A long leaseback hands the buyer the building and leaves most of the gain in the seller's right-of-use asset, whatever the board paper says.
Under IFRS 16 the seller recognises only the gain on the rights it actually transferred: total gain × (fair value − present value of the leaseback payments) ÷ fair value. On an illustrative property carried at 55,000,000 and sold at its 100,000,000 fair value, with a fifteen-year leaseback worth 60,225,486, the gain recognised is 17,898,531, not the 45,000,000 a straight sale would show. The rest stays inside a right-of-use asset measured at 33,124,017.
Worked in full in Sale and Leaseback by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A sale and leaseback is often sold to a board as a way to release the gain locked in an old book value. Under the previous standard, a sale at fair value into an operating lease released all of it. IFRS 16 changed that: the seller keeps using the building, so in accounting terms it has sold only the part of the asset it will not use. The share it keeps is measured by the leaseback payments.
| Input | Value |
|---|---|
| Carrying amount of the property | 55,000,000 |
| Fair value | 100,000,000 |
| Sale price | 100,000,000 |
| Leaseback rent, annual in arrears, fixed | 6,000,000 |
| Lease term, years | 15 |
| Seller-lessee's incremental borrowing rate | 5.5% |
The first test comes before any arithmetic. If the transfer is not a sale under IFRS 15, typically because the seller holds a repurchase option, there is no sale and no gain at all: the seller keeps the building on its balance sheet and shows the cash as a financial liability under IFRS 9. Everything below assumes the sale test is passed.
1. Lease liability = PV of lease payments at the incremental borrowing rate = 6,000,000 × 10.0376 = 60,225,486
2. Share of the asset retained = lease liability ÷ fair value = 60.2%
3. Right-of-use asset = carrying amount × share retained = 55,000,000 × 60.2% = 33,124,017
4. Total gain = fair value − carrying amount = 45,000,000
5. Gain recognised = total gain × share transferred = 45,000,000 × 39.8% = 17,898,531
In Excel: =PV(IBR,Term,-Rent) for the liability, then =CA*Liab/FV for the right-of-use asset and =(FV-CA)*(FV-Liab)/FV for the gain.
| Account | Debit | Credit |
|---|---|---|
| Cash | 100,000,000 | |
| Right-of-use asset | 33,124,017 | |
| Property, derecognised at carrying amount | 55,000,000 | |
| Lease liability | 60,225,486 | |
| Gain on rights transferred | 17,898,531 | |
| Total | 133,124,017 | 133,124,017 |
The 27,101,469 of gain not recognised has not disappeared. It sits as a lower right-of-use asset, 33,124,017 rather than the 60,225,486 it would be on a new lease of a building the company never owned, and it comes through the income statement over fifteen years as lower depreciation. In year one, depreciation of 2,208,268 and interest of 3,312,402 make 5,520,670 of charges against 6,000,000 of rent paid.
The right-of-use asset is measured on the carrying amount, not on the fair value. That is what keeps the retained part of the gain off the income statement. A right-of-use asset at 60,225,486 would book the whole 45,000,000 and contradict the standard's logic.
Sellers often push the price up and accept a higher rent in exchange. IFRS 16 treats any excess over fair value as additional financing from the buyer, not as sale proceeds. Take a price of 110,000,000 with a rent of 7,000,000: the extra 1,000,000 a year repays the extra 10,000,000.
| Line | At fair value | Above fair value |
|---|---|---|
| Sale price | 100,000,000 | 110,000,000 |
| Annual rent | 6,000,000 | 7,000,000 |
| PV of all payments | 60,225,486 | 70,263,067 |
| of which additional financing | 0 | 10,000,000 |
| of which lease liability | 60,225,486 | 60,263,067 |
| Right-of-use asset | 33,124,017 | 33,144,687 |
| Gain recognised | 17,898,531 | 17,881,620 |
The higher price buys no extra gain. The 10,000,000 is a loan, booked as a financial liability, and the gain is essentially unchanged. That is the accounting reaching the same conclusion as the credit analysis of over-rent: the part of the price no building supports is a loan from the buyer to the seller.
| Lease term, years | Lease liability | Right-of-use asset | Gain recognised | Share of total gain |
|---|---|---|---|---|
| 5 | 25,621,707 | 14,091,939 | 33,470,232 | 74.4% |
| 10 | 45,225,755 | 24,874,165 | 24,648,410 | 54.8% |
| 15 | 60,225,486 | 33,124,017 | 17,898,531 | 39.8% |
| 20 | 71,702,295 | 39,436,262 | 12,733,967 | 28.3% |
| 25 | 80,483,596 | 44,265,978 | 8,782,382 | 19.5% |
The incremental borrowing rate moves the answer too, in the direction people do not expect. At 4.5 per cent the lease liability is 64,437,274 and the gain 16,003,227; at 6.5 per cent the liability is 56,416,013 and the gain 19,612,794. A weaker borrower books a larger gain on the same transaction, because a higher discount rate makes the retained share look smaller.
Under IFRS 16 a leaseback releases the gain in proportion to what was given up, and a long lease gives up little: 39.8 per cent of the gain on fifteen years here, 19.5 per cent on twenty-five. Run the arithmetic before the board paper promises a profit. Sale and Leaseback sets out the seller's accounting alongside the lender's and the buyer's; the free model for that case carries the IFRS 16 sheet with the rest of the transaction. Why a buyer would advance more than the property is worth in the first place is worked in does over-rent repay the over-price.
As the share of the previous carrying amount that relates to the right of use retained: carrying amount times lease liability over fair value. On an illustrative property carried at 55,000,000 with a 100,000,000 fair value and a 60,225,486 lease liability, that is 33,124,017, well below the liability.
The excess is accounted for as additional financing from the buyer-lessor, a financial liability, not as sale proceeds. On an illustrative sale at 110,000,000 against a 100,000,000 fair value, 10,000,000 is booked as a loan, and the gain recognised stays at about 17,881,620, almost exactly the at-fair-value figure.
Because the gain is recognised only on the rights transferred, and a longer lease retains more of the asset. With an illustrative 6,000,000 rent at 5.5 per cent on a 45,000,000 total gain, a five-year lease books 33,470,232 and a twenty-five-year lease 8,782,382.
This article is one calculation from Sale and Leaseback. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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