Entities that sub-lease properties are required to evaluate the classification of sub-leases on transition to the new leases standard. This is critical to determine the accounting that applies, particularly where the terms of the sub-lease differ from the head-lease or where only a portion of the property is sub-leased. Here we respond to the common questions we are hearing from sub-lessors on the impact of transitioning to AASB 16 Leases.
Let’s pose a scenario that Company Y leases 5 floors of an office building for 10 years (head lease). After four years, Company Y sub-leases three floors separately for the remaining lease term. Under AASB 117 Leases Company Y classified the head lease and the sub-lease as operating leases.
On adoption of the new leases standard, the head lease and sub-lease have a remaining lease term of three years. Company Y adopts the modified retrospective method and recognises a lease liability and right-of-use (ROU) asset equal to the carrying amount of the lease liability for the remaining three years of the head-lease.
Company Y is also required to reassess the classification of the sub-lease on transition.
Question 1: What is the impact of reassessing the classification of the sub-lease on transition?
Interpretive response: Under the new leases standard, Company Y evaluates the classification of the sub-lease with reference to the ROU asset, that is, it is a three-year remaining asset.
Company Y assesses whether each floor is a separate lease component. In evaluating whether each floor is a separate lease component, the fact that Company Y has the ability to enter into an arrangement to sub-lease each floor suggests that the right to use each floor is a separate lease component.
The sub-lease is for each of the three floors for the remaining term of the head lease. There are no other factors suggesting that Company Y has retained significant risks and rewards associated with the term of the ROU asset of those three floors for the remaining three years.
Hence, Company Y classifies the sub-leases as finance leases on adoption.
As Company Y is still responsible for all of the lease payments relating to the head lease, Company Y does not adjust the lease liability recognised under the head lease. The implicit interest rate for the sub-lease would need to be separately determined.
Question 2: If Company Y does not have the allocation of lease payments for each of the different floors, how would Company Y estimate the carrying amount of the various ROU assets that are sub-leased at the date of initial application?
Interpretive response: By adopting the transition option of measuring the ROU asset at the present value of the remaining lease payments, Company Y could:
On transition, an intermediate lessor must:
The right to use an underlying asset is a separate lease component if both:
If you would like to discuss the implementation of the new standard for your organisation, please contact us.
As you prepare to comply with the new leases accounting standard, we share our perspectives on the common questions we hear.
The new leases standard (AASB 16) will bring a number of changes and challenges beyond the financial reporting process. We look at the impacts.
This webinar examines the options and practical expedients for transitioning to AASB 16 Leases.
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