During 2020, this column looked at some judgments made by the IFRS Interpretations Committee, in particular a specific issue concerning IFRS 16, Leases, in respect of sale and leaseback transactions. As a result of this judgment, the International Accounting Standards Board (IASB) has released an exposure draft proposing a change to the standard.
The question arose in relation to transactions that satisfy the requirements of IFRS 15, Revenue from Contracts with Customers, to be accounted for as a sale, specifically where variable consideration was involved. These transactions could arise where payments are based on a percentage of the seller-lessee’s revenue generated from using the right-of-use (ROU) asset. Commenters believed that transactions could occur in retail environments (where lease payments could be a percentage of revenue) or energy production facilities (where lease payments could be a percentage of energy generated).
The committee advised that in such a case a liability – and corresponding ROU asset – should be included, despite the presence of variable payments not being included in the current wording of the standard. It also recognised that IFRS 16 currently gave no guidance on how that would be subsequently measured.
This was recognised as an important issue, as the wording around the lease payments would affect numerous items. This will not only impact the amount recognised as a lease liability, but also therefore the amount recognised by the entity as an ROU asset and any gain/loss relating to the rights transferred to the buyer, as both are dependent on the calculation of the initial liability.
The example further down will highlight this further.
Following this decision, the IASB has released an exposure draft proposing an amendment to IFRS 16. This seeks to clarify the payments that would be included in a lease liability in a sale and leaseback transaction, in addition to providing guidance on the subsequent treatment of the lease liability.
This proposal would introduce a new paragraph (paragraph 100A) into the standard to clarify which payments would be included within the expected lease payments in a sale and leaseback transaction. These will now include:
- fixed payments less any lease incentives
- variable lease payments (regardless of whether they depend on an index or rate)
- amounts expected to be payable by the seller-lessee under residual value guarantees
- payments of penalties for terminating the lease, if the lease term reflects the seller-lessee exercising an option to terminate the lease.
See the example below.
Under the proposals, an entity would make an assessment of the initial liability based on its expectation of the variable payments at the commencement of the lease
Treatment of payments in a lease and payback transaction
A seller-lessee holds an asset with a carrying amount of $1m and then enters into a sale and leaseback arrangement, leasing it back for five years. The agreement constitutes a sale per IFRS 15.
The amount paid by the buyer-lessor (equal to the fair value of the asset) is $1.8m, and the expected amount of variable lease payments are $91,000, $98,000, $101,000, $104,000 and $105,000. Discounted to present value using a rate of 3.5%, this gives a present value of approximately $450,000.
Here, the present value of the payments is $450,000 compared with the $1.8m fair value of the asset. $450,000/US$1.8m = 25%. This means effectively that 25% of the asset has been retained for use and 75% of the asset has been disposed of.
Applying this to the carrying amount of the asset would give an ROU asset of $250,000 (25% x $1m = $250,000). Therefore, the entries would be as follows:
Dr ROU asset $250,000
Dr Cash $1,800,000
Cr PPE $1,000,000
Cr Lease liability $450,000
Cr Gain on disposal $600,000
The ROU asset would then be depreciated over the lease term of five years, giving an annual depreciation of $50,000.
The final thing that the exposure draft outlines is the subsequent treatment of a lease liability. Much of this is in line with the treatment of lease liabilities, increasing the liability by the interest and decreasing by the lease payment.
If the payment was to be the $91,000 as expected, the lease liability would follow the pattern below:
Liability b/f Interest 3.5% Payment Liability c/f
$450,000 $15,750 ($91,000) $374,750
This example looks completely in line with the normal treatment for a lease liability. The difference in this case lies in the variable payment.
Under the proposals, an entity would make an assessment of the initial liability based on its expectation of the variable payments at the commencement of the lease. Following this, there will be no subsequent remeasurement of the liability due to changes in the expected variable payments. Instead, any differences between the expected lease payments for the period and the actual payments made will be recorded in the statement of profit or loss for the year.
Therefore, in the above example, if the payment at the end of year one was US$93,000 rather than US$91,000, there would be no impact on the liability. Instead, the additional US$2,000 paid would simply be expensed in the statement of profit or loss.
Under the proposed amendment to the standard, the IASB states that this should be applied retrospectively. Comments are due by 29 March 2021.