payments should be recognised on a straight-line basis prospectively over the
remaining revised lease term, whether or not the original lease contract contained
a renewal option.
Accounting for the original lease until its expiry and then treating the modification (e.g.
the extended term) as if it were a new lease may be an attractive option as it avoids any
change if there are straight-line prepayments or accruals; these will reduce to zero at
the end of the original lease term. However, it is inconsistent with the fact that there
has been a contractual change to the existing lease.
Because tenants in financial difficulties may negotiate changes to their lease terms, any
asset that is being spread forward may need to be assessed for impairment.
7
SALE AND LEASEBACK TRANSACTIONS
These transactions involve the original owner of an asset selling it to a provider of
finance and immediately leasing it back. The lease payment and the sale price are
usually interdependent because they are negotiated as a package. These parties will be
termed the seller/lessee (the original owner) and buyer/lessor (the finance provider)
respectively. Sometimes, instead of selling the asset outright, the original owner will
lease the asset to the other party under a finance lease and then lease it back. Such a
transaction is known as a ‘lease and leaseback’ and has similar effects so for these
purposes is included within the term ‘sale and leaseback’.
1670 Chapter 23
Sale and leaseback transactions are a fairly common feature in sectors where entities
own many properties, such as the retail and hotel industries. Many parties are involved
as buyer/lessors, not only finance houses and banks but also pension funds and property
groups. From a commercial point of view, the important point of difference lies
between an entity that decides that it is cheaper to rent than to own – and is willing to
pass on the property risk to the landlord – and an entity which decides to use the
property as a means of raising finance – and will therefore retain the property risk.
However from the accounting point of view, a major consideration is whether a profit
can be reported on such transactions.
The buyer/lessor will treat the lease in the same way as it would any other lease that
was not part of a sale and leaseback transaction. The accounting treatment of the
transaction by the seller/lessee depends on the type of lease involved, i.e. whether the
leaseback is under a finance or an operating lease. [IAS 17.58].
7.1
Sale and finance leaseback
In order to assess whether the leaseback is under a finance lease, the seller/lessee will
apply the qualitative tests in IAS 17 that are described at 3.2.2 above. If a sale and
leaseback transaction results in a finance lease, any excess of sales proceeds over the
carrying amount should not be recognised immediately as income by a seller/lessee.
Instead, the excess is deferred and amortised over the lease term. [IAS 17.59]. It is
inappropriate to show a profit on disposal of an asset which has, in substance, been
reacquired by the entity under a finance lease. The lessor is providing finance to the
lessee with the asset as security. [IAS 17.60]. The asset will be restated to its fair value (or
the present value of the minimum lease payments, if lower) in exactly the same way as
any other asset acquired under a finance lease.
Example 23.25: Sale and finance leaseback – accounting for the excess sale
proceeds
An asset that has a carrying value of €700 and a remaining useful life of 7 years is sold for €1,200 and leased
back on a finance lease. This is accounted for as a disposal of the original asset and the acquisition of an asset
under a finance lease for €1,200. The excess of sales proceeds of €500 over the original carrying value should
be deferred and amortised (i.e. credited to profit or loss) over the lease term.
The net impact on income of the charge for depreciation based on the carrying value of the asset held under
the finance lease of €171 (€1200 over 7 years) and the amortisation of the deferred income of €71 (€500 over
7 years) is the same as the annual depreciation of €100 based on the original carrying amount.
In 2007 the Interpretations Committee considered the related area of sale and
repurchase options, concluding that IAS 17 itself contains ‘the more specific guidance
with respect to sale and leaseback transactions’.11
However, some consider that there is an alternative treatment which they believe
is more consistent with the substance of the arrangement and with the approach
in SIC-27 described at 2.2 above, which deals with transactions that have the form
but not the substance of leases. It follows the standard’s description of the
transaction as ‘a means whereby the lessor provides finance to the lessee, with the
asset as security’. [IAS 17.60]. The previous carrying value is left unchanged, with
the sales proceeds being shown as a liability. Historically, this was consistent with
paragraph 16 of IAS 18 – Revenue – which stated that a transaction is not a sale
Leases (IAS 17) 1671
and revenue is not recognised if the entity retains significant risks of ownership.12
By definition the entity will have retained the significant risks and rewards,
because it now holds the asset under a finance lease. It is also consistent with the
logic in IFRS 15 for sale and repurchase agreements. If a repurchase agreement is
a financing arrangement, IFRS 15 requires the selling entity to continue to
recognise the asset, and to record a financial liability for the consideration
received. [IFRS 15.B68].
Both methods of accounting for sale and leaseback transactions are seen in practice.
Therefore, an entity should select a treatment as a matter of accounting policy and
apply it consistently.
If the sales value is less than the carrying amount then the apparent ‘loss’ need not
be taken to income unless there has been an impairment under IAS 36. [IAS 17.64].
There may be an obvious reason why the sales proceeds are less than the carrying
value; for example, the fair value of a second-hand vehicle or item of plant and
machinery is frequently lower than its book value, especially soon after the asset
has been acquired by the entity. This fall in fair value after sale has no effect on the
asset’s value-in-use. This means that, in the absence of impairment, a deficit (sales
proceeds lower than carrying value) will be deferred in the same manner as a profit
and spread over the lease term.
Sale and leaseback arrangements containing repurchase agreements and options are
discussed at 7.3 below.
7.2 Operating
leaseback
If a sale and leaseback transaction results in an operating lease, and it is clear that
the transaction is established at fair value, any profit or loss should be recognised
immediately. If the sale price is below fair value, any profit or loss should be
recognised immediately unless the loss is compensated by future lease payments at
below market price, in which case it should be deferred and amortised in
proportion to the lease payments over the period for which the asset is expectedr />
to be used. If the sale price is above fair value, the excess over fair value should be
deferred and amortised over the period for which the asset is expected to be used.
[IAS 17.61-63].
The rationale behind these treatments is that if the sales value is not based on fair
values then it is likely that the normal market rents will have been adjusted to
compensate. For example, a sale at above fair value followed by above-market
rentals is similar to a loan of the excess proceeds by the lessor that is being repaid
out of the rentals. Accordingly, the transaction should be recorded as if it had been
based on fair value.
However, this will not always be the case. Where the sales value is less than fair value
there may be legitimate reasons for this to be so, for example where the seller has had
to raise cash quickly. In such situations, as the rentals under the lease have not been
reduced to compensate, the profit or loss should be based on the sales value.
The standard includes an Appendix, which comprises the following table of the
standard’s requirements concerning sale and leaseback transactions, and is aimed at
1672 Chapter 23
providing guidance in interpreting the various permutations of facts and circumstances
that are set out in the requirements.
Sale price
established at fair
Carrying amount
Carrying amount less
Carrying amount
value (paragraph 61)
equal to fair value
than fair value
above fair value
Profit
no profit
recognise profit
not applicable
immediately
Loss
no loss
not applicable
recognise loss
immediately
Sale price below fair
value (paragraph 61)
Profit
no profit
recognise profit
no profit (note 1)
immediately
Loss not
recognise loss
recognise loss
(note 1)
compensated by
immediately
immediately
future lease
payments at below
market price
Loss compensated
defer and
defer and
(note 1)
by future lease
amortise loss
amortise loss
payments at below
market price
Sale price above fair
Carrying amount
Carrying amount less
Carrying amount
value (paragraph 61)
equal to fair value
than fair value
above fair value
Profit
defer and amortise
defer and amortise
defer and amortise
profit(note 3)
profit (note 3)
profit (note 2)
Loss
no loss
no loss
(note 1)
Note 1
These parts of the table represent circumstances that would have been dealt with under paragraph 63 of the standard.
Paragraph 63 requires the carrying amount of an asset to be written down to fair value where it is subject to a sale
and leaseback.
Note 2
The profit would be the difference between fair value and sale price as the carrying amount would have been written
down to fair value in accordance with paragraph 63.
Note 3
Any excess profit (the excess of sale price over fair value) is deferred and amortised over the period for which the
asset is expected to be used. Any excess of fair value over carrying amount is recognised immediately.
IAS 17’s disclosure requirements for lessees and lessors apply equally to sale and leaseback
transactions. The requirement of the standard for lessees to give a general description of
their significant leasing arrangements will lead to the disclosure of unique or unusual
provisions of the agreement or terms of the sale and leaseback transactions. [IAS 17.35(d), 65].
Furthermore, sale and leaseback transactions may meet the separate disclosure criteria set
out in IAS 1 – Presentation of Financial Statements (see Chapter 3). [IAS 17.66].
Sale and leaseback arrangements may also include features such as repurchase options.
These are not addressed by IAS 17 and are discussed below.
Leases (IAS 17) 1673
7.3
Sale and leaseback arrangements including repurchase
agreements and options
IAS 17 does not deal explicitly with the function of options in the context of sale and
leaseback arrangements, where circumstances could be complex and there may be a
variety of options that may affect the overall assessment of the lease.
Under IFRS 15, if an entity has an obligation or a right to repurchase an asset, a customer
does not obtain control of that asset. [IFRS 15.B66]. Consequently, the transfer of the asset
would not be accounted for as a sale. This raises the question of whether an entity entering
into a sale and leaseback arrangement containing repurchase agreements or options must
apply the requirements for determining when a performance obligation is satisfied in IFRS 15
in determining whether the transfer of the asset is accounted for as a sale. We do not believe
that this would be appropriate. Paragraph 5(a) of IFRS 15 prior to the effective date of IFRS 16
notes that IFRS 15 excludes lease contracts in scope of IAS 17 and therefore we believe that,
for arrangements in scope of IAS 17, that standard contains more specific guidance than
IFRS 15 with respect to sale and leaseback transactions. Entities should use IFRIC 4 and
SIC-27 to analyse whether or not the arrangement contains a lease. SIC-27 is helpful in the
analysis; it includes the following indicators that an arrangement is not in substance a lease:
(a) the entity retains all the risks and rewards of ownership and there is no significant
change in its rights to use the asset; and
(b) 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].
If the arrangement does contain a lease, both buyer/lessor and seller/lessee will need to
classify the lease as either a finance or an operating lease. If a lease arrangement
includes an option that can only be exercised by the seller/lessee (a call option) at the
then fair value of the asset in question, the risks and rewards inherent in the residual
value of the asset have passed to the buyer/lessor.
In some cases, the buyer/lessor may have an option to require the seller/lessee to
repurchase the asset (a put option). Where there is both a put and a call option on
equivalent terms at a determinable amount other than the fair value, it is clear that the
asset will revert to the seller/lessee. It is in the interests of one or other of the parties to
exercise the option so as to secure a profit or avoid a loss. Therefore the likelihood of
the asset remaining the property of the buyer/lessor rather than reverting to the seller
would be remote. In such a case, this is a bargain purchase option (see 3.2.2 above) and
r /> the seller/lessee has entered into a finance leaseback.
However, the position is less clear where there is only a put option or only a call option,
rather than a combination of the two. Where there is only a put option by the
buyer/lessor, the effect will be (in the absence of other factors) that the seller/lessee has
disposed of the rewards of ownership to the buyer/lessor but retained the risks. This is
because the buyer/lessor will only exercise his option to put the asset back to the
seller/lessee if its value at the time is less than the repurchase price payable under the
option. This means that if the asset continues to rise in value the buyer/lessor will keep it
and reap the benefits of that enhanced value; conversely if the value of the asset falls, the
option will be exercised and the downside on the asset will be borne by the seller/lessee.
1674 Chapter 23
This analysis does not of itself answer the question of whether the deal should be treated
as an operating or financing leaseback. The overall commercial effect will still have to be
evaluated, taking account of all the terms of the arrangement and by considering the
motivations of both of the parties in agreeing to the various terms of the deal; in particular
it will need to be considered why they have each agreed to have this one-sided option.
Where there is only a call option exercisable by the seller/lessee, the position will be
reversed. In this case, the seller/lessee has disposed of the risks, but retained the rewards to
be attained if the value of the asset exceeds the repurchase price specified in the option.
Once again, though, the overall commercial effect of the arrangement has to be evaluated
in deciding how to account for the deal. Emphasis has to be given to what is likely to happen
in practice, and it is instructive to look at the arrangement from the point of view of both
parties to see what their expectations are and what has induced them to accept the deal on
the terms that have been agreed. It may be obvious from the overall terms of the
arrangement that the call option will be exercised, in which case the deal will again be a
financing arrangement and should be accounted for as such. For example, the exercise price
of the call option may be set at a significant discount to expected market value, the
seller/lessee may need the asset to use on an ongoing basis in its business, or the asset may
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 330