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)

Sale-and-leaseback

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.

Buyer-landlord

Transfer to buyer-landlord is a sale

  • Recognise the underlying asset as property, plant and equipment or investment property*
  • Account for the leaseback in accordance with IFRS 16*

* 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

  • Do not recognise the underlying asset
  • Recognise a financial asset under IFRS 9 for amounts transferred to or receivable from the seller-lessee

Seller-tenant

Transfer to buyer-landlord is a sale

  • Derecognise the underlying asset and apply the lessee accounting model to the leaseback*
  • Measure the right-of-use asset at the retained portion of the previous carrying amount (i.e. at cost)*
  • Recognise a gain or loss related to the rights transferred to the lessor*

* 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

  • Continue to recognise the underlying asset
  • Recognise a financial liability under IFRS 9 for any amount received from the buyer-landlord
Something else -   IFRS 16 Right to use

Case – Buyer-landlord accounting for a sale-and-leaseback transaction when transfer is a sale

Company C sells an office building to Company D for cash of 1,000,000. At the same time, C enters into a contract Sale-and-leaseback of real estatewith D for the right to use the building for 15 years with annual payments of 80,000 payable at the end of each year. (IFRS 16.101–102, IFRS 16.IE11 )

The transfer of the office building qualifies as a sale under IFRS 15. The fair value of the office building, which is deemed to be more readily determinable than market rentals on the leaseback, on the date of sale is 900,000. Because the consideration for the sale of the office building is not at fair value, D makes 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.

At the commencement date, D makes the following entries.

Building

900,000

Financial asset

100,000

Cash

1,000,000

To recognise sale-and-leaseback of building

After the commencement date, D allocates the annual payments of 80,000 that it receives from C as follows.

  • Lease payments: Assuming that D classifies the lease as an operating lease, D will probably recognise these payments on a straight-line basis over the lease term of 15 years.
  • Repayment of the financing: i.e.:
    • payments received to settle the financial asset of 100,000; and
    • interest income, applying the effective interest rate method.

Case – Buyer-landlord accounting for a sale-and-leaseback transaction when transfer is not a sale

Modifying Case – Buyer-landlord accounting for a sale-and-leaseback transaction when transfer is a sale above, Company C has an option to repurchase the building at the end of 15 years.

D notes that C has a call option over the building. Therefore, D applies the guidance in IFRS 15 on sale-and-repurchase agreements and concludes that the transfer does not qualify as a sale. This is because C retains control of Sale-and-leaseback of real estatethe building through the call option, which is considered to be substantive.

Because the transfer does not qualify as a sale, D does not recognise the building as property, plant and equipment or investment property. Instead, D accounts for the transaction as a financing arrangement under IFRS 9.

At the commencement date, D makes the following entries.

Financial asset

1,000,000

Cash

1,000,000

To recognise receivable due from C

Food for thought – How does a buyer-landlord assess whether a transaction qualifies for sale-and-leaseback accounting?

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

There is no specific or additional guidance in IFRS 16 about how to make this assessment. Instead, the parties apply the guidance in IFRS 15.

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-tenant 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-tenant 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-landlord 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.

Something else -   Cash-generating unit (CGU)

Food for thought – Does a buyer-landlord assess whether historical transactions qualify for sale-and-leaseback accounting?

No. This test applies only to transactions entered into after the date of initial application of IFRS 16. A buyer-landlord does not reassess transactions classified as sale-and-leaseback transactions under IAS 17 to determine whether the transfer qualifies as a sale. (IFRS 16.C16)

Even if a buyer-landlord applies IFRS 16 retrospectively, it does not reassess transactions classified as sale-and-leaseback transactions under IAS 17.

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

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. (IFRS 16.100)

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.

Something else -   IFRS 16 Assets of low value

Food for thought – What does a buyer-landlord need to consider when accounting for a financial asset recognised in a failed sale-and-leaseback transaction?

A sale-and-leaseback transaction often fails to meet the requirements for a sale under IFRS 15 because the seller-tenant (‘the borrower’) has an option to repurchase the underlying property – i.e. the option gives the borrower an interest in the leased property. This means that the buyer-landlord (‘the lender’) recognises a financial asset (‘loan’)IFRS 9-Sale-and-leaseback of real estate equal to the transfer proceeds, and accounts for the loan under IFRS 9. A question arises over whether the terms of the loan recognised are SPPI-compliant. (IFRS 16.103(b), IFRS 9.4.1.3(b), IFRS 9.B4.1.16 )

A financial asset is ‘SPPI-compliant’ if its contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. IFRS 9 provides guidance on what is meant by ‘interest’. Also, IFRS 9 provides guidance on when a financial asset fails SPPI because it represents an investment in a particular asset.

For example, in a failed sale-and-leaseback transaction, the seller-tenant may have an option to purchase the underlying property at the end of the financing agreement at a price determined at inception of the contract that aims to approximate the value of the property at that time. Assuming that the option price is not de minimis, the contractual cash flows of the loan are not consistent with the SPPI criterion. This is because:

  • not only is the borrower obliged to make payments of interest and principal, but also as part of the contract the borrower can hand the underlying property back to the lender;
  • the underlying property is not just collateral for the loan but under the terms of the contract the borrower can choose whether to keep the underlying property, or not keep it and avoid making the final payment by handing it back to the lender; and
  • even if there is no default, the lender is exposed to the changes in the value of the underlying property.

In other facts and circumstances – e.g. where the option exercise price is trivial – a different analysis may apply. Judgement is required when making this assessment. A company may need to consider additional factors in more complex arrangements.

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.

Something else -   Best guide IFRS 16 Lessee modifications

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