Sale and leaseback accounting under IFRS 15

Sale and leaseback accounting

A sale and lease back transaction is a popular way for entities to secure long-term financing from substantial property, plant and equipment assets such as land and buildings. IFRS 16 made significant changes to sale and lease back accounting in comparison with IAS 17. A sale and leaseback transaction is one where an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) for consideration and leases that asset back from the buyer-lessor.

The IFRS 16 guidance on ‘failed sales’ means that some sale-and-lease back transactions are accounted for as pure financing transactions by both lessors and lessees.

In a sale-and-lease back transaction, a company (the seller-lessee) transfers an underlying asset to another company (the buyer-lessor) and leases that asset back from the buyer-lessor.  [IFRS 16.98–103]

Sale and leaseback

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

Lessee (seller)

Lessor (buyer)

Transfer to buyer-lessor is a sale

Disclosure non-financial assets and liabilities

Transfer to buyer-lessor is not a sale

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

Case – Sale-and-leaseback transaction when transfer is a sale

[IFRS 16.IE11]

Company C sells an office building to Company D for cash of 1,000,000.

Immediately before the transaction, the building is carried at a cost of 500,000.

At the same time, C enters into a contract with D for the right to use the building for 15 years with annual payments of 80,000 payable at the end of each year.

The transfer of the office building qualifies as a sale under IFRS 15.

The fair value of the office building on the date of sale is 900,000. Because the consideration for the sale of the office building is not at fair value, C and D make adjustments to recognise the transaction at fair value. The amount of the excess sale price of 100,000 (1,000,000 – 900,000) is recognised as additional financing provided by D to C. The incremental borrowing rate of the lessee is 5.0% per annum. The present value of the annual payments is 830,400, of which 100,000 relates to the additional financing and 730,400 relates to the lease – corresponding to 15 annual payments of 9,634 and 70,366, respectively, when discounting at 5.0% per annum.

Seller-lessee perspective

C recognises the transaction as follows.

  • C measures the right-of-use asset retained through the leaseback of the office building as a proportion of its previous carrying amount, which is 405,778 (730,400 / 900,000 x 500,000).
  • The total gain on the sale of the building amounts to 400,000 (900,000 – 500,000), of which:
    • 324,622 (730,400 / 900,000 x 400,000) relates to the right to use the office building retained by C; and
    • 75,378 ((900,000 – 730,400) / 900,000 x 400,000) relates to the rights transferred to D.
  • C recognises only the portion of the gain on sale that relates to the rights transferred to D, which is 75,378.

At the commencement date, C makes the following entries.

Debit

Credit

Cash

1,000,000

Right-of-use asset

405,778

Building

500,000

Financial liability

830,400

Gain on sale-and-leaseback

75,378

To recognise sale-and-leaseback

Buyer-lessor perspective

At the commencement date, D makes the following entries.

Debit

Credit

Building

900,000

Financial asset

100,000

Cash

1,000,000

To recognise acquisition

Case – Sale and leaseback

SellCo sells a building to BuyCo for cash of CU1,800,000, which is its fair value at that date. The previous carrying value of the building is CU1,000,000. At the same time, SellCo enters into a lease with BuyCo conveying back the right to use the building for 18 years. Annual payments are CU120,000 payable at the end of each year, which is at market rate. The transfer qualifies as a sale based on the guidance on satisfying a performance obligation in IFRS 15. The rate implicit in the lease is 4.5%, which is readily determinable by SellCo.

SellCo

The present value of the annual payments (18 payments of CU120,000, discounted at 4.5%) is CU1,459,200. SellCo measures the right-of-use asset retained through the leaseback as a proportion of the previous carrying amount of the building. This is calculated as: CU1,000,000 (previous carrying value) x [CU1,459,200 (PV of lease payments)/ CU1,800,000 (fair value of building)]. The right-of-use asset calculated in this way is CU810,667. SellCo recognises a portion of the total gain on the sale, to the extent it relates to the rights retained in the underlying asset by BuyCo at the end of the leaseback. The total gain on sale of building is CU800,000 (CU1,800,000 – CU1,000,000). This total is split into: Sale and leaseback accounting

  • the portion relating to the rights to use the building retained by SellCo, calculated as CU800,000 x [CU1,459,200/ CU1,800,000] which is CU648,533; and
  • the portion relating to BuyCo’s rights in the underlying asset at the end of the leaseback, calculated as CU800,000 x [(CU1,800,000 – CU1,459,200)/CU1,800,000], which is CU151,467.

At the commencement date, SellCo’s accounting entries are: Sale and leaseback accounting

BuyCo The case – Sale and leaseback

At the commencement date, BuyCo’s accounting entries are: The case – Sale and leaseback

BuyCo classifies the lease as an operating lease taking into account, among other things, that the present value of the lease payments is 19% less than the fair value of the building. BuyCo accounts for the lease accordingly.

How does a buyer-lessor assess whether a transaction qualifies for sale-and-leaseback accounting?

The buyer-lessor assesses whether the transfer leg meets the requirements for determining when a performance obligation is satisfied under IFRS 15. Put another way, the buyer-lessor assesses whether the seller-lessee has transferred control of the property. This assessment is made from the perspective of the seller-lessee. [IFRS 16.99]

There is no specific or additional guidance in IFRS 16 about how to make the Transfer of control-assessment. Instead, the parties apply the guidance in IFRS 15, which is as follows: [IFRS 15.31–32]

Control is …..
the ability
  • the buyer (and now lessor) has ‘acquired’ the present right

to direct the use of
  • the right enables it to:
    • deploy the property in its activities
    • allow another entity to deploy the property in its activities
    • prevent another entity from deploying the property
and obtain the remaining benefits from
  • the right also enables it to obtain potential cash flows directly or indirectly – for example, through:
    • use of the property
    • consumption of the property
    • sale or exchange of the property
    • pledging the property
    • holding the property
    • lease the property to an entity
… the property by which buyer-lessor is the legal owner and has leased it to the seller (and now lessee)

Cases in which the assessment is clear – Repurchase options

In some cases, it will be clear that the transfer leg does not meet this test, and therefore the transaction should be accounted for as a financing transaction.

For example, some transactions contain a call option under which the seller-lessee can, at its option, repurchase the property. Such an option generally precludes sale accounting under IFRS 15, because the existence of the call option means that the seller-lessee retains control of the property. Therefore, sale-and-leaseback accounting does not apply and both parties account for the transaction as a financing transaction.

Cases in which the assessment is less clear

In the absence of a substantive call option or other feature that generally precludes the transfer leg being a sale, judgement is required to assess the appropriate accounting.

For example, whether the leaseback would be classified as a finance or operating lease by the buyer-lessor would not in itself determine whether the transfer leg qualifies as a sale. The standard does not preclude the possibility that the transfer leg is a sale when the classification of the leaseback is a finance lease – i.e. sale-and-finance-leaseback accounting is not prohibited under IFRS 16. However, in our experience, only in rare circumstances would the transfer qualify as a sale in this case.

How should a company account for a sale-and-leaseback transaction with variable payments?

[IFRS 16.100]

Seller-lessee

In some cases, the payments for the lease in a sale-and-leaseback transaction may include variable lease payments depending on sales or usage. In these cases, a question arises over how the seller-lessee measures the right-of-use asset arising from the leaseback and determines the amount of any gain or loss to be recognised at the date of the transaction.

The IFRS Interpretations Committee received a request to address this issue from the perspective of the seller-lessee. It issued an agenda decision stating that the right-of-use asset should be measured as a proportion of the previous carrying amount of the underlying asset, reflecting the rights retained under the leaseback. It also addressed how to determine the gain or loss relating to the rights transferred to the buyer-lessor. The initial measurement of the liability that is recognised at the transaction date is a consequence of how the right-of-use asset is measured.

The Committee recommended that the Board discuss how to subsequently measure the lease liability. The Board issued an exposure draft in November 2020 proposing to amend IFRS 16 to add subsequent measurement requirements for sale-and-leaseback transactions.

Buyer-lessor

The Committee’s agenda decision and the Board’s exposure draft do not address the accounting for the buyer-lessor in these circumstances. The buyer-lessor applies the guidance in IFRS 16, recognising the purchase of the asset applying applicable standards and accounting for the lease under the lessor accounting requirements in IFRS 16.

If the leaseback is an operating lease, then the lessor recognises lease payments on either a straight-line or another systematic basis. Variable lease payments are recognised as income in profit or loss. They are recognised in the period in which a change occurs in the facts and circumstances on which the variable payments are based.

If the leaseback is a finance lease, then the lessor recognises a net investment in the lease according to the guidance provided in IFRS 16.

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Sale and leaseback

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