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Lease liability in a sale and leaseback

Date recorded:

Sweep issue—Measuring the ROU asset and lease liability (Agenda Paper 12)

Background

At its April 2020 meeting, the Board tentatively decided to propose a narrow-scope amendment to IFRS 16 to add subsequent measurement requirements for sale and leaseback transactions. The Board confirmed at its May 2020 meeting that it is satisfied that it has (a) complied with the applicable due process requirements and (b) undertaken sufficient consultation and analysis to begin balloting the proposed amendment.

The purpose of this paper was to consider a sweep issue related to how a seller-lessee measures the right-of-use (ROU) asset and the lease liability arising from the leaseback initially, and how it applies the subsequent measurement requirements in paragraphs 36–38 of IFRS 16 to that lease liability.

Staff analysis

Concerns had been raised regarding the Board’s tentative proposed approach, including concerns around understandability and consistent application. The staff’s analysis acknowledges these concerns and considers two alternative approaches that would achieve the objective of the proposed amendment.

Approach A would require a seller-lessee to start with the initial measurement of the lease liability as determined applying paragraph 100(a) of IFRS 16 and impute a discount rate that would result in the present value of the expected payments equalling that liability. That rate would then be used when subsequently measuring the lease liability. Approach A would address concerns around understandability and consistent application, but would raise other concerns. The discount rate applied for purposes of subsequently measuring the lease liability may namely not be the same as the rate that would be determined applying paragraph 37 of IFRS 16. This approach might therefore appear to indirectly ‘require’ the seller-lessee to determine the initial measurement of the ROU asset and lease liability using the present value of expected lease payments, even though IFRS 16 would not specify that method.

Approach B would require a seller-lessee to initially measure the ROU asset and the lease liability that arise in a sale and leaseback transaction using the present value of expected payments for the lease. When subsequently measuring the resulting lease liability, the seller-lessee would then reduce the carrying amount of the lease liability to reflect those expected payments for the lease. The staff believe that Approach B would address concerns around understandability and consistent application but would expand the initial scope of the project, as this approach would also address the initial measurement of the ROU asset and the lease liability that arise in a sale and leaseback transaction.

Nevertheless, the staff’s view is that Approach B is consistent with the Board’s objective for the proposed amendment and retains the Board’s objective and rationale when it developed the sale and leaseback requirements in IFRS 16. Therefore, Approach B is considered to represent the most effective way to address concerns raised about the tentative proposed approach.

Staff recommendation

The staff recommended that the Board:

  • a) Specify that when applying paragraph 100(a) of IFRS 16 (i.e. initially measure the ROU asset and lease liability arising from the leaseback), a seller-lessee determines the proportion of the asset sold that relates to the right of use it retains by comparing the present value of the expected payments for the lease at market rates—discounted using the interest rate implicit in the lease (if that rate can be readily determined) or the seller-lessee’s incremental borrowing rate—to the fair value of the asset sold.
  • b) Modify its tentative proposed approach for how a seller-lessee subsequently measures the lease liability arising from the leaseback such that the seller-lessee would reduce the carrying amount of the lease liability to reflect expected payments for the lease at market rates.
  • c) Specify that a seller-lessee would apply the proposed amendment to IFRS 16 retrospectively in accordance with IAS 8, except when that application to sale and leaseback transactions with variable lease payments is possible only with the use of hindsight. In that case, the seller-lessee would determine the expected payments for the lease at the beginning of the annual reporting period in which it first applies the proposed amendment.

The staff’s recommendation would not change:

  • a) other aspects of the Board’s tentative proposed approach for how a seller-lessee applies paragraphs 36–38 of IFRS 16; and
  • b) the Board’s tentative decision about developing an illustrative example.

Board discussion and voting

The staff highlighted that hey recommend that the transition relief the Board previously decided to provide for instances in which the retrospective application of the proposed amendments would require the use of hindsight should be extended to the initial measurement of sale and leaseback transactions that include variable lease payments. A seller-lessee applying the transition relief would determine expected payments from the lease at the date it first applies the proposed amendments. Whilst not discussed in the paper, they also recommend that the seller-lessee would adjust the ROU asset at that date with any remaining adjustments recognised in retained earnings.

A Board member agreed with the direction of the paper and the staff’s suggestion that Approach B is the better approach, however they thought that the staff’s recommendation around a seller-lessee reducing the carrying amount of the lease liability to reflect expected payments for the lease at market rates should be phrased more clearly in order to stress that it’s only the expected payments for the lease determined at the initial measurement date that would be allowed to be deducted from the carrying amount of the lease liability and to avoid confusion. Another Board member agreed with this point and suggested that for clarity there should be a reference around the significance of the assumption that the terms are at market.

Another Board member also agreed that Approach B is the better approach but asked for the staff’s views on how this would be applied in practice for preparers as the scope of the project is being expanded. The staff responded that despite the scope of the project being expanded, they would not expect a difference in terms of the transactions this would affect, as, similarly to the Board’s previous decisions, even though the amendment applies to all sale and leaseback transactions, the expectation is that any changes in accounting would only arise in the case of sale and leaseback transactions with variable payments. Furthermore, they consider Approach B to be the intuitive method to use for the initial measurement and noted that it is aligned with one of the illustrative examples accompanying IFRS 16. The staff also noted that they have not seen substantial evidence in practice to suggest that preparers are approaching the initial measurement of the ROU asset and lease liability differently.

The Vice-Chair noted that she agrees with the staff’s recommendation and believes this is an important proposal in order to avoid an instance similar to the example set out in the agenda paper, which illustrates how one could get to the odd situation of having lease payments which are fixed but ending up with a portion of these payments being described as variable when the model gets applied. She also highlighted that this is an increase in scope but she considers it to be a natural extension of the concepts in IFRS 16.

A Board member asked the staff to clarify whether the scope of their recommendations applies to sale and leaseback transactions with both fixed and variable payments, which the staff confirmed.

One Board member noted that even though they would be voting in favour of the staff’s recommendation and they consider it to be an improvement of the current wording in the Standard, they will be voting against the overall amendment. Their decision is due to the fact that they believe that there is a conflict between the principles of variable lease payments not qualifying as lease payments and that when entering into a sale and leaseback transaction there should not be any gain on the interest retained by the seller-lessee, which the Board should redeliberate upon.

12 Board members voted in favour of the staff’s recommendation, with 1 Board member absent.

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