Treatment of Sale and Leaseback Under Ind AS Standards

1. Question

Orion Manufacturing Limited (hereinafter referred to as “the company”), a manufacturing entity, owns an office building that is recorded in its books at a carrying amount of Rs. 800 lakhs. The company decides to sell this building to XYZ Finance Limited for Rs.1,000 lakhs, which also represents the fair value of the property.At the time of sale, control as well as the significant risks and rewards associated with ownership of the building, are transferred to XYZ Finance Limited.

Immediately after the sale, the company enters into a leaseback arrangement with XYZ Finance Limited for a period of 10 years.

The key terms of the leaseback are as follows:

(a) Annual lease payments of Rs. 120 lakhs, payable at the end of each year.

(b) The company’s incremental borrowing rate is 8%.

(c) Control of the building is transferred to XYZ Finance Limited at the time of sale.

The management of the company seeks advice from its consultant on two aspects:

1. Whether the transfer of the building qualifies as a sale under the applicable accounting standards; and

2. How the leaseback arrangement should be accounted for in the company’s books of account.

2. Relevant Provisions

Ind AS 116- Leases

Para 26– At the commencement date, a lessee shall measure the lease liability at the present value of the lease payments that are not paid at that date. The lease payments shall be discounted using the interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate.

Para 98 – If an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) and leases that asset back from the buyer-lessor, both the seller-lessee and the buyer-lessor shall account for the transfer contract and the lease applying paragraphs 99-103.

Para 99 – An entity shall apply the requirements for determining when a performance obligation is satisfied in Ind AS 115 to determine whether the transfer of an asset is accounted for as a sale of that asset.

Para 100 – If the transfer of an asset by the seller-lessee satisfies the requirements of Ind AS 115 to be accounted for as a sale of the asset:

(a) the seller-lessee shall measure the right-of-use asset arising from the leaseback at the proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller-lessee. Accordingly, the seller-lessee shall recognise only the amount of any gain or loss that relates to the rights transferred to the buyer-lessor.

(b) the buyer-lessor shall account for the purchase of the asset applying applicable Standards, and for the lease applying the lessor accounting requirements in this Standard.

Para 101 – If the fair value of the consideration for the sale of an asset does not equal the fair value of the asset, or if the payments for the lease are not at market rates, an entity shall make the following adjustments to measure the sale proceeds at fair value:

(a) any below-market terms shall be accounted for as a prepayment of lease payments; and

(b) any above-market terms shall be accounted for as additional financing provided by the buyer-lessor to the seller-lessee.

Para 102 – The entity shall measure any potential adjustment required by paragraph 101 based on the more readily determinable of:

(a) the difference between the fair value of the consideration for the sale and the fair value of the asset; and

(b) the difference between the present value of the contractual payments for the lease and the present value of payments for the lease at market rates.

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