IFRS16 intermediate lessor

[noobIFRSnoob]

Hi,

I have a following question regarding IFRS16. Lets say that there is a company A, that is buying some assets from a vendor. Company A is going to sell these assets to the bank and is going to lease them from bank for 3 years with 5% interest rate. And at the end of the period the assets will belong to company A. Now, the company A is going to sell these equipment to the bank immediately after giving in the order to the vendor (creating an invoice to the bank after ordering the equipment). And company A is going to lease them back from the bank after the equipment is made available to them. So company A is going to recognize it as a regular lease for IFRS16.
Now, company A is going to be a intermediate lessor in the transaction, as the same equipment is rented out to their customers. The contract between company A and customers is an open ended contract and the equipment will belong to company A any time the customer decides to cancel the rental contract. Also, the cancellations can happen any time, some customers might rent it for example 3 months, others could rent for 5 years. The equipment does not necessarily lose value per se and is still generating value to the company even after the lease end with the bank. Company A would recognize this lease as an operational lease, since the risks do not transfer to the customer and even after lease end with customer, the equipment would go under a quality check and would be re-rented to a new customer.

I would appreciate if anybody can give their opinion on this approach that company A has in this case and if you find it correct or would classify anything differently as mentioned above

[Ketan Marwah]

Hi,

Can you please try to cull out your question from the two paragraphs? Just gets a bit difficult to scan through long paragraphs to get to the question and the associated relevant details.

[noobIFRSnoob]

Is it correct for the intermediate lessor to recognize a lease as regular IFRS16 lease, if the head lessor has rented the equipment for 3 years for example with 5% interest rate and the lessee will be the owner of the asset after the rent period end. And for the intermediate lessor to recognize the equipment when subleased as operational lease, if the sublease contracts are open-ended, and the intermediate lessor will be the owner of the equipment after the contract should be canceled? Also the contracts can be canceled anytime, and usually they vary, they could be leased out for 1 month or 5 years or more, depending on when the customer cancels it.

[Ketan Marwah]

Hi,

These are too little details to give an opinion so I would recommend that you go through the following links first to have a basic understanding of the topic:

https://ifrscommunity.com/knowledge-bas ... g-a-lease/
https://ifrscommunity.com/knowledge-bas ... ease-term/

The reason why I have guided you to the above links is because you need to understand the contract details better and it's accounting implications such as enforceability etc. What I can answer though from your post is that under IFRS 16 subleases are accounted for by the sub-lessor in the same way as other leases. Happy reading.

[noobIFRSnoob]

Thank you for the links, Ketan!

I will try to be more specific now though, because I would really appreciate your opinion, as right now there is a new approach for our company and nobody is exactly sure how would be the correct way to account for it.
The company is a telecom operator and the equipment is routers. So basically each unit separately is of a low value, but since they are bought in bulk they form quite an amount in balance sheet and also generate a significant sum of revenue. Now, the company has decided that all of the new equipment would be sold to the bank and would be leased from the bank. To my understanding, if this selling of the asset transfers the control to the bank and is done immediately then according to IFRS 16.B45-B47 it would qualify as a regular IFRS 16 lease.
The contract with the bank has the following details:
- contract is for 2 years
- there is an interest rate, lets say for example 5%
- at the end of the contract the equipment would belong to the company (not to the bank)

Now, the company itself rents out these equipment to its customers with a contract that is open-ended, there is no fixed term. Also, the customer can cancel the contract any time and they would just pay the period that they used the router. So they can for example rent it for 1 month or even long as 5 years or more.

To my understanding the company should classify the contract with the bank as a lease under IFRS16 if it transfers the control and risk of the asset to the bank. But I am unsure in this part, as in what instance this would qualify as purchase (IFRS 16.BC138-140) and not as a finance lease.
Also the company should account for the subleases as operational leases, since this seems to be more the nature of these contracts, as they are open-ended and the company will be the owner of the asset, when the customer decides to cancel the lease.
Which means that the company would recognize an asset and liability for the head contract under IFRS 16 (basically everything would be as with a regular lease) and from sub-leasing these assets, the company would recognize it as operational lease and would retain the head contract as it is and from sub-leases would recognize the revenue.

So in short, my question is, if the described approach seems logical or if somehow the initial contract between bank and company would classify more as a purchase? Or am I missing some crucial part of information that I should still look for. For example, if the enforceability would determine if it is more like a purchase? In case there is no cancellation option defined, and the contract would have to be fulfilled until the end of 2 years?

Anyways I really hope someone can answer to it and give me some insight if my logic is failing me on this case.

[Ketan Marwah]

Hi,

You went pretty quick with the lease assessment so let’s try to tackle a couple of important aspects from the opening piece of your post and once clarified then we go along from there to the remaining parts of your post:

- at the end of the contract the equipment would belong to the company (not to the bank)

Your understanding is correct that the accounting treatment for such transactions depends on whether a genuine sale has taken place. If the buyer-lessor has not gained control over the asset (indicating no sale has taken place), the supposed sale and leaseback is viewed as a financing arrangement, with the underlying asset acting as collateral. This assessment is based on the IFRS 15 criteria in which sale recognition is precluded when the party that would be the seller-lessee has a substantive repurchase option or obligation with respect to the underlying asset. If so, the buyer-lessor has not obtained control. A non-substantive repurchase option does not preclude sale accounting so please confirm whether a sale has actually happened or not by referring the buyback clause?

So basically each unit separately is of a low value, but since they are bought in bulk they form quite an amount in balance sheet and also generate a significant sum of revenue

The exemption for leases of low-value assets is available on a lease-by-lease basis. [IFRS 16:8] In particular, an entity is not required to consider the aggregate of the leases identified as relating to low-value assets to determine if the overall effect is material. Subject to IFRS 16’s general requirements regarding the combination of interdependent contracts, and the specific requirements in IFRS 16:B5 regarding assets that are highly interdependent or highly interrelated, each lease is assessed separately. For example, a hospital enters into a rental contract for a large number of hospital beds. Each bed within the contract constitutes an identified underlying asset and the other conditions for identification of a lease are met. The value of an individual hospital bed would be considered to be ‘low’, even though the contract for all of the beds is not. The conditions of IFRS 16:B5 are met (the hospital can benefit from the use of an individual bed together with other resources that are already available, and each individual bed does not need other assets to make it functional for patients). Consequently each bed qualifies as a low-value asset and the entity can elect to apply the low value asset exemption to all of the beds under the contract. This is however not a mandatory exemption as IFRS 16.5(b) allows lessees to bypass its recognition requirements for leases where the underlying asset has a low value.
However, if an asset is subleased or intended for subleasing, the head lease does not qualify for the low-value exemption (IFRS 16.B7). Further in the post you mentioned that the company subleases the routers therefore the head leases does not qualify for low-value exemption. While your conclusion “might” be correct to apply lease accounting but a reference to the assets in bulk generating a significant sum of revenue if was used towards choosing to apply lease accounting then it was not correct.

Once you confirm that an actual sale has taken place then we can continue to explore other parts of your post otherwise the two of us would just simply be wandering in the wonderland.

[noobIFRSnoob]

Thank you for a really insightful answer! And yes, sorry my answers might not be to the point at times, since I feel like a newby with the IFRS. Yes, the idea would be to not use the low-value exemption and this would be our conclusion to account it as a lease under IFRS16.

Also regarding the initial transaction with the bank being a sale or not, I have understood from the following article (https://ifrscommunity.com/knowledge-bas ... nsactions/) in the community, that if the entity does not gain the control of the asset before selling it to the bank, then it would in fact be accounted for as a standard lease within IFRS16. IFRS 16.B45-B47 states the following:
"...For example, this may be the case if a manufacturer, a lessor and a lessee negotiate a transaction for the purchase of an asset from the manufacturer by the lessor, which is in turn leased to the lessee. The lessee may obtain legal title to the underlying asset before legal title transfers to the lessor. In this case, if the lessee obtains legal title to the underlying asset but does not obtain control of the asset before it is transferred to the lessor, the transaction is not accounted for as a sale and leaseback transaction, but as a lease."

So if in this case, the entity is just negotiating with the dealer and whenever an order is made and it is immediately sold to the bank (before entity gains any control of the asset), would it still be necessary to consider IFRS 15 and the repurchasing fact you are mentioning. Or would this qualify as a regular lease within IFRS 16 scope?

[Ketan Marwah]

Hi,

No issues. We all start from somewhere. This is an excellent place to bounce off your queries and I am sure, one or the other member would try to give you a perspective on your query.

Of course your interpretation of the paragraph as such is correct but the question is whether it applies to the situation you described or not. Don't interpret basis IFRS 16.B47 that it only requires a quick turnaround to preclude the existence of sale. For the company to be able to make a sale it first has to gain control over the underlying asset before transferring it to the bank. The assessment simply becomes crucial in such scenarios as it is indicative of absence of control obtained by the company. Test the arrangement holistically both from the aspect of obtaining control and transferring it later. This assessment includes a consideration of paragraph B66 of IFRS 15 which specifies that “if an entity has an obligation or a right to repurchase the asset (a forward or a call option), a customer does not obtain control of the asset because the customer is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset”. Refer the following link to identify if a sale was made to the bank by the company and whether the company obtained control of the underlying asset before it’s transferred to the bank: https://ifrscommunity.com/knowledge-bas ... ing-a-sale

[noobIFRSnoob]

Hi Ketan,

Thank you for your answer! I looked a the IFRS15 paragraph you mentioned but also tried to google some example on IFRS16 b47 and why I think this could apply on our case here.
In this KPMG article (https://assets.kpmg.com/content/dam/kpm ... seback.pdf) the following is mentioned regarding IFRS B45-B47:

For highly-customised assets, a manufacturer, a lessor and a lessee may enter into a negotiation for the purchase of an asset from the manufacturer by the lessor, which in turn is leased to the lessee.
For example, an aircraft manufacturer, a bank (lessor) and an airline company (lessee) may negotiate that the aircraft manufacturer will build an aircraft to the airline company’s specifications, but it will be the bank that purchases the aircraft and then leases it to the airline company.
In determining whether sale-and-leaseback accounting is required, the key question is whether the airline company obtains control of the aircraft before it is purchased by the bank. If it is determined that the bank obtains control of the aircraft from the aircraft manufacturer before it is leased to the airline company, then the transaction will be accounted for solely as a lease between the bank (lessor) and the airline company (the lessee): there is no sale and leaseback.
In contrast, if the airline company is determined to obtain control of the aircraft from the aircraft manufacturer, then the arrangement between the airline company and the bank will be accounted for as a sale and leaseback.
In some cases, legal title of the asset may momentarily be transferred to the lessee (i.e. the airline company in our example) before it eventually transfers to the lessor (i.e. the bank). This may occur for various reasons, including tax and legal. However, paragraph B47 of IFRS 16 indicates that this alone does not mean that the lessee controlled the asset before its acquisition by the lessor.

This sounds extremely similar to our case, since the item itself is quite specific and the initial negotiation is necessary by lessee. Also why there would be no control for the entity before bank is purchasing it, is the fact that the entity would not obtain the routers. The shipment would take place after the bank purchase.

But please correct me or bring out any ideas that I am maybe missing and should still consider before determining that IFRS 16 B45-B47 could apply here.

[noobIFRSnoob]

Or should the fact still be considered that probably the equipment will belong to the company at the end of the lease (as the bank does not have much to do with the item)? It is just that I am thinking if it is so then why would anything else be considered as a finance lease and not just financing.
This is why it seems to me that in this instance the IFRS16 B45-B47 could apply, because I can not figure out any other case, where this could be potentially applied. Since the company would not control the equipment before the bank has purchased it.