IFRS 16 purchase option

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hubertd
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IFRS 16 purchase option

Post by hubertd »

Hi Everyone,

We're about to lease one of our properties. The term of the lease is 10 years with annual rent of £52,000. However, there is also an option to buy the property which affects the first two years – this can be at any time within those two years. The option is for £900k, plus index linking, so there is a variable element on top. The lessee told us he would do everything he can to execute the option ASAP.

The question is: how should we account for this arrangement? Can we apply short term lease exception?

IFRS 16:Appendix A "Has the entity applied the short-term lease exception only to leases that, at the commencement date:
(i) have a lease term of 12 months or less; and
(ii) do not contain a purchase option?"

I'm not sure how to interpret the above and how to account for a lease I know will be most probably less than 12 months due to execution of a purchase option.
Any ideas?

Thank you
DJP
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Re: IFRS 16 purchase option

Post by DJP »

Hello,

This is not my area of expertise, but I am certain that you cannot apply the short-term lease exception. IFRS 16 is quite clear in that leases with purchase options are not eligible for the short-term lease exception.
JRSB
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Re: IFRS 16 purchase option

Post by JRSB »

you are the lessor?
hubertd
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Re: IFRS 16 purchase option

Post by hubertd »

Yes, we are and it seems I've actually had the total eclipse of the mind. I can treat it as an operating lease as short-term lease notion does not actually apply to lessors..., right?
JRSB
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Re: IFRS 16 purchase option

Post by JRSB »

it's still on your balance sheet so doesn't apply no
DJP
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Re: IFRS 16 purchase option

Post by DJP »

Not sure if you can account for this as an operating lease. It seems to me that you are transferring substantially the risks and rewards of the asset.
hubertd
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Re: IFRS 16 purchase option

Post by hubertd »

DJP wrote: 01 Oct 2021, 18:10 Not sure if you can account for this as an operating lease. It seems to me that you are transferring substantially the risks and rewards of the asset.
But if not an operating lease what term would l need to set-up the lease for in this case?
DJP
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Re: IFRS 16 purchase option

Post by DJP »

I'd say 10 years in your case since that's the contractual term of the lease.
hubertd
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Re: IFRS 16 purchase option

Post by hubertd »

DJP wrote: 02 Oct 2021, 13:25 I'd say 10 years in your case since that's the contractual term of the lease.
I don’t think so given the lessee is 100% certain to execute purchase option within 12 months.
DJP
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Re: IFRS 16 purchase option

Post by DJP »

But how can you, being the lessor, determine when the lessee will exercise their option if they can do so at anytime during the first 2 years?

(Again, I note that I am not an IFRS 16 expert)
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Marek Muc
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Re: IFRS 16 purchase option

Post by Marek Muc »

How does the exercise price of the option compare with the fair value of the building? Is the exercise price significantly lower than fair value?
hubertd
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Re: IFRS 16 purchase option

Post by hubertd »

Marek Muc wrote: 02 Oct 2021, 21:18 How does the exercise price of the option compare with the fair value of the building? Is the exercise price significantly lower than fair value?
No, it’s actually higher than the fair value.
DJP
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Re: IFRS 16 purchase option

Post by DJP »

So how come you conclude that it's highly certain that the lesse will exercise the option?
hubertd
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Re: IFRS 16 purchase option

Post by hubertd »

DJP wrote: 03 Oct 2021, 01:11 So how come you conclude that it's highly certain that the lesse will exercise the option?
As I wrote in my initial post- because he told us he’s planning to do so as soon as he can. He cannot find a similar building in the given location and he’s priority is to be exactly there.
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Marek Muc
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Re: IFRS 16 purchase option

Post by Marek Muc »

I would stick to IFRS 16 requirements, non-binding lessee's verbal declarations are not enough to conclude on accounting treatment

10 years is a rather short term for a property lease, if the purchase option is for a price that is not considerably lower than fair value, I would treat it as an operating lease and simply recognise a gain/loss on disposal once the lessee exercises his option

You may want to carefully go through criteria set out in paragraphs IFRS 16.63-64 to see whether there are other terms&conditions in your contract that are worth noting in light of the classification
JRSB
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Re: IFRS 16 purchase option

Post by JRSB »

You said 'we're about to lease..', so why don't you negotiate a sale of the property rather than a lease?
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