International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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recognition of costs and revenue over the term of the arrangement. IAS 17 requires
lessors and lessees to recognise operating lease payments on a straight-line basis over
the lease term unless another systematic basis is more representative (see 5.1.2 below)
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and this may not be in line with the payments for the lease element so some adjustments
might be required. [IFRIC 4.BC39].
See below for disclosure implications if the arrangement is deemed to contain an
operating lease and the purchaser concludes that it is impracticable to separate the
payments reliably.
2.1.7 Disclosure
requirements
IAS 17 requires a general description of the lessee’s material leasing arrangements.
[IAS 17.31(e)]. This will require disclosure of the details of major transactions that have
fallen within IFRIC 4.
As long as the entity is able to distinguish the lease payments from other elements of
the lease, the disclosed information will relate only to the lease element of the
arrangement. There appears to be no intention to require entities to disclose the service
(executory) element of arrangements.
If the arrangements are assessed as containing finance leases, these arrangements are
deemed to be within the scope of IAS 17 and therefore within its disclosure
requirements (see 9 below).
However, if it were considered to be an operating lease, the Interpretation may result
in additional disclosures, because IAS 17 specifies that the lessor and lessee should
disclose the future minimum lease payments. Although the arrangements discussed in
the Interpretation typically represent significant future commitments, purchasers are
not required to disclose them in the financial statements unless they fall within the
scope of IAS 17. The Interpretations Committee argues that bringing such arrangements
within the scope of IAS 17 will provide users of financial statements with relevant
information that is useful for assessing the purchaser’s solvency, liquidity and
adaptability. [IFRIC 4.BC39].
If the arrangement is one of those in which it is impracticable to separate the payments
reliably, the Interpretation requires disclosure of all payments under the arrangement
separately from other minimum lease payments, together with a statement that the
disclosed payments also include payments for non-lease elements in the arrangement.
[IFRIC 4.15].
2.2
Transactions that involve the legal form of a lease but are not, in
substance, leases
While there are some arrangements that contain leases that are not formally lease
contracts, the reverse is also true: there are some formal lease contracts that do not, in
substance, contain leases. These issues are addressed by SIC-27.
Essentially, SIC-27 deals with the issue of how to evaluate the substance of
transactions, or a series of linked transactions, in the legal form of a lease. The main
purpose of the Interpretation is to reinforce the principle of substance over form,
and to ensure that, where appropriate, a series of linked transactions should be
accounted for as one transaction. If the transaction does not meet the definition of
a lease under IAS 17, SIC-27 deals with the extent to which the arrangement gives
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rise to other assets and liabilities of the reporting entity, the reporting of any other
obligations and the recognition of fee income. [SIC-27.2].
An entity may enter into a transaction or a series of structured transactions (an
arrangement) with an unrelated party or parties (an investor) that involves the legal form
of a lease. Although the details may vary considerably, a typical example involves an
entity leasing or selling assets to an investor and leasing the same assets back. The lease
and leaseback transactions are often entered into so that the investor may achieve a tax
advantage. [SIC-27.1]. In recent years these arrangements have become less common as
taxation authorities in various jurisdictions have restricted the tax benefits. The
following example illustrates an arrangement that does not, in substance, involve a lease
under IAS 17. [SIC-27.A2(a)].
Example 23.4: Substance of an arrangement
Entity A leases a specialised asset that it requires to conduct its business to an Investor and leases the same
asset back for a shorter period of time under a sublease. At the end of the sublease period, Entity A has the
right to buy back the rights of the Investor under a purchase option. If Entity A does not exercise its purchase
option, the Investor has options available to it under each of which it receives a minimum return on its
investment in the headlease – the Investor may put the underlying asset back to Entity A, or require it to
provide a return on the Investor’s investment in the headlease.
The arrangement achieves a tax advantage for the Investor who pays a fee to Entity A and prepays the lease
payment obligations under the headlease. The agreement requires the amount prepaid to be invested in risk-
free assets and, as a requirement of finalising the execution of the legally binding arrangement, placed into a
separate investment account held by a Trustee outside of the control of the entity.
Over the term of the sublease, the sublease payment obligations are satisfied with funds of an equal amount
withdrawn from the separate investment account. Entity A guarantees the sublease payment obligations, and
will be required to satisfy the guarantee should the separate investment account have insufficient funds.
Entity A, but not the Investor, has the right to terminate the sublease early under certain circumstances (e.g.
a change in local or international tax law causes the Investor to lose part or all of the tax benefits, or Entity A
decides to dispose of (e.g. replace, sell or deplete) the underlying asset) and on payment of a termination
value to the Investor. If Entity A chooses early termination, then it would pay the termination value from
funds withdrawn from the separate investment account, and if the amount remaining in the separate
investment account is insufficient, the difference would be paid by Entity A.
A series of transactions that involve the legal form of a lease should be accounted for
as one transaction when the overall economic effect cannot be understood without
reference to the series of transactions as a whole. All aspects and implications of an
arrangement should be evaluated to determine the substance of the arrangement, with
greater weight given to those aspects and implications that will have an economic
effect in practice. The accounting should reflect the substance of the arrangement.
[SIC-27.3, 4].
2.2.1 The
arrangement
First, the series of transactions must be part of a single ‘arrangement’; a series of
transactions may be closely interrelated, negotiated as a single transaction, and take
place concurrently or in a continuous sequence. [SIC-27.3].
Second, there must be indicators that individually demonstrate that an arrangement
may not, in substance, involve a lease under IAS 17. SIC-27 states that in circumstances
such as those in Example 23.4 above, these indicators are as follows:
Leases (IAS 17) 1617
(a) the entity retains all the risk
s and rewards of ownership and there is no significant
change in its rights to use the asset;
(b) the primary reason for the arrangement is to achieve a particular tax result, and
not to convey the right to use an asset; and
(c) the options on which the arrangement depends are included on terms that make
their exercise almost certain (e.g. a put option that is exercisable at a price
sufficiently higher than the expected fair value when it becomes exercisable).
[SIC-27.5].
In other words, the entity retains more rights than it would in a straightforward sale and
finance leaseback. In Example 23.4 above, for instance, it retains all of the residual
interests in the asset. The investor has no interest at all in the underlying asset while a
lessor under a finance lease will often retain title and some residual value in the asset.
The investor has only entered into the transaction to obtain a tax benefit.
2.2.2
Accounting for assets and liabilities arising under the arrangement
The balances arising under the arrangement (in Example 23.4 these comprise the
separate investment account and the lease payment obligations under the sublease)
must be assessed to see whether they represent assets and liabilities of the entity.
SIC-27 refers to definitions of assets and liabilities and guidance in the Conceptual
Framework for Financial Reporting (‘Framework’). [CF(2010) 4.4-19]. It argues that:
(a) the investment account is not an asset of the entity because it cannot control it;
(b) there is only a remote risk that the entity will have to pay out under the guarantee
or reimburse the entire amount of any fee received; and
(c) once the arrangement has been set up and the initial payments have been made,
no further cash flows will be made by the entity.
The entity cannot use the cash in the investment account for its own benefit, nor can it
prevent it from being used to make lease payments to the investor. The lease payments
will be satisfied solely from funds withdrawn from the separate investment account
established with the initial cash flows. In the example, the terms of the arrangement
require that a prepaid amount is invested in risk-free assets that are expected to
generate sufficient cash flows to satisfy the lease payment obligations. [SIC-27.6]. This also
demonstrates, among other things, that the entity is not, in substance, entering into a
financing arrangement, as it has no need for the funds.
Care must be taken to ensure that the assets in which the prepayment is invested are in
fact ‘risk-free’ and this will have to be monitored throughout the arrangement. The
financial crisis in 2008 revealed that many so-called ‘AAA’ or ‘risk-free’ assets, including
sovereign debt, were not risk-free, leaving entities exposed to shortfalls in the cash held
in the investment account for which they may have been required to make provision.
Other obligations of the entity, including any guarantees provided and obligations incurred
on early termination, should be accounted for under IFRS 4 – Insurance Contracts (or
IFRS 17 – Insurance Contracts – if the entity applies that standard), IAS 37 – Provisions,
Contingent Liabilities and Contingent Assets – or IFRS 9 – Financial Instruments,
depending on the terms of the arrangement. [SIC-27.7]. Therefore, if Entity A were to elect
to terminate the arrangement, it would have to provide for its exposure in excess of the
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available funds in the investment account. In addition, if the arrangement is within a special
purpose entity or trust, the entity will need to consider the effect of IFRS 10 –
Consolidated Financial Statements. The interaction of IFRS 10 and IAS 17 in connection
with special purpose entities leaves room for interpretation, but the Interpretations
Committee decided in May 2015 not to clarify the matter (see Chapter 6 at 4.1.3).
2.2.3 Fee
income
SIC-27 addresses the recognition of fee income. There are many factors that could
affect the economic substance and nature of the fee, and it may not be appropriate to
recognise it in its entirety at the inception of the agreement if the entity has significant
future performance obligations, retained risks or a significant risk of repayment. Factors
to be taken into account include:
(a) obligations that are conditions of earning the fee so that entering into the
agreement is not the most significant act required by the arrangement;
(b) limitations are put on the use of the underlying asset that lead to significant
changes in the entity’s rights to use the asset, e.g. the entity’s right to deplete or sell
it or pledge it as collateral;
(c) the possibility of reimbursing any amount of the fee and possibly paying some
additional amount is not remote. This occurs when, for example:
(i) the underlying asset is essential for the entity’s business, in which case there
is a possibility that the entity may be prepared to pay to terminate the
arrangement early and be required to repay all or part of the fee; or
(ii) the possibility that there are insufficient assets in the investment account to
meet the lease payment obligations is not remote, and therefore it is possible
that the entity may be required to pay some additional amount. This may
occur if the entity is required, or has some or total discretion, to invest in
assets carrying more than an insignificant amount of risk (e.g. currency,
interest rate or credit risk). [SIC-27.8].
An entity must take great care before it considers any investment as carrying an
insignificant amount of risk.
2.2.4
Presentation and disclosure requirements.
The fee must be presented in the income statement based on its economic substance
and nature. [SIC-27.9]. The entity must disclose the following in each period that an
arrangement exists:
An entity has to make the disclosures that are necessary to understand the arrangement
and the accounting treatment adopted, including the following:
(a) a description of the arrangement including:
(i) the underlying asset and any restrictions on its use;
(ii) the life and other significant terms of the arrangement;
(iii) the transactions that are linked together, including any options; and
(b) the accounting treatment of any fee received, the amount that has been recognised as
income in the period, and the line item of the income statement in which it is included.
Leases (IAS 17) 1619
These disclosures should be provided individually for each arrangement or in aggregate
for each class of arrangement. A class is a grouping of arrangements with underlying
assets of a similar nature. [SIC-27.10, 11].
3
SCOPE AND DEFINITIONS OF IAS 17
3.1
Scope of IAS 17
The standard applies in accounting for all leases other than:
• lease agreements to explore for or use minerals, oil, natural gas and similar non-
regenerative resources (see Chapter 39); and
• licensing agreements for such items as motion picture films, video recordings,
plays, manuscripts, patents and copyrights.
The standard should not be applied to the measurement by:
• lessees of
investment property held under finance leases;
• lessors of investment property leased out under operating leases, as in these cases
IAS 40 – Investment Property – applies (see Chapter 19);
• lessees of biological assets held under finance leases; or
• lessors of biological assets leased out under operating leases, as in these cases
IAS 41 – Agriculture – applies (see Chapter 38). [IAS 17.2].
3.1.1
Leases and licensing agreements
IAS 17 does not define a licensing agreement so the distinction between ‘leases’ and
‘licensing agreements’ is not clear.
Whether or not the arrangement is within scope of IAS 17 does not depend on the type
of asset or, as discussed in 2.2 above, on how the contract is labelled, but rather on the
nature of that arrangement.
IAS 17 does not apply to agreements that do not transfer the right to use assets from one
contracting party to the other. A conventional licence over an intangible asset such as
a film or video commonly gives a non-exclusive right of ‘access’ to show or view the
video simultaneously with many others but not a ‘right of use’ of the original film or
video itself because the licensee does not control that asset. This puts many licence
agreements outside the scope of IAS 17. However, if the right to use the intangible asset
is provided in the license agreement, the arrangement may be a lease; see the discussion
in 2.1 above regarding IFRIC 4 and the right to use the asset.
The assets subject to licensing agreements excluded from the scope of IAS 17 (such as
motion picture films, video recordings, plays, manuscripts, patents and copyrights) are
specific intangible assets but arrangements involving, for example, motion picture films
are not out of scope simply because of the nature of that asset but rather because the
nature of arrangements over such assets typically grants a non-exclusive right of access
to those assets rather than a right of use.
It follows, therefore, that an arrangement that has been labelled a ‘licence’ will be within
scope of IAS 17 if it transfers a right of use of the asset that is the subject of the
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arrangement to the licensee. This ‘licence’ will include features in addition to those in