TECHNICAL EXCELLENCE

IFRS 16 LEASES

DON’S COLUMN: IFRS 16 LEASES

NG ENG JUAN

CONSOLIDATION ISSUES IN ACCOUNTING FOR INTRA GROUP LEASE TRANSACTIONS

IFRS 16 (and its Singapore equivalents of FRS 116 and SFRS(I) 16) Leases is effective for annual periods beginning on or after 1 January 2019, superseding IAS 17 (and its Singapore equivalents of FRS 17 and SFRS(I) 1.17) Leases. For ease of discussion, the international standard codes of “IFRS 16” and “IAS 17” are used in this article. But the discussion is equally applicable to the corresponding Singapore equivalents of FRS 116 and FRS 17, and SFRS(I) 16 and SFRS(I) 1.17.

While IAS 17 adopts the “purchase” model for both lessee accounting and lessor accounting, IFRS 16 adopts a new “right-of-use” model for lessee accounting and retains the old purchase model for lessor accounting. Consequently, lessee accounting and lessor accounting are substantially symmetrical under IAS 17, but they are substantially asymmetrical under IFRS 16 (especially in cases where lessor accounts for a lease transaction as an operating lease while lessee capitalises the right-of-use asset and the related lease liability, which may happen in most cases as indicated by IASB’s Effect Analysis (January 2016) that showed approximately 85% of the US$3.3 trillion lease commitments were off balance sheet under IAS 17).

Given that lessee accounting and lessor accounting are substantially asymmetrical under IFRS 16, there will be consolidation issues arising from intra group lease transactions under IFRS 16. This article discusses the consolidation issues involved.

Lessee accounting and lessor accounting are substantially symmetrical under IAS 17, but they are substantially asymmetrical under IFRS 16 (especially in cases where lessor accounts for a lease transaction as an operating lease while lessee capitalises the right-of-use asset and the related lease liability, which may happen in most cases.

INTRA GROUP LEASE TRANSACTIONS UNDER IAS 17

For purposes of comparison, the consolidation issues involved in intra group lease transactions under IAS 17 will first be examined. As mentioned, IAS 17 adopts the purchase model for both lessee accounting and lessor accounting. Consequently, lessee accounting and lessor accounting are substantially symmetrical. With some very rare exceptions, if lessee accounts for a lease transaction as an operating lease, lessor will similarly account for the lease transaction as an operating lease, and if lessee accounts for a lease transaction as a finance lease, lessor will similarly account for the lease transaction as a finance lease.

Given that lessee accounting and lessor accounting are substantially symmetrical under IAS 17, consolidation for intra group lease transactions under IAS 17 is relatively simple.

For an intra group lease transaction that is accounted for as an operating lease by both lessee and lessor, the lease transaction will be accounted as if it is a rental transaction. The leased asset will remain in lessor’s books. The periodic lease payment will be accounted by lessee as an expense, and accounted by lessor as income. Thus, the only consolidation adjustment required at group level will be to eliminate the lease expense against the lease income. (Additional consolidation adjustments may be required, for example, where lessor accounts for the leased asset as an “investment property” but the lessee uses the leased asset as a “property, plant and equipment”. In such cases, consolidation adjustments will be required to effect the leased asset as a “property, plant and equipment” at group level.)

For an intra group lease transaction that is accounted for as a finance lease by both lessee and lessor, the lease transaction will be accounted for as if lessee purchases the leased asset with financing provided for by lessor. Consequently, the lessor will derecognise the asset and recognise a lease receivable, and the lessee will recognise a leased asset and a lease payable. The periodic lease payments will be accounted for by lessor as comprising a principal portion that reduces the lease receivable and interest portion that is treated as an income. The periodic lease payments will be accounted similarly by lessee as comprising a principal portion that reduces the lease payable and interest portion that is treated as an expense. Consolidation adjustments in this case will involve eliminating the lease receivable against the lease payable, and eliminating the interest income against the interest expense. (Alternatively, the same group effects may be achieved by reversing out the lease transaction in the lessee’s books and in the lessor’s books.) The leased asset should of course be accounted at group level on the basis it is used by the group.

INTRA GROUP LEASE TRANSACTIONS UNDER IFRS 16

As mentioned earlier, IFRS 16 adopts different accounting models for lessee accounting (the right-of-use model) and lessor accounting (the purchase model).

Under the right-of-use model, lessee has to capitalise all leases (except for (i) short-term leases, and (ii) leases with low-value underlying assets), very much like finance leases under IAS 17. Under the purchase model, lessor has to categorise a lease transaction into either an operating lease or a finance lease (as in IAS 17).

For an intra group lease transaction that is accounted for by lessor as finance lease (and capitalised by lessee as right-of-use asset), lessor accounting and lessee accounting will still be symmetrical. Consolidation adjustments will involve eliminating the lease receivable (recognised by lessor) against the lease payable (recognised by lessee), and eliminating the interest income (recognised by lessor) against the interest expense (recognised by lessee). The right-of-use asset will be accounted for at group level on the basis it is used by the group. (Alternatively, the same group effects may be achieved by reversing out the lease transaction in the lessee’s books and the lessor’s books.) See Example 1 for illustration.

For an intra group lease transaction that is accounted for by lessor as an operating lease (but capitalised by lessee as right-of-use asset), lessor accounting and lessee accounting will be asymmetrical. While the lessor retains the leased asset in its books (as required under operating lease accounting), the lessee will recognise a right-of-use asset. Also, while lessor recognises the periodic lease payment as lease income (as required under operating lease accounting), the lessee will recognise depreciation expense on the right-of-use asset and the interest expense on the lease liability. It may be noted that part of the asset is double counted, and the income effects of the intra group lease transaction do not offset each other. It may also be noted that eliminating intra group accounts is not possible, as the relevant accounts and account balances in lessor’s books and those in lessee’s books do not match. In this case, probably the easiest consolidation adjustment is to reverse out the effects of the lease transaction at lessor’s level, and at lessee’s level, as if the group has not entered into the lease transaction (which in fact is the effect from group’s viewpoint). Of course, the leased asset has to be accounted for at group level on the basis of use by the group. See Example 2 for illustration.

CONCLUSION

As IFRS 16 adopts different accounting models for lessee accounting (the right-of-use model) and lessor accounting (the purchase model), lessee accounting and lessor accounting may be asymmetrical under IFRS 16. Consequently, in the preparation of consolidated financial statements, intra group lease transactions under IFRS 16 will have to be addressed. This article suggests ways to deal with these consolidation issues under different circumstances.


Ng Eng Juan is Professor, Accountancy Programme, School of Business, Singapore University of Social Sciences.