IFRS 16 Lease aspects -5-

General principles

With the introduction of (International Financial Reporting Standard) IFRS 16 Leases, a new category of asset was created in the financial statements: the right-of-use asset.

A topic that is receiving a great deal of attention as a result of the current comment period for the Exposure Draft (ED) Lease Liability in a Sale and Leaseback is the accounting for variable lease payments. The IFRS 16 Leases standard was only drafted with great efforts and deals with quasi-variable payments (‘in-substance fixed lease payments’), i.e. payments that are not based on any real variability and which, when realistically chosen, result in at least a series of payments. But other forms of variable payments are explicitly not included in the calculation of the lease liabilities.

The recent ED now proposes that in the case of a sale and leaseback, variable payments should be included in the calculation of the lease obligation. From a consistency point of view, this is clearly a dual and therefore inconsistent application, which could be signaling a sliding scale. Opponents often yet understand the underlying idea that when transferring an own asset to a leased asset, the entire book profit should not be realized, but have great difficulty with the conceptual justification.

Research results

72 Companies were surveyed in the articles referred to above, all of which reported on variable payments and the occurrence or non-occurrence of sale and leaseback transactions.

Of the surveyed companies, (n=35) 49% reported on variable lease payments.

Of the surveyed companies, (n=23) 32% report on future variable lease payments.

Companies in (n=11) 15% reported the completion of sale and leaseback transactions.

Variable lease payments

It appears that in (n=35) 49% of the enterprises have leases with variable payments.

Of these 35 companies, (n=19) 27%  did not report variable amounts for future years. In itself, this finding fits in with the variable nature of payments, of which it is often impossible to estimate in advance whether there will be or how high an amount will be.

Of the same 35 companies, (see right axis in graph and orange line) 74% report that the amount of the variable payments is less than 25% of the sum of depreciation of lease assets and the interest charge on the lease liabilities.

This indicates that, in general, variable lease payments can actually be viewed as additional payments within a lease agreement.

Variable future payments

Of the companies surveyed, (n=23) 32% do report on future variable lease payments.

In some cases, companies report only in the form of a text in the explanatory notes, in other cases only with an amount and (n=11) 15% reports both an amount and a textual explanation.

For this category of future payments too, uncertainty or the impossibility of arriving at a responsible estimate will have played a role in the way of reporting.

Reporting of sale and leaseback transactions

A total of 11 companies reported sale and leaseback transactions.

Of these companies, (n=7) 10% reported a positive result and gave an explanation.

Another (n=4) 5% of the companies report that a sale and leaseback transaction took place, but without reporting a result. This may well include companies with a negative result from the sale and leaseback transaction, but it is more likely that no loss-making transactions were concluded.

For all the companies which have reported a positive result (see right-hand axis and orange line) from the sale and leaseback transactions, the result is less than 25% of the sum of depreciation of lease assets, the interest expense of the lease liabilities and any variable payments.

The latter observation, in combination with the observation, that sale and leaseback transactions only occur in 15% of the companies (in a normal -not Covid-19- year) means, that the application of variable lease payments, as pointed out in the ED ‘Lease Liability in a Sale and Leaseback’, has a disproportionate focus.

One of the arguments, namely that the asset remains ‘in control’ of the same business owner and that it is ‘therefore’ justified not to take the entire sales gain when entering into a sale and leaseback transaction, is flawed in that the IASB does not sufficiently recognize that the position of the lessee in a lease is essentially different from that of the legal owner of the same property.  In essence, this discussion goes back to the essence of a lease transaction versus an asset owned by the company.

Conclusion

The standard IFRS 16 Leases issued by the (International Accounting Standards Board) IASB in January 2016, which must be compulsorily applied by large, listed companies from 2019, also contains a number of concrete guidelines, for example about sale and leaseback transactions. It looks like a relatively limited number of  sale and leasing back transactions of previously owned assets seem to take place. From the research, it does not appear that in the majority of situations this is about real estate, but that very well could be the most common category.

Whether this is also the case in practice has not or insufficiently been investigated by the IASB.

Currently, Tweuus is conducting a study into the occurrence of sale and leaseback transactions in Small and Medium-sized Enterprises and their recognition by lessors. The results so far show a wide variation and are not yet unambiguous.

In this fifth report, the conclusion is that this time (prospectively) an allegedly large problem is raised by means of an Exposure Draft, while practice shows that the effects are limited. Both in numbers and in size. The (alleged) lack of clarity of obligations hidden in sale and leaseback transactions will not be improved by the introduction of variable lease payments in a sale and leaseback. In fact, the IASB is treading on dangerous ground conceptually with its proposals for dual application of variable lease payments.