Accounting for Sub-Leases

Summary

In this podcast, Tom Clendon explains the complexities of accounting for subleases under IFRS 16, introduced post-September 24 exams. He begins with a quick recap on IFRS 16, detailing the recognition of right-of-use assets and liabilities for lessees. Tom then delves into lessors' accounting, emphasizing the classification process and the distinction between finance and operating leases. Using a family tree analogy, he illustrates sublease accounting, where a lessee becomes a sublessor. He provides examples to clarify the accounting treatment when a sublease is short-term versus when it covers the entire lease period, affecting the recognition of assets and liabilities.

Takeaways

• 📚 The introduction of subleases into the SPR syllabus from the September 24 exam onwards is a significant update.
• 👤 Tom Clendon is a professional who helps students pass the exam and discusses accounting for subleases in this podcast.
• 🏢 IFRS16 requires recognizing both a right-of-use asset and an associated liability for lessees when entering into a lease.
• 💼 The right-of-use asset is initially recognized at the present value of minimum lease payments, including any initial direct costs.
• 🔄 The asset is depreciated, and the liability attracts a finance cost, which affects the P&L through its changes.
• 🏢 Lessors need to classify leases as either finance or operating based on the transfer of risks and rewards of ownership.
• 💼 For finance leases, lessors recognize a net investment in the lease and earn interest, without the physical asset on the balance sheet.
• 🚗 In operating leases, lessors keep the physical asset on their balance sheet and recognize rental income through the P&L.
• 🔄 Accounting for subleases involves recognizing the dual role of a lessee who has sublet an asset, becoming a lessor in the process.
• 🏢 The example of Alex subletting office space for 2 years out of a 5-year lease illustrates the accounting for a sublease without transferring risks and rewards.
• 💡 A more complex scenario is presented where Alex sublets for 4 years out of a 5-year lease, which could be classified as a finance lease, affecting asset recognition and P&L.

Q & A

What is the main topic discussed in the podcast by Tom Clendon?

The main topic discussed in the podcast is accounting for subleases, which was introduced to the SPR syllabus from the September 24 exam onwards.

According to IFRS 16, what is recognized by a lessee when entering into a lease?

A lessee will normally recognize both a right-of-use asset and an associated liability, even without legal title to the asset, due to control over the asset and the obligation to make lease payments.

How is the initial recognition of a right-of-use asset and liability determined under IFRS 16?

The initial recognition is at the present value of the minimum lease payments, which may include capitalizing any transaction or dismantling costs.

What are the two main components of accounting for a lease from a lessor's perspective?

From a lessor's perspective, accounting for a lease involves recognizing either a net investment in the lease (for finance leases) or the physical asset in the balance sheet (for operating leases).

What is the difference between a finance lease and an operating lease from a lessor's perspective?

A finance lease is when the risks and rewards of ownership have passed to the lessee, and the lessor recognizes a net investment in the lease and income. An operating lease is when the lessor retains the risks and rewards of ownership, recognizing the physical asset in the balance sheet and rental income through the P&L.

What is the scenario presented by Tom Clendon involving Alex, the lessee, and Murray, the sublessee?

The scenario involves Alex leasing an asset from Tom and then subletting it to Murray. Alex is both a lessee and a sublessor in this context.

How does Alex account for the sublease of office space for 2 years when he has a 5-year lease?

Alex accounts for the sublease by recognizing a right-of-use asset and lease liability for the original 5-year lease. The sublease is considered an operating lease, and rental income flows through the P&L.

In the second scenario, why does Alex as a sublessor recognize a financial asset instead of a right-of-use asset?

In the second scenario, Alex enters into a sublease for four years, representing the whole life of the asset. As a sublessor, Alex has entered into a finance lease, indicating that the risks and rewards of ownership have passed, and thus a financial asset is recognized instead.

What is the impact on Alex's financial statements when he enters into a finance lease as a sublessor?

Alex derecognizes the right-of-use asset from the balance sheet and recognizes a new financial asset, an investment in the finance leasee. The difference between the two is recognized as an immediate profit or loss.

How does the duration of the sublease affect the accounting treatment for Alex as a sublessor?

If the sublease duration is less than the original lease (e.g., 2 years out of 5), it is treated as an operating lease. If the sublease covers the entire life of the asset (e.g., 4 years out of 5), it is treated as a finance lease, affecting the recognition of assets and liabilities.

What additional services does Tom Clendon offer to help students pass the SPR exam?

Tom Clendon offers assistance through WhatsApp, a website, and a YouTube channel where he provides further insights and explanations to help students understand and pass the SPR exam.

Outlines

00:00

📚 Introduction to Subleases and IFRS16 Basics

In this introductory paragraph, Tom Clendon sets the stage for a discussion on subleases by first recapping the fundamentals of IFRS16. He explains that when a lessee enters into a lease, they recognize both a right-of-use asset and a corresponding liability at the present value of the minimum lease payments. This includes any initial direct costs. The asset is then depreciated, and the liability accrues interest over time. Tom emphasizes the importance of understanding how a lessee and lessor account for their respective assets and liabilities under IFRS16, especially since the accounting for subleases builds upon these principles. He uses the family tree analogy to introduce the concept of a sublease, where Alex, acting as both a lessee and a lessor, sublets an asset to his son, Murray.

05:03

🏢 Accounting for Subleases: Scenarios and Implications

In the second paragraph, Tom delves into the specifics of accounting for subleases, using hypothetical scenarios to illustrate the process. He first presents a simple example where Alex, who has leased office space for five years, sublets it for two years. Tom explains that since the sublease term does not cover the entire lease term, Alex continues to recognize the right-of-use asset and lease liability, with depreciation and finance costs reflected in the profit and loss. In a more complex scenario, Tom describes a situation where Alex enters into a four-year sublease after one year of his original five-year lease. This sublease covers the majority of the asset's life, leading to a reclassification of the original lease for Alex as a lessor. As a result, the right-of-use asset is derecognized, and a new financial asset representing the investment in the finance lease is recognized, with any difference between the two treated as an immediate profit or loss. Tom concludes by wishing listeners well in their SPR exam preparation and inviting them to connect with him for further assistance.

Keywords

💡IFRS 16

IFRS 16, also known as International Financial Reporting Standard 16, is a standard that sets out how to account for leases. It is the main theme of the video as it provides the foundation for understanding subleases. In the script, Tom Clendon explains that under IFRS 16, a lessee recognizes both a right-of-use asset and a lease liability upon entering into a lease agreement.

💡Right-of-Use Asset

A right-of-use asset is a term used to describe the asset that a lessee controls as a result of a lease agreement. It is a key concept in the video, as it represents the tangible or intangible asset that the lessee has the right to use but does not own. In the script, it is mentioned that this asset is initially recognized at the present value of the minimum lease payments.

💡Lease Liability

A lease liability is the obligation of the lessee to make lease payments over the term of the lease. It is a critical component of lease accounting under IFRS 16. In the context of the video, the lease liability is recognized to reflect the lessee's obligation to pay rent over time, attracting a finance cost that affects the profit and loss.

💡Sublease

A sublease is when a lessee rents out the asset they have leased to another party. It is the central topic of the video, as Tom Clendon discusses how to account for subleases under IFRS 16. The script provides examples of subleasing, where Alex, who is a lessee, becomes a lessor to Murray, his son.

💡Lessee

A lessee is an individual or entity that has entered into a lease agreement to use an asset for a specified period in exchange for making lease payments. The script uses the term to describe Alex's position when he leases an asset from Tom and then sublets it to Murray.

💡Lessee Accounting

Lessee accounting refers to the process by which a lessee records and reports a lease transaction in its financial statements. In the script, Tom Clendon explains the accounting treatment for a lessee, which includes recognizing a right-of-use asset and a lease liability.

💡Lessee Classification

Lessee classification is the process of determining whether a lease is classified as an operating lease or a finance lease based on the transfer of risks and rewards. The script mentions that this classification affects how the lease is accounted for on the lessee's financial statements.

💡Finance Lease

A finance lease is a type of lease where the lessor transfers substantially all the risks and rewards of ownership to the lessee. In the script, Tom Clendon explains that if the risks and rewards of ownership have passed, the lessor would not recognize the physical asset on its statement of financial position.

💡Operating Lease

An operating lease is a lease where the lessor retains the risks and rewards of ownership of the asset. The script discusses how, in an operating lease, the lessor recognizes the physical asset in its balance sheet and rental income through the profit and loss account.

💡Depreciation

Depreciation is the systematic allocation of the cost of a right-of-use asset over its useful life. In the context of the video, Tom Clendon mentions that the right-of-use asset is depreciated, which means its cost is spread out over the lease term in the lessee's profit and loss account.

💡Net Investment in the Lease

Net investment in the lease is the net amount the lessor will earn from the lease payments, which includes the present value of minimum lease payments receivable and any unguaranteed residual value. The script uses this term to describe the lessor's accounting treatment in a finance lease scenario.

Highlights

Introduction to accounting for subleases in the SPR syllabus from the September 24 exam onwards.

Recap on IFRS 16 and the recognition of a right of use asset and an associated liability for lessees.

Explanation of the initial recognition of lease assets and liabilities at the present value of minimum lease payments.

Depreciation of the right of use asset and finance cost associated with the liability.

Classification process for lessors to determine the type of lease: finance or operating.

Lessors' accounting for assets and lease agreements based on the transfer of risks and rewards of ownership.

Accounting for finance leases involves recognizing a net investment in the lease and earning interest.

In operating leases, the physical asset remains on the lessor's balance sheet with rental income recognized in the P&L.

Introduction to the concept of subleases and the dual role of a lessee as a sublessor.

Simple example of accounting for subleases when a lessee sublets an asset for a shorter period than the original lease.

Scenario where the sublease term represents the entire asset's life, leading to a finance lease for the sublessor.

Accounting implications for Alex as a lessee and sublessor, including the recognition of a new financial asset.

Difference between the original right of use asset and the new financial asset resulting in immediate profit or loss.

The simultaneous existence of finance cost on the liability and finance income from the investment in the finance lease.

Tom Clendon's offer to help students pass the SPR exam and invitation to connect via WhatsApp, website, or YouTube.

Emphasis on the importance of understanding the accounting treatment for subleases in the exam context.

Transcripts

accounting for

subleases this is something that was

introduced to the spr syllabus from the

September 24 exam

onwards my name is Tom clendon and I

help students pass the exam and what I

want to do in this podcast is to talk to

you about accounting for sub

leases now before before we get involved

in

sues I want first of all to do a very

quick

recap on

ifrs16 if I'm a l c when I enter into a

lease I will normally recognize both a

right of use asset and an Associated

liability even though I won't have legal

title to the asset I will control it and

I will have an obligation to make those

lease payments

now that's initially going to be

recognized at the present value of the

minimum lease payments the asset might

capitalize any transaction or

dismantling

costs a lesie has a right of use asset

and a liability the asset will be

depreciated and the liability will

attract a finance

cost that liability will go up with that

Finance cost charged the p&l and will go

down with the cash

repaid so far I probably haven't said

anything too

radical accounting for less

SS is a little bit more tricky because a

less s has to work out what type of

lease it has so there's a classification

process and a Lea is somebody who owns

the asset so they have the legal title

but they are effectively renting it out

to somebody else so somebody else has

got

possession now if the risks and rewards

of ownership are

passing to the less e the less or will

think of that as a finance lease and

will not have the the physical asset on

its statement of financial position

because the asset that the lessor will

have if it's a finance lease is

basically a deta a net investment in the

lease yeah it will be owed money and it

will be earning interest if it's a

finance lease if the risk and rewards of

ownership have

passed but if the business is oh I don't

know Avis or a Car Hire business the

less or isn't passing away the risk and

rewards of ownership at that under the

lease and therefore the physical asset

remains s in the balance sheet in the

statement of financial position of the L

saw and the actual money that is being

received well that's the income yeah

that's the revenue that's the that what

that's what goes through profit so I

think it's important first of all to

make sure that you understand how a

lessi accounts for an asset right of use

liability how a less or accounts for an

asset uh a lease agreement depends on

whether it's a Finance lease risk and

rewards have passed therefore you've got

a net investment in the lease and you're

recognizing income or if it's an

operating lease you've got the physical

asset in the balance sheet in the

statement of financial position and

you're recognizing through the p&l uh a

rental

income right now I can talk about

accounting for sub

leases but before we talk about

accounting for sub leases I need to tell

you a little bit about my family

tree I am a father and my son is

Alex Alex is also a father and his son

is Murray which therefore makes me a

grandfather I want you to be Alex I want

us to think about Alex who is in the

middle because Alex has a father and

Alex has a son now if Alex leases an an

asset from me in this context Alex is

the L C so he will recognize a right of

use

asset if Alex then leases that asset to

Murray then in addition to Alex being a

lesi Alex is now a lur in respect of the

same asset and that's what we're talking

about it is that is the accounting for

the sub lease all right which is when

Alex who has leased an asset from me is

now leasing it

onwards so let's make up a very simple

example so Alex is leasing some office

space for 5 years and at the same time

it sublets all the office space on a

2-year

lease so it will regain possession of

the premises in two years time

now from Alex's perspective Alex has got

two things to account for first of all

Alex is a

Lessie you've rented it for 5 years you

recognize a right of use asset and

therefore the depreciation through the

p&l and you recognize a lease liability

and therefore Finance cost through the

p&l as a l saw we're subletting the

asset for only 2 years

is and therefore in my judgment

substantially all the risk and rewards

of ownership have not

passed and therefore uh there's no D

recognition of the original uh lease

asset and a rental income will flow

through to the profit and loss account

yeah when Murray in effectively is

paying the

rent that's the relatively

straightforward example

I could complicate the example with a

second scenario where Alex still leases

the office space for 5 years but 12

months

later enters into a subase for four

years now in that situation the four

years one year after the 5year leas has

occurred that represents the whole of

the asset's life and then therefore Alex

as a lur has now entered into a finance

lease Alex as a lur no longer has the

risks and rewards of ownership of the

asset and therefore Alex as I Le saw

would D recognize the right of use

asset remove that right of use asset

from the balance sheet and recognize in

its place a new asset an investment in

the finance leasee a financial asset

and the difference between the two would

re would be an immediate profit or

loss now because Alex still has a a a a

a is still a l e there will still be a

finance cost on the

liability but Alex is also a l s so

we'll have a finance income going

through the profit and loss account on

the investment in the fin

lease I wish I could jump into your uh

brain and uh show you all of the

numbers but this is a podcast I've

explained the ideas and it may well be

that in the exam you're explaining the

ideas or it may be there will be some

simple numbers uh to

manipulate thank you very much for

listening my name is Tom clendon I help

students pass the spr exam reach out to

me on my WhatsApp

07725

35793 or connect with me through my

website ww. clendon

doc. find me on YouTube I'm out there

good luck