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.