Sale and Leaseback Guide - IFRS 16

Introduction

Sale and leaseback transactions occur when an entity sells an asset and immediately leases it back. IFRS 16 contains specific accounting guidance for sale and leaseback transactions. The standard requires entities to assess whether the sale portion of the transaction qualifies as a sale under IFRS 15. This assessment drives the accounting treatment for both the seller-lessee and the buyer-lessor.

Determining Whether a Sale Occurred

The first, and arguably the most important, consideration when evaluating a transaction, is whether the transaction represents a sale. The specific guidance in IFRS 16 around sale and leaseback transactions only apply if a sale occured.
In determining whether a sale has occurred, the standard references the performance obligation satisfaction guidance under IFRS 15 Revenue.

IFRS 16.99: An entity shall apply the requirements for determining when a performance obligation is satisfied in IFRS 15 to determine whether the transfer of an asset is accounted for as a sale of that asset.

IFRS 15.31: ... the entity satisfies a performance obligation by transferring a promised good or service (ie an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset.

IFRS 15.33: Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset.

This means the transfer must meet the IFRS 15 criteria for revenue recognition — including transfer of control — for it to be accounted for as a sale. If the transfer does not meet these criteria, different accounting requirements apply.

The following are examples of transactions that may appear to be a sale and leaseback transaction, but are in fact structured in a manner that does not transfer control to the buyer-lessor:

1. Leaseback gives seller exclusive use for economic life
   • E.g. asset sold and leased back for 20 years, which is the full useful life.
   • Buyer cannot access or benefit from the asset independently.
2. Repurchase options or obligations
   • The seller-lessee has an option or obligation to repurchase the asset.
   • This implies the buyer never truly gains control.
3. Leaseback includes terms that restrict the buyer
   • E.g. buyer cannot sell, pledge, or otherwise use the asset independently of the lease.

Accounting Treatment When a Sale Occurs

IFRS 16.100: If the transfer of an asset by the seller-lessee satisfies the requirements of IFRS 15 to be accounted for as a sale of the asset:

• the seller-lessee shall measure the right-of-use asset arising from the leaseback at the proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller-lessee. Accordingly, the seller-lessee shall recognise only the amount of any gain or loss that relates to the rights transferred to the buyer-lessor.

• the buyer-lessor shall account for the purchase of the asset applying applicable Standards, and for the lease applying the lessor accounting requirements in this Standard.

The process for determining the proportion of right-of-use that is retained is not explicitly outlined in IFRS 16. The most common and accepted method is to use the percentage of the present value of the lease payments divided by the fair value of the asset.

Also take note, that the standard forbids recognising selling profit or loss on the portion of the right-of-use of the asset that has been retained.

Assessing Market Terms

Entities must assess whether the terms of the sale and leaseback are market related:

• Is the selling price equal to the fair value of the asset?
• Are lease payments at market rate?

If either is off-market, the difference must be assessed and adjusted using the most readily determinable of:

• the difference between the fair value of the consideration for the sale and the fair value of the asset; or
• the difference between the present value of contractual lease payments and the present value of market lease payments.

Adjustments:

• Below-market terms: accounted for as prepaid lease payments.
• Above-market terms: accounted for as additional financing provided by the buyer-lessor.

Market Adjustment Summary Table

What is the rationale for prepaid lease payments and additional financing?

• Prepaid lease payments: Under-market terms imply that a portion of the lease payments was set-off against, and deducted from, the consideration that the buyer-lessor transferred to the seller-lessee on day 1.
• Additional financing: Over-market terms imply that not all the consideration transferred by the buyer-lessor to the seller-lessee relates to the transfer of an asset - a portion thereof relates to a loan.

Step-by-Step Accounting

1. Determine whether any amounts relate to additional financing or prepaid lease payments.

2. Calculate the percentage of the asset retained:

   % Retained = PV of lease payments / Fair value of asset
   

   • Adjust PV of payments for prepaid rent (included) and additional financing (excluded).

3. Calculate gain or loss to be recognised:

   Gain or loss = (Fair value - Consideration) × (% Transferred)
   

Examples

1. Consideration < Fair Value

• Carrying amount: $1,000,000
• Fair value: $1,100,000
• PV of market lease payments: $750,000
• Sale proceeds: $1,000,000 (underpaid)

Treatment:

• Prepaid lease payments of $100,000.
• % rights retained = (750,000 + 100,000) / 1,100,000 = 77.27%
• Gain on sale recognised = (1,100,000 - 1,000,000) × (1 - 0.7727) = 22,730

Dr. Cash                           1,000,000  
Dr. Right-of-use asset               772,730  
    Cr. PPE                                     1,000,000 
    Cr. Lease liability                           750,000
    Cr. Profit on sale                             22,730

2. Consideration > Fair Value

• Same as example 1, except the consideration is $1,200 (overpaid)

Treament:

• Additional financing: $100,000
• PV relating to lease: 750,000 - 100,000 = 650,000
• % rights retained = 650,000 / 1,100,000 = 59.1%
• Gain = (1,100,000 - 1,000,000) × (1 - 0.591) = 40,900

Dr. Cash                            1,200,000
Dr. Right-of-use asset                590,900  
    Cr. PPE                                     1,000,000
    Cr. Lease liability                           650,000
    Cr. Other financial liability                 100,000  
    Cr. Profit on sale                             40,900

Subsequent Measurement

What the standard says:

Paragraph 102A: After the commencement date, the seller-lessee shall apply paragraphs 29–35 to the right-of-use asset arising from the leaseback and paragraphs 36–46 to the lease liability arising from the leaseback. In applying paragraphs 36–46, the seller-lessee shall determine ‘lease payments’ or ‘revised lease payments’ in a way that the seller-lessee would not recognise any amount of the gain or loss that relates to the right of use retained by the seller-lessee. Applying the requirements in this paragraph does not prevent the seller-lessee from recognising in profit or loss any gain or loss relating to the partial or full termination of a lease as required by paragraph 46(a).

In the majority of cases however, this can be simplified to:

• The right-of-use asset is depreciated over the lease term on a straight-line basis
• The lease liability increases with interest and is reduced by payments made

Conclusion

Sale and leaseback transactions under IFRS 16 require a structured and principles-based approach, anchored in the assessment of whether a sale has occurred under IFRS 15. Where a sale is deemed to have occurred, entities must carefully determine the portion of rights retained versus transferred and apply the appropriate measurement and recognition criteria, ensuring that only the portion of gain or loss relating to the rights transferred is recognised in profit or loss. Any off-market terms must be separately identified and accounted for as either prepaid lease payments or additional financing to reflect the substance of the arrangement.

In contrast, if the transaction does not constitute a sale, the seller-lessee must continue to recognise the asset and account for the proceeds as a financial liability under IFRS 9. Understanding and applying these distinctions correctly is critical for faithful representation of the transaction's economic reality in the financial statements.

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