FRS 116 Leases – Sale and Leaseback Transactions

FRS 116 Leases – Sale and Leaseback Transactions

You may have seen or heard a condition like this: Entity Y transfers an asset to Entity Z, and it leases that asset back from Entity Z. This is called a sale and leaseback transaction, and this is something common in the aircraft industry as well as Real Estate Investment Trusts (REITs). According to FRS 116: Leases, the party which sells the asset and lease it back, which is Entity Y in the example above, is the seller-lessee. On the other hand, the party that purchases the asset and lets out on lease, that is Entity Z, is the buyer- lessor. 

In some situations, the sale and leaseback transactions can bring advantages to both the lessee and the lessor. However, this type of transactions can be quite confusing for business owners, particularly if accounting is not their thing. If you are one of them, don’t attempt to do the accounting task related to such transactions on your own as you may end up suffering from a headache. Instead, engage an accounting firm in Singapore and get assistance from the professionals. 

Now, let’s get back to the topic. 

As we have mentioned above, an entity may transfer an asset to another before it leases the asset back. In such a situation, the seller-lessee and buyer-lessor should manage the contract for the transfer as well as the lease by implementing FRS 116. The first thing to do is to assess whether the transfer of asset can be considered as a sale. If an entity wants to do so, it should implement the requirements to identify if the transaction has satisfied the performance obligation in FRS 115: Revenue from Contracts with Customers. 

If that transfer of asset has met the requirements specified in FRS 115 to be a sale, the seller-lessee needs to recognise the right-of-use asset that arises from the leaseback at the asset’s preceding carrying amount relating to the right of use the seller-lessee has kept. Thus, it should only recognize the amount of gain or loss associated with the rights it has transferred to the buyer-lessor if there is any. 

On the buyer-lessor’s side, the buyer-lessor should treat the purchase of that asset by using applicable standards. Also, the buyer-lessor needs to manage the lease by implementing the accounting requirements as a lessor that FRS 116 has specified. 

In some cases, the fair value of the consideration for the sale of the asset and the fair value of that asset is not equivalent, or the payments for that lease are not the same as the market rates. If this happens, the entity needs to make some adjustments for it to measure the sale at fair value. Firstly, the entity needs to treat the below-market terms as a prepayment of the lease payments. Conversely, for the above-market terms, the entity should account (Also see Accounting – Closing Balance) for it as extra financing that the buyer-lessor has provided to the seller-lessee. 

For the purpose of measuring any possible adjustment mentioned in the previous paragraph, there are two methods that the entity may implement. The first one would be determining the difference between the consideration of the sale’s fair value and the asset’s fair value. Another way to do so is by identifying the difference between the present value of both the lease’s contractual payments as well as the lease’s payments according to the market rates. The entity should choose the method which is more readily determinable when they want to measure those possible adjustments. 

If that transfer of asset was unable to meet the requirements specified in FRS 115 to be a sale, the seller-lessee should keep on recognizing that transferred asset, and it has to recognize a financial liability that has the same value as the transfer proceeds. When managing financial liability, it should implement FRS 109. On the other hand, the buyer-lessor should not recognize that transferred asset. It needs to recognize a financial asset that has the same value as the transfer proceeds. It should also apply FRS 109 when accounting for the financial asset. 

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