Background, in a Sale and leaseback transactions (SALT), an entity transfers an asset to another entity and leases that asset back from the buyer. This kind of transactions are used for financing, where the seller immediately receive funds while possessing right to control the use of asset. The accounting treatment prescribed under Ind AS 116 is considerably changed from the existing standard (i.e. Ind AS17).
Concept of sale and leaseback accounting as per Ind AS 116:
In order to apply accounting treatment as prescribed by this standard, firstly an entity shall apply the requirements of Ind AS 115 to determine whether the transfer of an asset is accounted for as a sale of that
asset.
A. If the transfer of asset is treated as sale then:
Accounting treatment in the books of lessee:
o Derecognise the asset transferred.
o Measure right-of-use asset at the proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller-lessee.
o Recognise only the amount of any gain or loss that relates to the rights transferred to the buyer-lessor.
o Apply lease accounting as required for lessee.
Accounting treatment in the books of lessor:
o Account for the purchase of the asset applying applicable Standard.
o Apply lease accounting as required for lessor.
Important Point:
In order to recognize correct profit and loss on the sale of asset the transaction must be at fair value. If the consideration for the sale of an asset does not equal the fair value of the asset:
(a) If sale price is lower than fair value the variance will be accounted as “Prepayment of lease payments”.
(b) If sale price is higher than fair value the variance will be accounted as “Additional financing”.
B. If the transfer of asset is not treated as sale then:
Accounting treatment in the books of seller:
o Seller shall continue to recognise the transferred asset.
o Recognise financial liability equal to transfer proceeds by applying Ind AS 109.
Accounting treatment in the books of buyer:
o Buyer shall not recognise the transferred asset.
o Recognise financial assets equal to transfer proceeds applying Ind AS 109.
Example:
Entity X sells an office building to Entity Y for consideration of INR 10,00,000. Immediately before the transaction, carrying amount of the building is INR 5,00,000. At the same time, Entity X enters into contract with Entity Y, effective immediately, for the right to use the building for 15 years with annual payments of INR 80,000 payable at the end of each year. The transfer of the office building qualifies as a sale (i.e., it satisfies the requirements for determining when a performance obligation is satisfied) under Ind AS 115, Revenue from Contracts with Customers. The fair value of the office building on the date of sale is INR 9,00,000. The incremental borrowing rate of Entity X at the time of the above sale and leaseback transaction is at 10% per annum. What will the accounting for the above transaction in the books of Entity X and Entity Y?
Answer:
- The consideration for the sale of the office is higher than the fair value by Rs. 1,00,000 (10,00,000- 900,000), which is recognised as additional financing provided by Entity Y to Entity X.
- The present value of the annual payments is INR 6,08,486, of which INR 100,000 represents repayment of the additional financing of INR 100,000 and the balance of INR 508,486 represents payment towards lease.
· Carrying amount of building that relates to right-of-use asset retained by the entity X:
= Total carrying value x {(PV of lease rentals ± Adjustments) / Fair value}
= 5,00,000 x {(6,08,486-1,00,000) / 9,00,000} = 2,82,492
· Total gain on sale : (9,00,000 – 5,00,000) = 4,00,000
· Gain relating to rights transferred:
= Total Gain x {(Total carrying Value – Carrying value of right retained) / Total carrying value}
= 4,00,000 x {(5,00,000-2,82,492) / 5,00,000} = 1,74,006
In the books of seller-lessee:
Bank. 10,00,000
Right-of-use asset. 2,82,492
Building. 5,00,000
Financial Liability 6,08,486
Gain on rights transferred 1,74,006
· In the books of buyer-lessor:
Building 9,00,000
Financial Assets 1,00,000
Bank 10,00,000
Entity Y (buyer-lessor) classifies the lease of the building as an operating lease, applying the requirements of Ind AS 116.
Each annual receipt can be viewed as comprising of INR 13,147 towards repayment of additional financing and INR 66,853, towards lease rentals (i.e., the annual payment of INR 80,000 is split between the two parts in the ratio of 100,000:508,486) each of which is discounted at 10.% per annum.
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