All,
I am putting my understanding of Subleases which are Finance in nature and request others validation.
a. When the sublease is ‘Finance’ and upon its activation, the ROU on the Head Lease is offset with the appropriate percentage. For example, if 80% of the property is on sublease, we will offset 80% of the ROU on the Head lease. If so, after this offset, the Head Lease will only record amortization for remaining 20% of the ROU on Head Lease? The ROU will get displayed for only 20% remaining value?
Is this understanding, correct?
We understand that the following journal entries are possible at the time of activation of Sublease:
On the Head Lease:
Dr Sublease Net Investment Clearing
Cr ROU
On the Sublease:
Dr Net investment
Cr Sublease Net Investment Clearing
Cr Gain/Loss
Does this accounting look good?
b. We are assuming that discount rate on Head Lease can be used as-is on Sublease if that’s a ‘Finance’ lease. This will ensure that Gain/Loss between calculated Net Investment and ROU offset (80% in the above example) is recorded correctly. But if we use implicit rate, then IRR gets calculated with ROU offset= Net investment Net investment and there would be no Gain/Loss at all. Is this correct understanding.
c. Net investment is treated as ‘Financial Asset’ per IFRS 9. Hence any amendment to the Sublease for changes like lease extension, contraction, changes to lease payments will result in Gain/Loss on Sublease. Is this understanding, correct?
Accounting on amendments to Subleases:
Dr Net investment
Cr Gain/Loss on amendment
Amendments to Finance Subleases will result in the following scenarios:
a. Fin to OPER Sublease: New lease to be created
b. Changes to Sublease Payments other than from Market Rates for Interest- No 1 time gain/loss but use the latest interest rate for amortization of Netinvestment
c. Changes to Payments other than int rates- 1 time gain loss. Use original EIR and amortize new Net Investment using this rate
d. Changes or modifications leading to Derecognition: 1 time Gain/Loss. If new Net Investment comes into play, amortize that.
e. All other changes to be treated similar to point c)
d. ROU on Head Lease is offset after upon the Finance Sublease activation. We are presuming the Head Lease and Subleases are worked upon independently for the changes to Head Lease or Sublease made by user on those respective leases.
For example, if Head Lease is extended by 6 months without changing the classification of Sublease, then Scope Increase calculations are performed only on the Head Lease. This will not trigger any changes to Net Investment as Sublease agreement doesn’t witness any change. Is this correct understanding?
e. Like above, if Net Investment changes on Sublease, this doesn’t impact the remaining ROU on the Head Lease. Is this understanding correct. Though Sublease is always within the Head Lease effective from and to periods, changes made to Sublease only impacts Sublease.
f. During termination of Sublease, our understanding is that the remaining Net investment is treated as loss and Net investment is closed with a credit and debit to Loss Account. Now since the property area reverts to Head Lease, the re-recognition or re-instatement of ROU on Head Lease takes place at carrying value of Net Investment that’s going to be rolled off from Termination of Sublease. Is this understanding, correct?
g. Should the Net investment on Sublease be broken down into Lease Receivables and Unearned Interest or tracked as single Net investment account?