Operating leases in IFRS 3 Business Combinations

Operating leases in IFRS 3 Business Combinations

If the acquired company (target company) in a business combination under IFRS reporting is a party to lease contracts at the date of acquisition, the acquirer needs to record these leases as part of the acquisition method. The acquired company can either be lessee (obtaining the right to use the leased asset) or lessor (providing the right to use the leased asset), the recognition of assets and liabilities and the classification of the lease contracts are depended on the role of the acquired company in the Business Combination.

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Here is a table with the IFRS accounting for operating leases in IFRS 3 Business Combinations in summary, this is explained in more detail below.

Acquired company’s role

Classification

Assets and liabilities that are recognised by the acquirer

Lessee

N/A

Right-to-use asset adjusted for favourable or unfavourable lease contract terms

Lease liability at present value of remaining lease payments at a discount rate incremental at the date of acquisition

Lessor

Operating lease

Leased asset with incorporated favourable or unfavourable lease contract terms (see below)

Customer relationships and other identifiable intangible assets measured at fair value

Leasehold improvements measured at fair value

Finance lease

Net investment in the lease (lease receivable and unguaranteed residual value of leased assets)

Customer relationships and other identifiable intangible assets measured at fair value

Acquiree in a business combination is a lessee

Reference IFRS 3 28A, IFRS 3 28BCustomer loyalty cards

Initial measurement of a lease

Consequential amendments to IFRS 3 specify the initial measurement requirements for leases that are acquired in a business combination.

The acquirer measures the acquired lease liability as if the lease contract were a new lease at the acquisition date. That is, the acquirer applies IFRS 16’s initial measurement provisions, using the present value of the remaining lease payments at the acquisition date. The acquirer follows the requirements for determining the lease term, lease payments and discount rate as for accounting for a new lease contract (which in fact the contract is from the perspective of the acquirer).

The right-of-use asset is measured at an amount equal to the recognised liability, adjusted to reflect the favourable (favourable operating leases on acquisition) or unfavourable terms of the lease (unfavourable operating leases on acquisition), relative to market terms. Because the off-market nature of the lease is captured in the right-of-use asset, the acquirer does not separately recognise an intangible asset or liability for favourable or unfavourable lease terms relative to market.

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The acquirer is not required to recognise right-of-use assets and lease liabilities for leases with lease terms which end within 12 months of the acquisition date and leases for low-value assets. The IASB considered whether to require an acquirer to recognise assets and liabilities relating to off-market terms for short-term leases and leases of low-value assets. However, the IASB indicated in the Basis for Conclusions (BC 298) that the effect of off-market terms would rarely be material for short-term leases and leases of low-value assets and so decided not to require this.

Subsequent measurement of a lease

The subsequent measurement requirements for an acquired lease liability and right-of-use asset are the same as the requirements for any other existing lease arrangement.

Recognising operating leases and intangible assets

Acquiree in a business combination is a lessor

Reference IFRS 3 17, IFRS 3 B42

IFRS 16 requires an acquirer to classify acquired lessor leases as either finance or operating leases using the contractual terms and conditions at the inception of the lease, or, if the terms of the contract have been modified in a manner that would change its classification, at the date of that modification. Therefore, the classification is not changed as a result of a business combination unless a lease in itself is modified. Such lease modifications have to be accounted for as regular IFRS 16 Lessor modifications (LLIIINNNK).

In measuring the acquisition-date fair value of an asset such as a building or a patent that is subject to an operating lease in which the acquiree is the lessor, the acquirer shall take into account the terms of the lease. The acquirer does not recognise a separate asset or liability if the terms of an operating lease are either favourable (favourable operating leases on acquisition) or unfavourable (unfavourable operating leases on acquisition) when compared with market terms (IFRS 3 B42).

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See also: IFRS Community – Lessee or Lessor in Business Combinations

Operating leases in IFRS 3 Business Combinations

Operating leases in IFRS 3 Business Combinations Operating leases in IFRS 3 Business Combinations Operating leases in IFRS 3 Business Combinations Operating leases in IFRS 3 Business Combinations Operating leases in IFRS 3 Business Combinations Operating leases in IFRS 3 Business Combinations Operating leases in IFRS 3 Business Combinations Operating leases in IFRS 3 Business Combinations

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