Sale and leaseback transactions - Ep 9

Transcript

Dipthi: Welcome to this episode of the Telco Talks podcast series focusing on topical issues in the telecommunications industry. I’m Dipthi Govind, a technical accounting manager in the PwC South African practice and I will be your host. Our aim is to keep you up to date on key accounting issues in the telecommunications industry.

Joining me on this podcast is Thamesha Chetty, a technical accounting manager, also in the PwC South African practice. 

Welcome Thamesha, it’s great to have you joining us again on the podcast series.

Thamesha: Hi Dipthi, thank you, I’m glad to be back!

Dipthi: Today we’re going to be chatting about IFRS 16 - Leases, focusing on sale and leaseback transactions which has been a topical area. While the leasing standard has been in effect for at least 2 years now for many entities, it appears that there are still quite a few discussions taking place around the application of the leases standard.

Thamesha: That’s correct Dipthi, while entities have become more familiar and comfortable with IFRS 16, there are still some complexities that arise,one of these being sale and leaseback transactions.

During the course of 2020, the IFRS Interpretations Committee, had also received requests regarding sale and leaseback transactions. There’s still quite a lot to talk about regarding leases!

Dipthi: I’m quite keen to hear about the IFRIC discussions, however before we get into that, would you mind reminding our listeners what exactly is a sale and leaseback transaction?

Thamesha: Sure, a sale and leaseback is a transaction in which the owner of an asset sells the asset and leases it back from the buyer.

For example, a telco operator may sell a cellphone tower that it owns to a tower company, and then leases the cellphone tower back.

Entities may often enter into such arrangements if they want to raise capital but also still want to have access to and use of the underlying asset.

From an accounting perspective, the seller-lessee must determine if the transaction qualifies as a sale for which revenue is recognised, or whether the transaction represents a collateralised borrowing or financing arrangement. Simplistically, this means that it needs to be assessed whether the transfer of the asset qualifies as a sale using the principles of IFRS 15, and whether the buyer-lessor obtains control of the underlying asset.

Dipthi: Can you also briefly explain what happens if the transfer does not qualify as a sale?

Thamesha: If the transfer does not qualify as a sale under IFRS 15, the seller-lessee does not de-recognise the transferred asset, and it accounts for the cash received as a financial liability.

From the buyer-lessor’s perspective - the transferred asset is not recognised and, instead, it accounts for the cash paid as a financial asset (i.e. a receivable).

Dipthi: Thanks for sharing that understanding Thamesha. Now getting into the intricacies around sale and leaseback, can you talk us through the discussions that have been taking place at the IFRIC?

Thamesha: Sure Dipthi. An agenda decision was finalised in June last year, regarding a request the Committee received about how to measure the right-of-use asset in a sale and leaseback transaction when there are only variable lease payments.

Dipthi: I haven’t seen this before in practice, but I’m assuming that this would be important to understand as the measurement of the right-of-use asset affects the gain or loss that is recognised at the date of the transaction?

Thamesha: That’s spot on. To briefly summarise the details of the fact pattern described in the request:

• an entity sold an item of PPE to another entity, and leased the asset back;
• The transfer of the PPE qualifies as sale in accordance with IFRS 15; and
• The payments for the lease are market rates, and include variable lease payments. These variable lease payments are not in-substance fixed payments.
  

The Committee observed that the seller-lessee should 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.

This means that only the amount of any gain or loss that relates to the rights transferred to the buyer-lessor shall be recognised by the seller-lessee.

Dipthi: Wow, that is quite a lot to take in - can this perhaps be broken down and explained through an example?

Thamesha: Certainly. Let’s assume the same facts that I just mentioned which were described in the fact pattern in the request, and put these into numbers.

• The carrying amount of the PPE at the date of the transaction is R1m.
• The amount paid by the buyer for the PPE which is also the fair value of the PPE is R1.8m, and
• The present value of the expected payments for the lease is R450 000.

IFRS 16 does not prescribe a method for determining the proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller-lessee, so using this example, one way to determine this proportion could be by comparing the present value of the expected lease payments, including the variable lease payments of R450 000, with the fair value of the PPE at the date of the transaction being R1.8m.

R450 000 divided by R1.8m is 25% - therefore the proportion of the right of use retained is 25%.

Consequently, the proportion of the PPE that relates to the rights transferred to the buyer-lessor is 75%.

Dipthi: I see, so following what you are saying, does that mean that the right-of-use asset will be measured at R250 000?

Thamesha: Yes Dipthi, that is correct - the R250 000 at which the right-of-use asset is measured is determined by using 25%, being the proportion of the right of use retained, multiplied by the carrying amount of the PPE of R1m.

A gain of R600 000 will be recognised. This is determined taking into account the proportion of the PPE that relates to rights transferred, being 75% as we noted, multiplied by the total gain on sale of the PPE of R800 000 calculated as the amount paid of R1.8 less the carrying amount of R1m.

Dipthi: I have definitely learned something new today about sale and leaseback transactions. Is there anything else that our listeners should be aware of.

Thamesha: Yes, there is one more principle that I would like to highlight, and this relates to the sale of an asset in a corporate wrapper, which is subsequently leased back.

There was a request submitted to the IFRIC in September last year, which described a scenario where an entity owns 100% of the equity in a subsidiary. The only asset in the subsidiary is a building, and it has no liabilities, and the building is not a business as defined by IFRS 3 - Business combinations.

The entity legally sells the shares in the subsidiary which holds the building, and loses control of the subsidiary in accordance with IFRS 10. However the entity subsequently leases the building back, and the transfer of the building qualifies as a sale in accordance with IFRS 15.

Dipthi: In this case, does the entity apply the requirements of IFRS 10 to account for the loss of control of the subsidiary, or the requirements of IFRS 16 regarding the accounting for sale and leaseback transactions?

Thamesha: That’s an excellent question Dipthi. The request asked how the entity should calculate the gain or loss on the sale if it applies the sale and leaseback guidance per IFRS 16 in its consolidated financial statements.

Now if IFRS 16 is applied, only a partial gain would be recognised, as this will follow the approach we spoke about a few minutes ago, whereby the right-of-use asset will be measured at the proportion of the previous carrying amount of the building that relates to the right of use it retains; and accordingly only the amount of the gain that relates to the rights transferred to the buyer-lessor is recognised.

In the example we used earlier, that gain was calculated as R600 000.

Under IFRS 10 however, a full gain or loss will be recognised from the sale of the entity’s equity interest in the subsidiary. Assuming in the example we spoke about, the item of PPE was included in a subsidiary which was disposed of, and the carrying value of the PPE and therefore the net assets of the subsidiary is R1m, and the equity interest in the subsidiary was sold for R1.8m.

Applying IFRS 10,a gain of R800 000 would be recognised.

Dipthi: So what did the Committee conclude?

Thamesha: In the staff’s view, the entity’s loss of control in the subsidiary is in the scope of IFRS 10 and the transaction is also a sale and leaseback transaction to which the sale and leaseback requirements in IFRS 16 apply. So essentially both standards will apply.

They explained that the 1st step would be to account for the loss of the sale of the subsidiary in accordance with IFRS 10, particularly paragraph B98 which requires the entity to derecognise the building held by the subsidiary and recognise the fair value of the consideration received.

Secondly, as the transfer of the building satisfies the requirements in IFRS 15 to be accounted for as a sale of the building —the entity therefore applies paragraph 100(a) of IFRS 16 to measure the right of use asset and determine the gain or loss, which will only be a partial gain or loss as we’ve just discussed.

There was a tentative agenda decision that was issued with regards to this in November 2020 and brought back to the IFRIC this year.

Dipthi: Can you shed some light on what took place during this meeting?

Thamesha: Certainly. After the tentative agenda decision was released in November last year, there were 19 comment letters that were received, as the tentative agenda decision sparked quite a lot of debate about what the broader impact this may have for similar, but more complex scenarios, as the fact pattern described in the request is not necessarily what entities may see very often in practice. For example, will the analysis be different if the entity disposes of its subsidiary that contains multiple assets and liabilities, and which is a business as defined, or what will the outcome be if the entity sells less than 100% of the equity interest in the subsidiary?

While the members of the Committee agreed with the analysis in the tentative agenda decision for the narrow fact pattern described in the request, for the concerns that I just mentioned and how far the agenda decision would have to be applied to more complex examples, a majority of the members agreed to perform narrow scope standard setting to address the issue.

Dipthi: Thanks for that update Thamesha, and thank you for taking us through this very topical issue which I’m sure our listeners will find valuable.

Thamesha: You’re welcome Dipthi and thank you for having me back on the podcast.

Dipthi: This brings us to the end of this episode of Telco Talks.

Stay tuned for the next episode where we will explore disruptors in the Telco industry such as satellites and the evolution to 5G.

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