provide in effect the only source of the seller/lessee’s future income. Equally, the financial
effects of not exercising the option, such as continued exposure to escalating costs, may
make it obvious that the option will have to be exercised (so-called ‘economic compulsion’).
The following is an example of a sale and leaseback deal where the seller has a call
option to repurchase the asset but has no commitment to do so:
Example 23.26: Sale and leaseback transaction involving escalating rentals and
call options
Company S sells a property to Company B for £100,000,000 and leases it back on the following terms:
Rental for years 1 to 5
£1,475,000 per annum
Rental for years 6 to 10
£2,900,000 per annum
Rental for years 11 to 15
£5,500,000 per annum
Rental for years 16 to 20
£10,800,000 per annum
Rental for years 21 to 25
£19,100,000 per annum
Rental for years 26 to 30
£30,025,000 per annum
Rental for years 31 to 35
£45,150,000 per annum
Rental thereafter
open market rent
Rentals are payable annually in advance.
Company S has a call option to buy back the property at the following dates and prices:
At the end of year 5
£125,000,000
At the end of year 10
£150,000,000
At the end of year 15
£168,000,000
At the end of year 20
£160,000,000
At the end of year 25
£100,000,000
Company B has no right to put the property back to Company S.
An analysis of the economics of this deal suggests that whilst Company S has no legal obligation to
repurchase the property, there is no genuine commercial possibility that the option will not be exercised. This
is because the rentals and option prices are structured in such a way as to give the buyer of the property a
lender’s return whilst, at the same time, there is no commercial logic for the seller not to exercise the option
at year 25, if not earlier. Exercising the option at the end of year 25 will mean that Company S will regain
Leases (IAS 17) 1675
ownership of the property and will have had the use of the £100,000,000 at an effective rate of approximately
6% per annum; failure to exercise the option will mean additional lease obligations of £375,875,000 over the
ten years from years 25 to 35, followed by the obligation to pay market rents thereafter.
Entities applying IFRS 16 must apply the requirements for determining when a
performance obligation is satisfied in IFRS 15 to determine whether the transfer of an
asset is accounted for as a sale of that asset. [IFRS 16.99]. If control of the underlying asset
passes to the buyer-lessor, the transaction is accounted for as a sale or purchase of an
asset and a lease. If not, both the seller-lessee and the buyer-lessor account for the
transaction as a financing transaction. If the seller-lessee has a substantive repurchase
option for the underlying asset (i.e. a right to repurchase the asset), no sale has occurred
because the buyer-lessor has not obtained control of the asset. [IFRS 16.BC262(c]. For
discussion of sale and leaseback arrangements under IFRS 16, see Chapter 24 at 8.
8
SUB-LEASES AND BACK-TO-BACK LEASES
8.1 Introduction
Sometimes there are more parties to a lease arrangement than simply one lessor and
one lessee. This section relates to situations involving an original lessor, an intermediate
party and an ultimate lessee. The intermediate party is unrelated to both lessor and
lessee and may be acting either as both a lessee and lessor of the asset concerned or,
alternatively, as an agent of the lessor in the transaction.
Both sub-leases and back-to-back leases involve the intermediate party acting as both
lessor and lessee of the asset. The difference between the two arrangements is that, for
a back-to-back lease, the terms of the two lease agreements match to a greater extent
than would be the case for a sub-lease arrangement. This difference is really only one
of degree. The important decision to be made concerns whether the intermediate party
is acting as both lessee and lessor in two related but independent transactions or
whether the nature of the interest is such that it need not recognise the rights and
obligations under the leases in its financial statements.
8.1.1
The original lessor and the ultimate lessee
The accounting treatment adopted by these parties will not be affected by the existence
of sub-leases or back-to-back leases. The original lessor has an agreement with the
intermediate party, which is not affected by any further leasing of the assets by the
intermediate party unless the original lease agreement is thereby replaced.
Similarly, the ultimate lessee has a lease agreement with the intermediate party. The lessee
will have use of the asset under that agreement and must make a decision, in the usual way,
as to whether the lease is of a finance or operating type under the requirements of IAS 17.
8.1.2
The intermediate party
It is common for entities whose business is the leasing of assets to third parties to
finance these assets themselves through leasing arrangements. There are also
arrangements in which a party on-leases assets as an intermediary between a lessor and
a lessee while taking a variable degree of risk in the transaction. The appropriate
accounting treatment by the intermediate party depends on the substance of the series
1676 Chapter 23
of transactions. Either the intermediate party will act as lessee to the original lessor and
lessor to the ultimate lessee or, if in substance it has transferred the risks and rewards
of ownership, it may be able to derecognise the assets and liabilities under its two lease
arrangements and recognise only its own commission or fee income.
In order to analyse the issues that may arise, the various combinations of leases between
lessor/intermediate and intermediate/lessee are summarised in the following table:
Lessor
Intermediate party
Lessee
Lease to
Lease from
Intermediate
Lease from Lessor
Lease to Lessee
Intermediate
(1)
Operating lease
Operating lease
Operating lease
Operating lease
(2)
Finance lease
Finance lease
Operating lease
Operating lease
(3)
Finance lease
Finance lease
Finance lease
Finance lease
Only in unusual circumstances could there be an operating lease from the lessor to the
intermediate and a finance lease from the intermediate to the lessee. The intermediate
would have to acquire an additional interest in the asset from a party other than the
lessor in order to be in a position to transfer substantially all of the risks and rewards
incidental to ownership of that asset to the lessee.
There are no significant accounting difficulties for the intermediate party regarding (1),
an operating lease from the l
essor to the intermediate and from the intermediate to the
lessee. The intermediate may be liable to the lessor if the lessee defaults, in which case
it would have to make an appropriate provision, but otherwise both contracts are
executory and will be accounted for in the usual way.
In situation (2), the intermediate will record at commencement of the lease term an
asset acquired under a finance lease and an obligation to the lessor of an equal and
opposite amount. As it has granted an operating lease to the lessee, its risks and rewards
incidental to ownership of the asset exceed those assumed by the lessee under the lease.
It is appropriate for the intermediate party to record a fixed asset, which it will have to
depreciate as set out in 4.1.4 above.
However, under scenario (3), the intermediate is the lessee under a finance lease with
the lessor and lessor under a finance lease with the lessee. Its statement of financial
position, prima facie, records a finance lease receivable from the lessee and a finance
lease obligation to the lessor. Both of these are treated as if they are financial
instruments for derecognition purposes (see 3.5 above for the circumstances in which
lease assets and liabilities are within scope of IFRS 9).
The intermediate may be in a position to derecognise its financial asset and liability if it
transfers to the lessor the contractual right to receive the cash flows of the lessee and
thereby extinguishes its liability under the lease. [IFRS 9.3.2.4]. However, it is more likely
that it retains the contractual right to receive the cash flow under the lease and takes on
a contractual obligation to pay the cash flows to the lessor. In accordance with the
derecognition rules in IFRS 9 it can derecognise its asset and liability if, and only if, it
meets certain criteria, which are summarised below and described in detail in Chapter 48.
In the context of leases, the most important of these conditions is that the intermediate
has no obligation to pay amounts to the lessor unless in collects equivalent amounts
from the lessee. [IFRS 9.3.2.5(a)]. If the ultimate lessee defaults on its lease obligations (for
Leases (IAS 17) 1677
whatever reason), the original lessor must have no recourse against the intermediate
party for the outstanding payments under the lease if derecognition is to be appropriate.
Another important factor is what happens if the original lessor defaults, for example
through insolvency. The analysis will also have to take account of the following
conditions for derecognition of a financial asset in IFRS 9:
(a) the entity (i.e. the intermediate party) is prohibited by the terms of the transfer
contract from selling or pledging the original asset; and
(b) the entity has an obligation to remit any cash flows it collects without material
delay. Investment in cash or cash equivalents is permitted, but interest earned must
be passed to the eventual recipients. [IFRS 9.3.2.5].
If all of these factors indicate that the intermediate party has derecognised its interest
in the two leases, i.e. commercially it is acting merely as a broker or agent for the original
lessor, it should not include any asset or obligation relating to the leased asset in its
statement of financial position. The income received by such an intermediary should
be taken to profit or loss on a systematic and rational basis – the discussion of the
recognition of fee income in SIC-27, as discussed in 2.2 above, may be helpful. If, on
the other hand, the intermediate party is taken to be acting as both lessee and lessor in
two independent although related transactions, the assets and obligations under finance
leases should be recognised in the normal way.
It should not be inferred from the above discussion that all situations encountered
can be relatively easily analysed. In practice this is unlikely to be the case, as the
risks and rewards will probably be spread between the parties involved. This is
especially likely where more than the three parties discussed above are involved.
Therefore, even if the arrangements meet the definition of a ‘transfer’ under IFRS 9,
the intermediate may have retained some of the risks and rewards of ownership or
control of the asset and it may be necessary to recognise other assets and liabilities
in this respect. The complex area concerning derecognition of financial assets is
dealt with in Chapter 48 at 3.
9
DISCLOSURES REQUIRED BY IAS 17
This section deals only with the disclosure requirements of IAS 17 and those of other
accounting standards to which it specifically refers. Disclosures required by SIC-27 are
dealt with in 2.2.4 above.
9.1
Disclosures relating to financial assets and liabilities
Because finance lease assets and obligations and individual payments currently due and
payable under operating leases are financial assets and liabilities, lessees and lessors
must make the disclosures required by IFRS 7 – Financial Instruments: Disclosures.
This principally applies to the general requirements regarding classification and
disclosure of financial assets and liabilities in the statement of financial position and
disclosure of interest income and expense, together with other gains and losses arising
from financial instruments, whether reflected in profit or loss or other comprehensive
income. IFRS 7’s disclosure requirements are covered in Chapter 50.
1678 Chapter 23
9.2 Disclosure
by
lessees
9.2.1
Disclosure of finance leases
As well as meeting the IFRS 7 disclosure requirements, IAS 17 requires lessees to make
the following disclosures for finance leases: [IAS 17.31]
(a) for each class of asset, the net carrying amount at the reporting date. Assets that are
recognised under a finance lease will generally be considered to be the same class
of assets with a similar nature that are owned, so there is no need to provide separate
reconciliations of movements in owned assets from assets under finance leases;
(b) a reconciliation between the total of future minimum lease payments at the
reporting date, and their present value. The minimum lease payments will include
adjustments that have been made following a rent review. In addition, an entity
shall disclose the total of future minimum lease payments at the reporting date,
and their present value, for each of the following periods:
(i) not later than one year;
(ii) later than one year and not later than five years;
(iii) later than five years.
(c) contingent rents recognised as an expense in the period. See 3.4.7 above for a
discussion about the meaning for disclosure purposes of future minimum lease
payments and contingent rents;
(d) the total of future minimum sublease payments expected to be received under
non-cancellable subleases at the reporting date;
(e) a general description of the lessee’s material leasing arrangements including, but
not limited to, the following:
(i) the basis on which contingent rent payable is determined;
(ii) the existence and terms of renewal or purchase options and escalation
clauses; and
(iii) restrictions imposed by lease arrangements, such
as those concerning
dividends, additional debt, and further leasing.
The following is an example of disclosures made in practice:
Extract 23.4: Deutsche Telekom AG (2016)
Notes to the Consolidated Financial Statements [extract]
Other disclosures [extract]
33 LEASES [extract]
DEUTSCHE TELEKOM AS LESSEE [extract]
Finance leases. When a lease transfers substantially all risks and rewards to Deutsche Telekom as lessee, Deutsche
Telekom initially recognizes the leased assets in the statement of financial position at the lower of fair value or
present value of the future minimum lease payments. Most of the leased assets carried in the statement of financial
position as part of finance leases relate to long-term rental and lease agreements for office buildings and technical
fixed-network or mobile facilities. The average lease term is 16 years. The agreements include extension and
purchase options. The following table shows the net carrying amounts of leased assets capitalized in connection
with a finance lease as of the reporting date:
Leases (IAS 17) 1679
millions of €
Of which: sale
Of which: sale
and leaseback
and leaseback
Dec. 31, 2016
transactions
Dec. 31, 2015
transactions
Land and buildings
490
246
559
290
Technical equipment and machinery
1,631
0
796
0
Other 14
0
9
0
NET CARRYING AMOUNTS OF
LEASED ASSETS CAPITALIZED
2,135
246
1,364
290
The increase in technical equipment and machinery is primarily a result of new finance leases for network upgrades
at T-Mobile US totaling EUR 0.6 billion.
At the inception of the lease term, Deutsche Telekom recognizes a lease liability equal to the carrying amount of the
leased asset. In subsequent periods, the liability decreases by the amount of lease payments made to the lessors using
the effective interest method. The interest component of the lease payments is recognized in the income statement.
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 331
