Consolidation of Intercompany Leases (Including Journal Entries) - IFRS 16 Leases

Intro

Intercompany or intragroup lease arrangements are common in group structures. Whether to facilitate centralised asset ownership or to optimise funding and tax positions, leases between related parties require particular attention under IFRS 16 Leases, especially in the context of consolidated financial statements. This article outlines how intercompany leases are treated under IFRS, implications for separate and consolidated financial statements, as well as consolidation journal entries.

What Are Intercompany or Intragroup Leases?

An intercompany lease is a lease between entities within the same group. For example, a parent company may lease office equipment to a subsidiary, or a subsidiary may lease a building it owns to its parent. Although these transactions are contractually valid and may have economic substance at the individual entity level, the group cannot lease an asset to itself — a concept that has critical implications during consolidation.

Accounting for Intercompany Leases – Separate Financial Statements

In the separate financial statements of each entity:

• IFRS 16 applies in full.
• The lessee recognises a right-of-use asset (ROUA) and a lease liability.
• The lessor classifies the lease as either an operating lease or a finance lease.

This treatment applies regardless of whether the counterparty is external or a group entity. The same recognition, measurement, and disclosure requirements apply.

Entities must also comply with IAS 24 – Related Party Disclosures, which requires detailed disclosure of transactions and balances with related parties, including leases.

Accounting for Intercompany Leases – Consolidated Financial Statements

From a group perspective, a lease cannot exist between entities under common control. As a result:

• All intercompany lease balances must be eliminated.
• The consolidated financial statements should only reflect leases with external third parties.

The elimination process affects:

• ROU assets, depreciation, lease liabilities, and finance cost (lessee)
• Net investment in lease, finance income, and underlying assets (lessor)

If the leased asset is held as an investment property under IAS 40 Investment Property, it must be reclassified to PPE under IAS 16 Property, Plant and Equipment (PPE) in consolidated accounts if used in group operations. Fair value adjustments must also be reversed.

Illustrative Example: Parent → Subsidiary (P → S)

Scenario:

• ParentCo leases a warehouse to SubsidiaryCo.
• SubsidiaryCo recognises a ROUA and lease liability.
• Based on the terms of the agreement, ParentCo treats the lease as an operating lease and recognises rental income.

Pro-forma consolidation entries:

Dr Rental Income (ParentCo)                     XXX
    Cr Depreciation (SubsidiaryCo)                  XXX
    Cr Finance cost (SubsidiaryCo)                  XXX
Dr Lease Liability (SubsidiaryCo)               XXX
    Cr Right-of-Use Asset (SubsidiaryCo)            XXX

If the warehouse was held at fair value under IAS 40, reclassification to PPE and reversal of fair value gains would be required.

Illustrative Example: Subsidiary to Parent (S → P)

Scenario:

SubsidiaryCo owns a fleet of vehicles and leases them to ParentCo.

• ParentCo recognises a ROUA and lease liability.
• SubsidiaryCo treats the lease as a finance lease.

Consolidation entries:

Dr Lease liability (ParentCo)                   XXX
    Cr ROU Asset (ParentCo)                         XXX  
    Cr Interest expense (ParentCo)                  XXX
    Cr Depreciation (ParentCo)                      XXX
Dr Property, plant and equipment (SubsidiaryCo) XXX
Dr Finance income (SubsidiaryCo)                XXX  
    Cr Net investment in lease (SubsidiaryCo)       XXX  

The lease entries are fully reversed, and the underlying asset as re-recognised as PPE. These adjustments reflect the principle that the group is using its own assets and cannot lease to itself.