Here’s the background to another issue recently discussed by Canada’s IFRS Discussion Group:
- An entity (Seller-lessee) sells a building to another entity (Buyer-lessor) for cash of CU2,000,000. Immediately before the transaction, the building is carried at a cost of CU1,000,000. At the same time, Seller-lessee enters into a contract with Buyer-lessor for the right to use the building for 18 years, with annual payments of CU120,000 payable at the end of each year.
- The terms and conditions of the transaction are such that the transfer of the building by Seller-lessee satisfies the requirements for determining when a performance obligation is satisfied in IFRS 15 Revenue from Contracts with Customers. Accordingly, Seller-lessee and Buyer-lessor account for the transaction as a sale and leaseback. This example ignores any initial direct costs.
- The fair value of the building at the date of sale is CU1,800,000. Because the consideration for the sale of the building is not at fair value, Seller-lessee and Buyer-lessor make adjustments to measure the sale proceeds at fair value. The amount of the excess sale price of CU200,000 (CU2,000,000 – CU1,800,000) is recognized as additional financing provided by Buyer-lessor to Seller-lessee.
- The interest rate implicit in the lease is 4.5 per cent per annum, which is readily determinable by Seller-lessee.
The group discussed how to present the inflow of CU2 million in the statement of cash flows. One view might be that the amount constitutes proceeds from an investing activity: the entity has transferred control of the underlying asset to the lessor and disposed of its interest in the property for cash consideration. Or you might see it as a financing activity, reflecting that the entity enters into the sale and leaseback transaction for financing purposes. Alternatively, maybe it has elements of both.
For one reference point, IFRS 16 addresses how the seller-lessee measures the right of use asset arising from such a transaction, that is “at the proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller-lessee.” If you applied an analogous approach to allocating the CU2 million, the amount recognized as an investing activity would be CU600,888 (I’ll leave you to go to the meeting report for the underlying mechanics). Or you might tweak that, on the basis that the CU200,000 received in excess of fair value should be recognized as a financing activity no matter what, and that only the remaining CU1.8 million is allocated between the two – this generates a somewhat smaller investing activity of $540,799.
Almost all group members agreed that the CU200,000 arises from a financing activity, but there wasn’t a consensus on the rest of it. Here’s a portion of the commentary:
- (Some members) thought that requiring entities to pro-rate the sale proceeds between investing and financing activities complicates the statement of cash flows and makes it more difficult for users to see the impact of the transaction. A few Group members noted that for cash flow statement presentation purposes, the entity’s business objective should be considered to reflect the substance of the transaction. For example, if the entity’s objective is to raise financing, then the cash flows should be presented as a financing activity. However, if the entity’s objective is to sell its asset to realize investment gains, then the cash flows should be presented as an investing activity. These Group members viewed that the purpose of presenting the sale proceeds in the statement of cash flows as different compared to calculating the gain on the sale and leaseback transaction because the gain is intended to reflect the rights transferred to the buyer-lessor.
You could argue though that the economics of the transaction should speak for themselves, regardless of whether it was originally motivated by one thing or another. Accordingly, other group members did support allocating the amount between the two categories, on the second basis set out above. Others thought that it’s reasonable (even if not preferable) to regard the $1.8 million as arising from an investing activity on the straightforward basis that the transaction qualifies as a sale, regardless of any other considerations (I think I would have to agree with that, although it probably wouldn’t be my conceptual preference either). It was noted that IAS 7 does allow a choice in some other aspects of preparing the cash flow statement, such as the classification of interest and dividends, subject to applying a consistent approach between periods.
In the end, the group emphasized the application of judgment and the broad requirement for an entity to present cash flows in a manner that’s most appropriate to its business (although it might be a bit hard to determine what that would actually mean). Of course, if an entity presents the elements in sufficient detail, then users who take a different view of the issue will be able to adjust accordingly in their analysis.
The opinions expressed are solely those of the author