Amendments to IFRS 16 Leases – Lease Liability in a Sale and Leaseback

These amendments clarify the subsequent measurement of sale and leaseback transactions where the initial sale of the underlying asset meets the IFRS 15 Revenue from Contracts with Customers (IFRS 15) criteria for recognition as a sale. In particular, these amendments clarify the subsequent measurement of the lease liability arising from these transactions where there are variable lease payments that do not depend on an index or rate.

Reminders

In IFRS 16, these transactions are analysed in substance as a sale of the right to use the underlying asset at the end of the lease. As a result, the standard requires the seller-lessee to recognise only a partial disposal gain or loss and to retain on its statement of financial position a proportion of the underlying asset (corresponding to the right to use the asset over the lease term).

To do so, the seller-lessee must determine the proportion of rights it retains in the asset. Typically, this is determined by comparing the present value of the lease payments (in other words, the initial value of the lease liability) with the fair value of the underlying asset (as suggested in Illustrative Example 24 of IRS 16).

However, when a sale and leaseback transaction only includes payments based on a variable that does not depend on an index or a rate, this approach results in the recognition of a sale and leaseback gain or loss calculated on the entire asset (the proportion of rights retained by the seller-lessee being zero).

This raised the question of whether, in such cases, another approach should be used to determine the proportion of rights retained by the seller-lessee.

The IFRS Interpretations Committee (Committee), to which this question had been submitted, was only able to provide a partial answer, noting that IFRS 16 does not specify a particular method for the subsequent measurement of sale and leaseback transactions. The agenda decision published in the June 2020 IFRIC Update, which only addressed the initial recognition of these transactions indicated that:

• the seller-lessee could determine the retained proportion of the right-of-use asset by comparing, for example the present value of expected payments for the lease (including those that are variable), with the fair value of the transferred asset at the date of the transaction
• the gain or loss recognised by the seller-lessee was a consequence of its measurement of the right-of-use asset and related only to the rights transferred to the buyer-lessor; and
• even if all the lease payments were variable and did not depend on an index or rate, the seller-lessee recognised a liability at the date of the transaction. The initial measurement of the liability was merely a consequence of how the right-of-use asset was measured (and could therefore include variable payments that did not depend on an index or rate).

At its May 2020 meeting, the IASB decided, on the recommendation of the Committee, to propose amendments to IFRS 16 to clarify how a seller-lessee should subsequently measure the liability arising from a sale and leaseback transaction. This project led to the publication of an exposure draft in November 2020 with a comment period expiring in March 2021.

The amendments now published represent the culmination of the process of clarifying IFRS 16 on sale and leaseback transactions, initiated by the Committee.

What changes have been made to the standard?

Taking into account the comments received on its exposure draft, the IASB has ultimately provided no clarification on how to measure the proportion of the seller-lessee’s retained interest in the asset, contrary to the position taken in the exposure draft. In practice, therefore, an entity will need to determine for itself how to measure the retained right-of-use asset, so that no gain or loss related to the retained right of use is recognised (the approach proposed in the June 2020 Interpretations Committee decision agenda being only one possible method).

The amendments are thus limited to modifying the existing sale and leaseback provisions to permit the subsequent measurement of the lease liability to include variable payments that do not depend on an index or rate (in a manner that is consistent with how the entity determined the proportion of retained interest in the asset and how it initially measured the lease liability).

A new paragraph (IFRS 16.102A) clarifies that a seller-lessee:

• shall subsequently measure the lease liability arising from a sale and leaseback transaction in accordance with the general provisions of the standard, but determining the lease payments so that no gain or loss relating to the retained right-of-use is recognised (which, in practice, allows variable payments that are not dependent on an index or rate to be included in the subsequent measurement of the lease liability); and
• in the event of a modification that reduces the scope of the lease, any gain or loss arising from the partial or total termination of the right-of-use will be accounted for in profit or loss as required by the general provisions of the standard (the new provisions do not preclude these).

A new example (IE12, example 25) illustrates the application of these new provisions. Once the proportion of the seller-lessee’s retained interest in the asset has been determined (the example does not describe how this was calculated, as the standard is not prescriptive on this issue), the seller-lessee develops an accounting policy to determine the lease payments so that no gain or loss related to the retained right of use is recognised. Depending on the circumstances, the seller-lessee could take either of the following two approaches:

• Approach 1 – Expected lease payments at the commencement date: the lease payments correspond to the payments expected at the commencement of the lease; or
• Approach 2 – Equal lease payments over the lease term: the lease payments reflect equal annual payments over the lease term (these annual payments are deducted from the value of the lease liability, their present value at the seller-lessee’s incremental borrowing rate being equal to the lease liability).

In the example, the lease liability is repaid according to the original schedule. Any positive or negative difference between actual lease payments and those initially expected is recognised in profit or loss. The lease liability is therefore not subsequently revised when expected lease payments or actual lease payments depart from the originally expected schedule.

Finally, the IASB has taken the opportunity to make some slight changes to the wording in one of the examples in the standard (IE11, example 24), in order to make it more readable and understandable.

Effective date and transitional arrangements

The IASB has set the effective date of these amendments for annual reporting periods beginning on or after 1 January 2024. Early application is permitted.

The transitional arrangements state that a seller-lessee shall apply these amendments retrospectively, in accordance with IAS 8, to all sale and leaseback transactions entered into after the date of initial application of IFRS 16 (in most cases this being 1 January 2019).