IFRS 16: Taking a closer look at sale and leaseback transactions

A sale and leaseback transaction will occur where an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) and leases that asset back from the buyer-lessor.

Has a sale occurred?

Under IFRS 16 an entity must apply the IFRS 15 requirements for determining when a performance obligation is satisfied (ie when a sale has occurred).

If it is concluded that the transfer of an asset is not a sale, then the seller-lessee will continue to recognise the transferred asset. The seller- lessee and buyer-lessor will recognise a financial liability and financial asset respectively which will be accounted for by applying IFRS 9.

Following the IFRS 15 assessment, if a sale is concluded to have occurred, then this is treated as a sale and leaseback transaction for which the accounting treatment is covered in the rest of this article.

A sale has occurred - how do I account for the transaction as a lessor?

There is no additional guidance for lessors other than to follow the applicable IFRS standards to account for the purchase and then apply the IFRS 16 lessor accounting for the lease.

A sale has occurred - how do I account for the transaction as a lessee?

A seller-lessee will recognise a right of use (ROU) asset, replacing the previously held asset, measured at the proportion of the previous carrying amount which is retained for use by the seller-lessee. This is best explained through an example:

Example 1 – Entity X holds a hotel at a carrying amount of £10,000. It enters into a contract to dispose of the hotel to Entity Y for its fair value of £15,000 and lease it back over 10 years with annual payments of £1,600 made in arrears (which is a market rate). The entity’s internal borrowing rate is 4%; using this rate it gives a present value of the lease payments of £12,977.

The ROU asset is capped as the proportion of the previous carrying amount retained for use by Entity X which is calculated as follows:

Present value of lease / fair value of asset = £12,977 / £15,000 = 86.51%

86.51% x £10,000 = £8,651

The example above illustrates that under IFRS 16 the gain on disposal is limited to only represent the gain on the portion of the asset sold recognising that the seller-lessee has retained an interest in the asset. By comparison, if this had been an operating leaseback under IAS 17, the profit on disposal would have been the total difference between the cash received and the carrying value of the hotel, ie £5,000.

The example assumes the sale price of the asset equates to fair value and the subsequent lease payments are at market rate. If either of these is not the case, then the standard requires a different accounting treatment.