Sale and lease back is a transaction in which one entity (seller-lessee) sells an asset to another entity (buyer-lessor) and then leases that asset back from the buyer immediately. In a sale and lease back transaction, sale price and rental payments for lease back are often interdependent because they are often negotiated as a package.

Because IFRS 16 applies a single model for all leases, therefore treatment for sales and lease back under IFRS 16 is much simpler than guidance in the previous version of lease standard (IAS 17). The seller-lessee no longer need to assess whether the leaseback transaction is an operating or finance lease to make accounting treatment accordingly. The only work to do is to determine whether the sale satisfies requirement to record as a normal sale under IFRS 15 (Revenue from Contracts with customer) or not. If yes, the seller records gain/losses on sale and ROU separately. Otherwise no gain/loss from sale can be recorded. The transaction is then recorded as a financial instrument in accordance with IFRS 9.

When the transfer is a sale under IFRS 15

1. Recognize gains/losses on sale

Pursuant to Par [IFRS 16.100] above the seller can recognize gain/loss on sale only to extent of asset rights transferred to the buyer.

Gain/loss associated with retained rights can not be recorded in P&L account.

2. Recognize ROU retained from the leaseback

As per Par [IFRS 16.100] above, carrying amount of ROU at the commencement date is recorded at the proportion of previous carrying amount of the asset which was retained by the seller as a result of the leaseback.

3. Variance between fair value of the asset and consideration of the sale and lease back transaction

Par [IFRS 16.101] said that:

- If sale price is lower than fair value of the asset, any deficit amount is accounted for as a prepayment of lease payments.

- If sale price is higher than fair value of the asset, any excessive amount is accounted for as additional finances provided by the lessor.

In determining deficit/surplus amount as mentioned in Par [IFRS 16.101] above, either of following basis can be used whichever is more readily determinable:

- The difference between sale price and fair value of the asset

- The difference between present value of the contractual lease payments and present value of payment for least at market rates.

In practice, the follower is more likely to be determinable than the leader.

Illustrative Example

To make it clearer to you guys, I would like to extract Example 24 published by IFRS Board for your reference:

Background:

- A seller sells a building to buyer at price of CU 2,000,000.

- Immediately before the transaction, the building is carried at cost of CU 1,000,000.

- At the same time, the buyer signed into a contract to lease this building back for 18 years, with annual payment at CU 120,000 payable at the each year-end.

- Terms and conditions of the sales and lease backs are assumed to satisfy requirement in IFRS 15 to account for as a sale.

- This example ignores any initial direct costs.

- Fair value of the building at the date of sale is CU 1,800,000.

- Implicit discounting rate for this lease is determined by the lessee is at 4.5% pa.

Calculation for the lessee:

- Because the sale is not made at fair value of the asset, the excessive amount of CU 200,000 will be accounted for as an additional finance provided by the lessor.

- Present value of lease payments over 18 years (discounted at 4.5 pa): CU 1,459,200.

In which CU 200,000 is related to additional finance provided by the lessor.

Remaining CU 1,259,200 is related to the lease.

- ROU at commencement date: CU 1,000,000 / CU 1,800,000 x CU 1,259,200 = CU 699,555.

- Gains on sale: total gain is CU 1,800,000 – CU 1,000,000 = CU 800,000.

+ Gains attributed to retained rights: CU 800,000 x CU 1,259,200/ CU 1,800,000 = CU 559,645

+ Gains attributed to transferred rights: CU 800,000 – CU 559,645 = CU 240,355

Entries for the lessee

Dr. Cash CU 2,000,000

Dr. ROU CU 699,555

Cr. Building CU 1,000,000

Cr. Financial liabilities CU 200,000

Cr. Lease liabilities CU 1,259,200

Cr. Gains of sale CU 240,355

Entries for lessor

Dr. Building CU 1,800,000

Dr. Financial asset CU 200,000

Cr. Cash CU 2,000,000

The lessor then applies guidance in IFRS 16 to record net investment and interest on the building leased to the lessee (seller). In which annual lease payment of CU 120,000 will be divided to both lease component and additional finance component. (Lease component: 1,259,200/1,459,200 x 120,000 = 103,553, additional financing component: 200,000/1,459,200 x120,000 = 16,447)

When the transfer of the asset is not a sale

If the transfer of the asset is not a sale in accordance with IFRS 15, no gain/loss can be recognized on the sale date. Instead, the transaction should be accounted for as following:

- The seller shall continue to recognize the transferred assets and additionally recognize a financial liability equal to the transferred proceeds. The financial liability is accounted for by applying IFRS 9.

- The buyer shall not recognize the transferred asset and shall recognize a financial asset equal to the transfer proceeds. The financial asset is accounted for by applying IFRS 9.

References

- IFRS 16 Lease

- Illustrative examples of IFRS 16