Sale and leaseback agreements – let in the variable payments!

The IASB issued for comment last year an exposure draft of proposed amendments to IFRS 16,  Lease Liability in a Sale and Leaseback, with comments requested by March 29, 2021.

Here’s how the accompanying news release summed it up: 

  • The International Accounting Standards Board has today proposed to amend IFRS 16 Leases by specifying how a company measures the lease liability in a sale and leaseback transaction.
  • Sale and leaseback transactions are transactions for which a company sells an asset and leases that same asset back from the new owner.
  • IFRS 16 includes requirements for how to account for sale and leaseback transactions at the time the transaction takes place. However, it does not specify how to measure the lease liability when reporting after that date.
  • The proposed amendment would improve the sale and leaseback requirements already in IFRS 16 by providing greater clarity for the company selling and leasing back an asset both at the date of transaction and subsequently. By doing so, the amendment would help ensure the Standard is applied consistently to such transactions.
  • The proposed amendment would not change the accounting for leases other than those arising in a sale and leaseback transaction.

Currently, IFRS 16.100 says that 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 measures 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 recognizes only the portion of any gain or loss that relates to the rights transferred to the buyer-lessor. The exposure draft proposes expanding this paragraph to specify that it determines that proportion by comparing the present value of the expected lease payments, discounted using the interest rate implicit in the lease (or, if that rate can’t be readily determined, the incremental borrowing rate), to the fair value of the asset sold. In turn, the seller-lessee then recognizes a lease liability arising from the leaseback, initially measured at the present value of the expected lease payments that are not paid at the commencement date,

The expected lease payments might include various kinds of variable lease payments – for example, if the leased object is a building, they might include future payments based on a percentage of revenue earned within it. The IASB reasoned that the present value of such payments is a necessary component of calculating the initial gain or loss on sale; however, because they don’t depend on an index or a rate, they’re not variable lease payments of a kind that are usually included in the definition of lease payments. The Board excluded such payments from the IFRS 16 model for various inter-related reasons, including the higher level of measurement uncertainty that would result from including them, and different views over whether they meet the definition of a liability for the lessee until the performance or use that gives rise to them occurs. But in the current case, the IASB concluded that given the different nature of sale-leaseback transactions, such payments should be included in both the initial and subsequent measurement, and sets out a methodology for initially and subsequently measuring the lease liability arising from the leaseback on that basis, designed to avoid “the recognition of an additional gain or loss associated with the sale of the asset when no transaction or event has occurred to give rise to such a gain or loss.”

The exposure draft contains a dissenting view by one of the members that, as in many such cases, is helpful in focusing attention on what’s being proposed. This argues that the analysis should more fully acknowledge “and not merely mention, that the Board’s analysis contradicts the definition of lease payments in IFRS 16—that IFRS 16 includes an implicit conflict between its sale and leaseback requirements and its definition of lease payments and related lease liability.” She argues that “a seller-lessee no longer has the same right to use the asset for the lease term as it had before the transaction— it now has to share benefits with the buyer-lessor. The seller-lessee no longer bears demand risk for the asset and consequently is not exposed to any cash outflow until and to the extent the asset performs, which is different from the economic exposure of other seller-lessees.” In her view, “such a significant change in the seller-lessee’s economic circumstances brings discontinuity that can justify full derecognition of the asset sold and recognition of any related gain in full.” She also cites the measurement uncertainty and other problems cited above, noting they might be particularly applicable in the age of covid-19. On its own terms, it’s a pretty persuasive dissent.

Still, it appears the appeal of a common defined approach will win out overall – the Board tentatively decided late last year to proceed with the proposals, subject to a few changes…

The opinions expressed are solely those of the author

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