Leases (ifrs 16) - Lessor classification and sale-and-leaseb...

Learning Outcomes

After reading this article, you will be able to classify leases from a lessor’s viewpoint in accordance with IFRS 16. You will distinguish finance leases from operating leases using the required criteria, explain the financial statement impacts for each type, and apply the sale-and-leaseback requirements. You should be prepared to justify lease accounting and sale recognition in typical ACCA SBR exam cases.

ACCA Strategic Business Reporting (SBR) Syllabus

For ACCA Strategic Business Reporting (SBR), you need to understand lessor accounting and sale-and-leaseback transactions under IFRS 16. In particular, your revision should focus on:

• The classification of leases by lessors as finance or operating leases
• Criteria and decision-making for identifying finance versus operating leases
• Accounting methods for finance leases (including net investment in the lease) and operating leases
• The requirements for recognising a sale in sale-and-leaseback transactions
• The financial statement impact of lease classification and sale-and-leaseback arrangements

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which indicator is most persuasive for classifying a lease as a finance lease for a lessor?
   1. Lease term is 30% of asset life
   2. Present value of lease payments is 95% of asset fair value
   3. Lease is cancellable by the lessee
   4. Asset is easily reusable by others
2. In a sale-and-leaseback, under what condition should a seller-lessee recognise a sale?
   1. Cash is received from the buyer-lessor
   2. Control of the asset transfers to the buyer per IFRS 15
   3. The leaseback payments start
   4. The leaseback is for less than 50% of asset life

3. True or false? Under an operating lease, the lessor removes the specified asset from its statement of financial position at lease commencement.

4. Name two recognition differences for lessors between finance and operating leases under IFRS 16.

Introduction

Leasing provides an alternative to outright purchase of assets, with lessors supplying assets to lessees for agreed periods. Under IFRS 16, lessors must classify leases as either finance leases or operating leases at lease inception. Proper classification is essential, as it determines balance sheet presentation, income recognition, and disclosure. Sale-and-leaseback transactions add further complexity, requiring careful assessment of whether a 'sale' has occurred and which rights and obligations are transferred.

Key Term: lessor
The party in a lease contract that provides the right to use a specified asset for a period of time in exchange for consideration.

Lessor Lease Classification under IFRS 16

Lessors decide at lease commencement whether each lease is a finance lease or operating lease. The substance and risks and rewards of each arrangement must be considered.

Key Term: finance lease
A lease that transfers substantially all the risks and rewards incidental to ownership of a specified asset. Legal title may or may not ultimately transfer.

Key Term: operating lease
A lease that does not transfer substantially all the risks and rewards incidental to ownership. The asset remains on the lessor’s statement of financial position.

Criteria for Finance Lease Classification

A lease is classified as a finance lease if it meets any of the following criteria:

• Legal ownership transfers to the lessee by the end of the lease term.
• The lessee has a purchase option priced low enough to ensure it is reasonably certain to be exercised (a ‘bargain purchase option’).
• The lease term covers the major part of the specified asset’s economic life.
• The present value of lease payments amounts to substantially all of the asset’s fair value.
• The specified asset is so specialised that only the lessee can use it without major modifications.

Other indicators include:

• The lessee is responsible for most of any loss in residual value.
• Gains or losses from fluctuations in residual value accrue to the lessee.
• The lessee can extend the lease for a secondary period at a rate significantly below market value.

If none apply, the default classification is operating lease.

Worked Example 1.1

A property company leases a building to a tenant for 35 years. The asset’s economic life is 40 years. Lease payments have a present value equal to 93% of the building's fair value. At lease end, ownership remains with the lessor.

Question: Should the property company (lessor) treat this as a finance lease or operating lease?

Answer:
Both the lease term (35/40 years) and the present value of payments (93% of fair value) indicate this is a finance lease. Substantially all risks and rewards are transferred. The lessor will derecognise the building and recognise a net investment in the lease.

Accounting Treatment for Finance Leases (Lessor)

For a finance lease:

• Remove (derecognise) the specified asset from the statement of financial position.
• Recognise a net investment in the lease (a receivable at the present value of future lease payments and any unguaranteed residual).
• Recognise finance income in profit or loss over the lease term, using a rate that produces a constant periodic rate of return on the net investment.
• Lease cash receipts reduce the net investment.

Key Term: net investment in the lease
The present value of gross lease payments and unguaranteed residual value, discounted at the interest rate implicit in the lease.

Accounting Treatment for Operating Leases (Lessor)

If the lease is classified as operating:

• Continue to recognise the specified asset and depreciate it over its useful life.
• Recognise lease income on a straight-line basis over the lease term unless another method better reflects pattern of use.
• Recognise costs (e.g., maintenance, repairs) as incurred.

Worked Example 1.2

An equipment lessor leases standard photocopiers for two years to customers. Typical asset life is eight years. The present value of lease payments is 25% of fair value. The lessor retains the obligation for repairs and asset risk.

Question: How should the lessor classify and account for these leases?

Answer:
Since the lease term covers only a small portion of economic life (2/8 years), and lease payments are a small portion of fair value, this is an operating lease. The lessor keeps the asset on its statement of financial position and recognises income over the lease term.

Exam Warning

Always check both lease term and present value of payments. Ignoring either the time or value test can lead to misclassification. Do not rely on legal title alone.

Sale-and-Leaseback Transactions

A sale-and-leaseback involves an entity selling an asset and leasing it back from the buyer. IFRS 16 requires assessment as follows:

• First, determine if the asset transfer to the buyer-lessor qualifies as a sale under IFRS 15.
• If a sale is achieved (i.e., control passes per IFRS 15 criteria):
  • The seller-lessee derecognises the asset and recognises a right-of-use asset for the retained portion.
  • Any gain or loss on sale is limited to the rights transferred to the buyer-lessor.
  • Buyer-lessor recognises the acquired asset and applies lessor accounting.

Key Term: sale-and-leaseback transaction
An arrangement where an entity sells an asset then immediately leases it back from the buyer.

If the transfer does not qualify as a sale (e.g., because the seller retains control or significant rights):

• The seller-lessee treats the proceeds as a financial liability, not revenue.
• The buyer-lessor recognises a financial asset (a receivable), not the asset itself.

Worked Example 1.3

A company sells a manufacturing facility to an investor for $2 million. Book value is $1.2 million. The facility is immediately leased back for 10 years, but this is much shorter than its 40-year remaining useful life. The investor obtains full control and can direct the use of the asset.

Question: How should both parties account for the transaction?

Answer:
The conditions indicate a sale under IFRS 15. The seller-lessee derecognises the asset, recognises a right-of-use asset for its leaseback, and recognises a limited gain reflecting only the portion of the asset transferred. The buyer-lessor recognises the property as an asset and treats the lease as a lessor lease, typically classified using the criteria in IFRS 16.

Revision Tip

List the main finance lease triggers (ownership transfer, lease term, present value, specialisation) and the key step for sale-and-leaseback (assess sale recognition under IFRS 15) for easy reference before the exam.

Summary

For lessors under IFRS 16, correct lease classification determines the accounting approach. A finance lease moves the asset off the lessor’s statement of financial position and creates a receivable, while an operating lease leaves the asset in place and recognises income straight-line. Sale-and-leaseback decisions hinge on whether a sale as defined by IFRS 15 has occurred—control must transfer. Gains on sale are restricted to the proportion of rights that are genuinely transferred.

Key Point Checklist

This article has covered the following key knowledge points:

• Identify classification indicators for finance and operating leases under IFRS 16 (lessor accounting)
• Explain accounting requirements for both lease types from the lessor viewpoint
• Apply the net investment in the lease approach for finance leases
• Determine if a sale is achieved in sale-and-leaseback transactions under IFRS 15
• Account for sale-and-leaseback transactions when a sale is or is not recognised

Key Terms and Concepts

• lessor
• finance lease
• operating lease
• net investment in the lease
• sale-and-leaseback transaction