

Food for thought – Do changes between the inception and commencement dates impact lease classification?

Yes, in some cases. Generally, the classification of a lease is determined at inception of the lease and is not revised unless the lease agreement is modified. However, the classification is updated for certain changes between inception date and commencement date that are deemed to have taken place at the inception date.

A significant amount of time may pass between the inception date and the commencement date – e.g. when parties commit to leasing an underlying asset that has not yet been built. A lease contract may also include terms and conditions to adjust the lease payments for changes that occur between the inception date and the commencement date – e.g. a change in the lessor’s cost of the underlying asset or a change in the lessor’s cost of financing the lease.

In such cases, the calculation of the present value of lease payments used in determining the classification of the lease covers all lease payments made from the commencement of the lease term. However, if the lease payments are adjusted for contractual changes such as changes in the construction or acquisition cost of the underlying asset, general price levels or the lessor’s costs of financing the lease between the inception and commencement dates, then the effect of these changes is deemed to have taken place at inception for the purpose of classifying the lease.

It appears that the lease payments for classification purposes should also be updated for changes between the inception and commencement dates in:

  • the non-cancellable period of the lease;
  • lease payments that depend on an index or a rate; and
  • variable payments that become in-substance fixed.

In general these changes are akin to contractual changes between the inception and commencement dates, and therefore the effect of these changes should be deemed to have taken place at inception for the purpose of classifying the lease. Consequently, a lessor should also update the rate implicit in the lease and its estimate of the unguaranteed residual value for classification purposes for such contractual changes.

However, for measurement purposes it appears that a lessor should update the lease payments, the rate implicit in the lease and the unguaranteed residual value for all changes between inception and commencement date. This is because a lessor measures the net investment in a finance lease, and the amount of operating lease income to be recognised, at the commencement date.

3 Operating lease model

The lessor classifies a lease that is not a finance lease as an operating lease. It accounts for an operating lease asLandlord accounting model follows.

Statement of financial position:

  • continue to present the underlying asset; and
  • add any initial direct costs incurred in connection with obtaining the lease to the carrying amount of the underlying asset.

Statement of profit or loss:

  • recognise lease income over the lease term, typically on a straight-line basis; and
  • expense costs associated with the underlying asset (e.g. depreciation).

Generally, a lessor recognises lease income on a straight-line basis from the commencement date over the lease term. However, it may be possible for the lessor to recognise lease income using another systematic basis if that is more representative of the time pattern in which the benefit from the use of the underlying asset is diminished. The initial direct costs are recognised as an expense on the same basis as the lease income over the lease term. (IFRS 16.81, IFRS 16.83)

A lessor applies IAS 36 Impairment of Assets to determine whether an underlying asset subject to an operating lease is impaired and to account for any impairment loss identified. In addition, the lessor applies the impairment and derecognition requirements of IFRS 9 Financial Instruments to operating lease receivables. (IFRS 16.85, IFRS 9.2.1(b)(i))

4 Finance lease modelLandlord accounting model

A lessor accounts for a finance lease as follows.

Statement of financial position:

  • derecognise the underlying asset; and
  • recognise a finance lease receivable at an amount equal to the net investment in the lease.

Statement of profit or loss:

  • recognise finance income on the net investment in the lease over the lease term, based on a pattern reflecting a constant rate of return on the net investment;
  • recognise any reduction in the estimated unguaranteed residual value; and
  • recognise any loss allowance on the finance lease receivable.

A lessor initially measures a finance lease receivable at the present value of the future lease payments plus any unguaranteed residual value accruing to the lessor, discounted at the interest rate implicit in the lease. Initial direct costs are included in the measurement of the finance lease receivable, because the interest rate implicit in the lease takes initial direct costs incurred into consideration. (IFRS 16.67–69)

The ‘interest rate implicit in the lease’ (IFRS 16 Definition) is the discount rate at which:

  • the sum of the present value of (i) the lease payments and (ii) the unguaranteed residual value equals
  • the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.

For additional guidance, see Discount rates.

A lessor applies the derecognition and impairment requirements of IFRS 9 to the net investment in the lease. A lessor regularly reviews estimated unguaranteed residual values used in computing the gross investment in the lease. If there is a reduction in the estimated unguaranteed residual value, then the lessor revises the income allocation over the lease term without changing the discount rate and immediately recognises any reduction in respect of amounts accrued. (IFRS 16.77)

For a discussion on measuring the expected credit losses on lease receivables, see ECL lease receivables.

Annualreporting provides financial reporting narratives using IFRS keywords and terminology for free to students and others interested in financial reporting. The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. Use at your own risk. Annualreporting is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org or the local representative in your jurisdiction.

Landlord accounting model

Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model

Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model Landlord accounting model

Leave a comment