Introduction
Rent-to-own or rent-to-buy arrangements are increasingly used in financing transactions as a flexible alternative to traditional leasing or outright purchase. These arrangements require careful analysis under IFRS 16 Leases to determine whether they contain a lease, a purchase in substance, or a combination of lease and non-lease components. The accounting outcome depends on the substance of the arrangement rather than its legal form or label.
This article explains how rent-to-own arrangements are assessed and accounted for by entities under IFRS 16, with a focus on identifying whether the arrangement is a lease, determining the lease term, and assessing whether ownership is transferred in substance.
See also, our IFRS 16 - Full Guide.
What is a rent-to-own arrangement?
A rent-to-own (or rent-to-buy) arrangement typically allows a customer to use an identified asset for a period in exchange for periodic payments, with an option or obligation to acquire legal ownership of the asset at or before the end of the arrangement. Common features include:
- Periodic payments described as rent
- An option to purchase the asset, often at a nominal or discounted price
- Payments that may be credited towards the purchase price
- Penalties or economic disincentives for lease terminations
Although these features may suggest a purchase in substance, IFRS 16 requires a structured assessment rather than an assumption based on terminology.
Identifying whether the arrangement contains a lease
Under IFRS 16, an arrangement contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. In most rent-to-own arrangements, this criterion is met because:
- The asset is explicitly or implicitly identified
- The customer has the right to obtain substantially all economic benefits from use of the asset
- The customer directs how and for what purpose the asset is used
If these conditions are satisfied, the arrangement (or part of it) is within the scope of IFRS 16, regardless of whether ownership may transfer later.
See our detailed article on lease identification, and determining whether a contract is or contains a lease.
Assessing whether ownership is transferred in substance
A critical judgement in rent-to-own arrangements is whether the customer is reasonably certain to obtain ownership of the asset. Indicators include:
- A purchase option price that is sufficiently low compared to the expected fair value at the date the option becomes exercisable
- Lease payments that are substantially equivalent to the asset’s fair value
- Contractual terms that make termination economically unattractive
- Payments that are non-refundable and credited towards the purchase price
If it is reasonably certain that the purchase option will be exercised, the arrangement is treated similarly to a lease that transfers ownership.
Determining the lease term
The lease term under IFRS 16 includes:
- The non-cancellable period of the lease, and
- Periods covered by an option to purchase the asset if the lessee is reasonably certain to exercise that option
In rent-to-own arrangements, this often results in the lease term extending to the expected purchase date rather than only the initial rental period. This assessment has a direct impact on the measurement of the lease liability and right-of-use asset.
Accounting for rent-to-own arrangements - Lessees
Once the arrangement is determined to be within the scope of IFRS 16, the lessee recognises:
- A lease liability, measured at the present value of future lease payments
- A right-of-use asset, initially measured at the amount of the lease liability, adjusted for initial direct costs and prepayments
If ownership is expected to transfer, or the lessee is reasonably certain to exercise a purchase option, the right-of-use asset is depreciated over the useful life of the underlying asset rather than the lease term.
Lease payments included in the lease liability typically include fixed payments and, where relevant, the exercise price of the purchase option.
Accounting for rent-to-own arrangements - Lessors
From the lessor’s perspective, rent-to-own arrangements are assessed to determine whether they represent an operating lease or a finance lease. The classification depends on whether substantially all the risks and rewards incidental to ownership of the underlying asset are transferred to the customer.
Indicators that a rent-to-own arrangement results in a finance lease for the lessor include:
- Ownership of the asset transfers to the customer by the end of the arrangement
- The customer is reasonably certain to exercise a purchase option
- The lease term covers the major part of the asset’s economic life
- The present value of lease payments amounts to substantially all of the asset’s fair value
Where these indicators are present, the lessor recognises a net investment in the lease rather than retaining the asset on the statement of financial position. We wrote a detailed article on understanding finance leases vs. operating leases from the perspective of a lessor.
If the arrangement does not transfer substantially all risks and rewards, it is classified as an operating lease, with the underlying asset remaining recognised by the lessor and lease income recognised over the lease term.
In practice, many rent-to-own arrangements result in finance lease classification due to the strong economic incentives for the customer to acquire ownership.
Manufacturer or dealer lessors and rent-to-own arrangements
Lessors in a rent-to-own arrangement commonly meet the criteria for being manufacturer or dealer lessors. For such entities, these transactions require additional consideration under IFRS 16. These entities typically sell or produce the underlying asset in the ordinary course of business and provide financing to customers through lease structures.
Where a rent-to-own arrangement results in a finance lease, a manufacturer or dealer lessor:
- Derecognises the underlying asset
- Recognises revenue equal to the fair value of the asset at lease commencement
- Recognises the cost of sale based on the carrying amount (or cost) of the asset
- Recognises a net investment in the lease, including any selling profit or loss
Unlike other lessors, manufacturer or dealer lessors recognise selling profit or loss at lease commencement, reflecting the substance of the transaction as a sale financed through a lease.
If the purchase option is reasonably certain to be exercised, the arrangement is often economically similar to a financed sale rather than a pure lease. This reinforces the need to assess whether lease payments and purchase options together recover substantially all of the asset’s fair value.
Where the arrangement does not qualify as a finance lease, the lessor accounts for it as an operating lease, recognising lease income over time and retaining the asset on its balance sheet.
Clear judgement and documentation are critical, as misclassification may materially affect reported revenue, profit margins and asset turnover for manufacturer or dealer lessors.
Separation of lease and non-lease components
Some rent-to-own arrangements may include non-lease components, such as maintenance services or insurance. These components must be separated and accounted for under other applicable IFRS standards unless the lessee elects the practical expedient to account for lease and non-lease components as a single lease component.
Key disclosure considerations
Entities entering into rent-to-own arrangements should ensure that disclosures under IFRS 16 clearly explain:
- Significant judgements made in determining the lease term and the likelihood of exercising purchase options
- The carrying amount of right-of-use assets subject to ownership transfer
- Maturity analysis of lease liabilities
Transparent disclosure is particularly important where rent-to-own arrangements are material, as they may significantly affect reported assets, liabilities and leverage ratios.
Conclusion
Rent-to-own arrangements require careful analysis under IFRS 16 to ensure that their economic substance is appropriately reflected in the financial statements. In many cases, these arrangements result in recognition of a right-of-use asset and lease liability that closely resemble a financed purchase. Entities should apply consistent judgement, document their conclusions, and ensure clear disclosures to avoid misclassification and unexpected balance sheet impacts.
For clarification, guidance, or feedback, reach out at insight@leash.co.za.