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.