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AASB 16 Check: Is there any impact for a sub-lessor?
AASB 16 Check: Is there any impact for a sub-lessor?
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.
Scenario
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.
Company Y:
- derecognises the portion of the ROU asset relating to the sub-leases of the three of the five floors
- recognises lease receivables for the lease payments receivable under the sub-leases; and
- it would appear that the difference, if any, between the amounts is recognised in opening retained earnings.
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:
- apportion the ROU asset equally amongst the floors; or
- allocate the remaining lease payments to the different floors based on a relative stand-alone price at the date of initial application.
In technical speak
On transition, an intermediate lessor must:
- reassess subleases that were classified as operating leases applying AASB 117 and are ongoing at the date of initial application, to determine whether each sublease should be classified as an operating lease or a finance lease. This assessment is performed at the date of initial application on the basis of the remaining contractual terms and conditions of the head lease and sublease at that date.
- for subleases that were classified as operating leases applying AASB 117 but finance leases applying AASB 16, account for the sublease as a new finance lease entered into at the date of initial application. [AASB 16: C15]
The right to use an underlying asset is a separate lease component if both:
- the lessee can benefit from use of the underlying asset either on its own or together with other resources that are readily available to the lessee. Readily available resources are goods or services that are sold or leased separately (by the lessor or other suppliers) or resources that the lessee has already obtained (from the lessor or from other transactions or events); and
- the underlying asset is neither highly dependent on, nor highly interrelated with, the other underlying assets in the contract. For example, the fact that a lessee could decide not to lease the underlying asset without significantly affecting its rights to use other underlying assets in the contract might indicate that the underlying asset is not highly dependent on, or highly interrelated with, those other underlying assets. [AASB 16.B32]
If you would like to discuss the implementation of the new standard for your organisation, please contact us.
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KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.
