TFRS16: Accounting for Sale and Leaseback Transactions
The requirement to use expected lease payments, including variable lease payments, is intended to provide a more accurate representation of the economic substance of the transaction.
Here are a few key reasons for this requirement:
1. Faithful representation: By including variable lease payments in the measurement of lease liabilities and right-of-use assets, the financial statements better reflect the true obligations and assets of the entity.
2. Comparability: This requirement ensures that entities with similar sale and leaseback arrangements report their financial positions consistently, enhancing comparability across companies.
3. Preventing off-balance-sheet financing: Without this requirement, entities could structure sale and leaseback transactions with primarily variable lease payments to avoid recognizing lease liabilities on their balance sheets, potentially misleading investors and other stakeholders.
4. Alignment with the general principles of IFRS 16: The standard requires the measurement of lease liabilities and right-of-use assets based on the present value of lease payments, including variable payments that depend on an index or rate. Extending this principle to sale and leaseback transactions ensures consistency in the application of the standard.
One of the most challenging scenarios under this standard involves transactions with variable lease payments. This article provides a practical example of how to account for a sale and leaseback transaction that qualifies as a sale under TFRS 15 and includes variable lease payments.
This example will include a step-by-step process of recognition, measurement, and subsequent accounting treatment. This will provide valuable insights for financial professionals dealing with similar transactions in their organizations.
Example
Sale and leaseback transaction that meets the conditions to be recognized as a sale transaction with variable lease payments.
1. On 1 January 20X1, Company A sells machinery to Company B for THB 30,000 in cash. The fair value of the machinery on the date of sale is THB 30,000.
2. Before the sale, the machinery had a book value of THB 22,000 (the machinery was purchased for THB 40,000 and had accumulated depreciation of THB 18,000 as of the date of sale).
3. Company A concludes that the transfer of the machinery meets the conditions for being recognized as a sale under TFRS 15.
4. Company A will pay rent in 3 instalments at the end of each year, starting from 31 December 20X1.
5. The lease payments at the end of each year consist of: (1) fixed payments of THB 6,000 per year; and (2) variable payments calculated based on the seller-lessee’s production volume reported in the 12 months before the lease payment is due, at a rate of THB 0.10 per unit.
6. Company A can reasonably estimate the production volume for years 20X1 - 20X3. The estimated production volume and rent are as follows:
| Date | Estimate production volume (units) | Variable rent (Baht) | Fixed rent (Baht) | Estimated total rent (Baht) |
| 31/12/20X1 | 40,000 | 4,000 | 6,000 | 10,000 |
| 31/12/20X2 | 42,000 | 4,200 | 6,000 | 10,200 |
| 31/12/20X3 | 50,000 | 5,000 | 6,000 | 11,000 |
7. The actual production volumes and lease payments Company A pays to Company B at the end of years 20X1, 20X2, and 20X3 are as follows:
Date | Production volume (units) | Variable rent (Baht) | Fixed rent (Baht) | Total rent (Baht) |
| 31/12/20X1 | 44,000 | 4,400 | 6,000 | 10,400 |
| 31/12/20X2 | 40,500 | 4,050 | 6,000 | 10,050 |
| 31/12/20X3 | 57,000 | 5,700 | 6,000 | 11,700 |
8. At the end of the lease term, Company A returns the machinery to Company B.
9. Company A’s incremental borrowing rate = 6% The entity measures the present value of the lease payments over the contract term discounted at the incremental borrowing rate of 6%, as follows:
Year | Estimated rent (Baht) | PV factor6% | PV (Baht) |
| 1 | 10,000 | 0.9434 | 9,434 |
| 2 | 10,200 | 0.8900 | 9,078 |
| 3 | 11,000 | 0.8396 | 9,236 |
PV of rent | 27,748 |
The lease liability amortization schedule can be shown as follows:
Date | Annual rent (Baht) | Interest expense (Baht) | Principle repayment (Baht) | Remaining principle (Baht) |
| 1/1/20X1 |
|
|
| 27,748 |
| 31/12/20X1 | 10,000 | 1,665 | 8,335 | 19,413 |
| 31/12/20X2 | 10,200 | 1,165 | 9,035 | 10,377 |
| 31/12/20X3 | 11,000 | 623 | 10,377 | - |
| Total | 31,200 | 3,451 |
|
|
Company A believes that the appropriate method for determining the portion of the right to use the machinery that the company retains is to compare the present value of the annual rent to the fair value of the machinery.
The present value of the annual rent is THB 27,748.
Company A recognizes the right to use the machinery that the company retains through the lease-back of the machinery in proportion to the previous book value
= (THB 27,748/THB 30,000) x THB 22,000
= THB 20,348
The total gain from the sale of the machinery is THB 8,000 (THB 30,000 – THB 22,000), divided into:
1. THB 7,400 ((THB 27,748/THB 30,000) x THB 8,000) related to the right to use the machinery that Company A retains
2. THB 600 ((THB 30,000 – THB 27,748)/THB 30,000) x THB 8,000) related to the rights transferred to Company B as shown in the following table:
| Total value (Baht) | Percentage of total Value | Leased back portion | Sold portion (Baht) |
| Sale Price | 30,000 | 100.0% | 27,748 | 2,252 |
| Book Value | 22,000 | 73.3% | 20,348 | 1,652 |
| Gain | 8,000 | 26.7% | 7,400 | 600 |
Accounting entries for Company A:
1/1/20X1
Record sale and leaseback transaction
Dr. Cash 30,000
Dr. Accumulated depreciation - Machinery 18,000
Dr. Right-of-use asset - Machinery under lease 20,348
Dr. Deferred interest expense 3,452
Cr. Machinery 40,000
Cr. Lease liability 31,200
Cr. Gain on sale and leaseback of machinery 600
31/12/20X1
Record lease payment
Dr. Lease liability 10,000
Dr. Difference from lease payment 400
Cr. Cash 10,400
Record interest expense
Dr. Interest expense 1,665
Cr. Deferred interest expense 1,665
Record depreciation of right-of-use asset
Dr. Depreciation expense - Right-of-use asset 6,783
Cr. Accumulated depreciation - Right-of-use asset 6,783
31/12/20X2
Record lease payment
Dr. Lease liability 10,200
Dr. Difference from lease payment 150
Cr. Cash 10,050
Record interest expense
Dr. Interest expense 1,165
Cr. Deferred interest expense 1,165
Record depreciation of right-of-use asset
Dr. Depreciation expense - Right-of-use asset 6,783
Cr. Accumulated depreciation - Right-of-use asset 6,783
31/12/20X3
Record lease payment
Dr. Lease liability 11,000
Dr. Difference from lease payment 700
Cr. Cash 11,700
Record interest expense
Dr. Interest expense 623
Cr. Deferred interest expense 623
Record depreciation of right-of-use asset
Dr. Depreciation expense - Right-of-use asset 6,783
Cr. Accumulated depreciation - Right-of-use asset 6,783
Record return of leased machinery
Dr. Accumulated depreciation - Right-of-use asset 20,348
Cr. Right-of-use asset - Machinery under lease 20,348
Key considerations:
- Sale recognition: The transaction must meet the criteria to be recognized as a sale under TFRS 15. This requires careful evaluation of the transfer of control.
- Right-of-use asset measurement: The right-ofuse asset is measured at the proportion of the previous carrying amount that relates to the right of use retained by the seller-lessee.
- Gain recognition: Only the portion of the gain relating to the rights transferred to the buyer lessor is recognized immediately. The remainder is deferred and amortized over the lease term.
- Variable lease payments: These are not included in the initial measurement of the lease liability but are recognized in profit or loss as they occur.
- Subsequent measurement: The lease liability is adjusted for interest and lease payments, while the right-of-use asset is depreciated over the lease term.
- Disclosures: Adequate disclosures should be made about the nature of the variable payments and their impact on the financial statements.
- Judgment and estimates: Significant judgment may be required in estimating future variable lease payments, which can affect the measurement of the right-of-use asset and gain on sale.
By understanding these key considerations, financial professionals can navigate the complexities of sale and leaseback transactions with variable lease payments under TFRS 16, ensuring accurate financial reporting and compliance with the standard.
Reference (in Thai):
- Assoc. Prof. Vorasak Toommanon, Ph.D. (2024). “TFRS16: Examples of Sale and Leaseback Transactions” Online. Retrieved May, 2024, from CPA Solution Facebook post