Sales and Leaseback transactions normally occur when an organization is in a financial crunch and looking for some funds to meet its financial difficulty, despite still needing to occupy the space. In a sale and leaseback transaction, entity sale an asset owned by it to a customer (lessor) and get it back on lease (lessee). Hence, retain the right to use that assets. Whenever a sale and lease back transaction undertaken, a common question which arises about the transaction is that whether the transaction qualifies as a sale as per IFRS 15 or not.
IFRS 15 allows to recognize revenue only when the significant risk and reward transfer. However, in case of finance lease significant risk and reward, retain by an entity (lessee). Hence, in case of finance lease sales does not occur and entity continues to recognize an asset on its balance sheet as there is no sale. In this case it is finance arrangement and an entity has to book financial liability in its book in accordance with IFRS 9. However, in cases where significant risk and reward transfer sales occur, it will always be accounted as an operating lease in the book of the lessor. In this case there is need to book sales and right of use asset in the book of lessee. The right of use asset should be recognized as a proportion of the previous carrying amount of the underlying asset retained by the seller-lessee. The entity shall de-recognize an asset as per IAS 16.
Example 01:
Company X sold a machine for Rs.150, fair value of the machine is 150, carrying value is Rs.100 and Lease liability is Rs.75. Assume a significant risk and reward transferred.
Accounting from the perspective of Seller-lessee
The consideration for sale an asset is equal to fair value. The entity shall de-recognize the asset at its carrying value and recognize right of use asset in proportion of rights actually retained by the entity. Right of use assets can be determined by using this formula:
[ Lease Liability/Fair Value of Asset]
The accounting entry will be.
Debit. Credit.
Cash 150
Right of use Asset 50
Machine 100
Lease Liability 75
Gain 25
Example 02:
Company X sold a machine for Rs.200, fair value of machine is 150, carrying value is Rs.100 and Lease liability is Rs.125. Assume a significant risk and reward transferred.
Accounting from perspective of Seller-lessee
The consideration for sale an asset is more than its fair value. The entity shall de-recognize the asset at its carrying value and recognize right of use asset in proportion of rights actually retained by the entity. Right of use assets can be determined by using this formula:
[ Lease Liability/Fair Value of Asset]
[125 (LL)-50 (SP-FV)=75][75/50=50%]
The accounting entry will be.
Debit. Credit.
Cash 200
Right of use Asset 50
Machine 100
Lease Liability 125
Gain 25
Example 03:
Company X sold a machine for Rs.125, fair value of machine is 150, carrying value is Rs.100 and Lease liability is Rs.50. Assume a significant risk and reward transferred.
Accounting from perspective of Seller-lessee
The consideration for sale an asset is less than its fair value. The entity shall de-recognize the asset at its carrying value and recognize right of use asset in proportion of rights actually retained by the entity. Right of use assets can be determined by using this formula:
[ Lease Liability/Fair Value of Asset]
[50 (LL)+25 (SP-FV)=75][75/150=50%]
The accounting entry will be.
Debit. Credit.
Cash 125
Right of use Asset 50
Machine 100
Lease Liability 50
Gain 25
Benefits of sales and Leaseback:
- Cash Flow. Through sale and lease back, an entity can arrange funds without compromising its occupying space.
- Business Expansion. An entity already owns an asset, but wants some funds for expansion of business, the leaseback agreement will allow the company to get funding. This will also enable the company to use the asset as before, by paying rent under the lease.
- Tax Saving. A company can save tax by claiming the rentals as an expense in the tax returns.
- To reduce the risk of owning an asset. A company can reduce its exposure of loss of an asset.
