A sale and leaseback transaction is one where an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) for consideration and leases that asset back from the buyer-lessor. Ind AS 116 makes significant changes to sale and leaseback accounting.
A sale and leaseback transaction is the most common technique used by entities to secure long-term financing from substantial property, plant and equipment assets such as land and buildings.
Ind AS 17 covered the accounting for a sale and leaseback transaction in considerable detail from the perspective of the seller-lessee as against Ind AS 116 which covers buyer lessor too.
The first and the foremost step in a sale and leaseback transaction is too determine whether such a transfer qualifies as sale, as per the requirement of Ind AS 115 ‘Revenue from contracts with customers’.
Ind AS 116 prescribes accounting for both type of transactions i.e. when transfer of asset is a sale and when it is not a sale. In this article we are dealing with sale and lease back transactions which are sale as per Ind AS 115.
Para 100, of Ind AS 116 states that when a transfer of an asset by the seller-lessee satisfies the requirements of Ind AS 115 to be accounted for as a sale of the asset:
a. The seller lessee will derecognise the carrying amount of asset sold from its books
b. The seller lessee will recognise a right of use asset measured at the proportion of the previous carrying amount that relates to the right of use retained
c. The seller lessee will recognise gain/loss in relation to the rights transferred to the buyer lessor
The accounting treatment by the seller lessee depends on whether the consideration received is equal to more than or less than the fair value of the asset so transferred.
> If the consideration is below the fair value, then the below market terms shall be accounted for as a prepayment of lease payments; and
> If the consideration is above the fair value, any above-market terms shall be accounted for as additional financing provided by the buyer-lessor to the seller-lessee.
Let us understand each of this scenario with the help of an example:
a. Consideration equal to fair market value:
> ABC Ltd decides to sell its main office building to a XYZ Ltd for Rs. 10 lakhs and lease it back on a 6-year lease. The current fair value of the office building is Rs. 10 lakhs and the carrying value of the same in books is Rs. 8 lakhs. The present value of the lease payments is calculated as Rs. 6 lakhs. Please note that this transaction constitutes a sale in accordance with Ind AS 15.
Treatment:
In this case, Ind AS 115 criteria have been met and the transaction is a sale and lease back transaction. Ind AS 116 therefore requires that, at the start of the lease, ABC Ltd should measure the right-of-use asset arising from the leaseback of the building at the proportion of the previous carrying amount of the building that relates to the right-of-use retained in the asset.
ROU= Carrying amount of the asset * Present value of minimum lease payments/ Fair value of the asset
=Rs.8 lakhs * Rs. 6 lakhs / Rs. 10 lakhs = Rs. 4.8 lakhs
ABC Ltd will pass the following entries:
| Cash – Dr | Rs. 10 lakhs |
| Right of Use asset – Dr | Rs. 4.8 lakhs |
| To Building – Cr | Rs. 8 lakhs |
| To Lease liability- Cr | Rs. 6 lakhs |
| To Profit and Loss – Cr | Rs. 0.8 lakhs |
b. Consideration less than the fair market value:
> All the facts in the above example remains the same except that the sale consideration is Rs. 9 lakhs.
Treatment:
Here the sales price is below fair value. The difference is accounted for as a lease prepayment and so is added to the right-of-use asset as per Ind AS 116 treatment for initial measurement of a right-of-use asset.
ROU= (Carrying amount of the asset * Present value of minimum lease payments/ Fair value of the asset) + (Fair value – sale price)
= (Rs.8 lakhs * Rs. 6 lakhs / Rs. 10 lakhs) + (Rs. 10 lacs – Rs. 9 lacs)
=Rs. 5.8 lakhs
ABC Ltd will pass the following entries:
| Cash – Dr | Rs. 9 lakhs |
| Right of Use asset – Dr | Rs. 5.8 lakhs |
| To Building – Cr | Rs. 8 lakhs |
| To Lease liability- Cr | Rs. 6 lakhs |
| To Profit and Loss – Cr | Rs. 0.8 lakhs |
c. Consideration more than the fair market value:
> All the facts in the above example remains the same except that the sale consideration is Rs. 12 lakhs.
Treatment:
Here the sale price is above the fair value of Rs. 10 lakhs. Ind AS 116 states that the excess over fair value should be accounted for as additional finance provided by the lessor, so Rs. 2 lakhs (Rs. 12 lakhs – Rs. 10 lakhs) above the fair value would be treated as an additional liability.
The lease liability is originally recorded at the present value of lease payments. This amount is then split between:
- the additional financing (the difference) which is in substance a loan, and
- the present value of lease payments at market rates (the balance).
The present value of minimum lease payment is Rs. 6 lakhs, of which Rs. 2 lakhs relate to financing and Rs. 4 lakhs relate to the lease.
ROU= (Carrying amount of the asset * Present value of minimum lease payments/ Fair value of the asset)
= (Rs.8 lakhs * Rs. 4 lakhs / Rs. 10 lakhs) = Rs. 3.2 lakhs
ABC Ltd will pass the following entries:
| Cash – Dr | Rs. 12 lakhs |
| Right of Use asset – Dr | Rs. 3.2 lakhs |
| To Building – Cr | Rs. 8 lakhs |
| To Lease liability- Cr | Rs. 6 lakhs |
| To Profit and Loss – Cr | Rs. 1.2 lakhs |
Treatment in the books of buyer lessor:
The buyer-lessor i.e. XYZ Ltd. accounts for the purchase of building as a normal purchase and for the lease (building given on lease) in accordance with Ind AS 116.
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