Subleases
Compared with IAS 17, IFRS 16 changes how an intermediate lessor assesses whether a sublease is a finance lease. IFRS 16 requires the sublease to be classified by reference to the right-of-use asset arising from the head lease, rather than by reference to the underlying asset (IFRS 16.B58(b)). The exception is a head lease that is a short-term lease which the entity, as a lessee, has accounted for applying the exemption in IFRS 16.6. In that case, the sublease is classified as an operating lease (IFRS 16.B58(a)).
If the underlying asset is leased for a lease term of ten years, has a remaining economic life of 50 years and is subleased for nine years, the intermediate lessor will often classify the sublease as a finance lease: the sublease covers the major part of the ten-year life of the right-of-use asset, even though it covers only a small part of the economic life of the underlying asset (IFRS 16.63(c)). In a sublease, the head lease remains in effect, so the intermediate lessor is not released from its obligation under the head lease and keeps the lease liability in its balance sheet. In a finance lease, however, the right-of-use asset is derecognised, and a receivable equal to the net investment in the lease is recognised instead (IFRS 16.67). The net investment is the present value of the future lease payments receivable and any unguaranteed residual value accruing to the lessor. In the example, the intermediate lessor must decide how to treat the final year, which is not covered by the sublease – in other words, what the residual value is.
The lessor uses the interest rate implicit in the lease to measure the net investment in the lease. In a sublease, if the interest rate implicit in the sublease cannot be readily determined, the intermediate lessor may use the discount rate used for the head lease (adjusted for any initial direct costs associated with the sublease) to measure the net investment in the sublease (IFRS 16.68).
Example – sublease for nine of ten remaining years
An intermediate lessor has a head lease with ten years remaining and enters into a sublease for nine years. The sublease is classified as a finance lease. Rent is EUR 25,000 per quarter, paid in advance, under both the head lease and the sublease. The interest rate implicit in the sublease cannot be readily determined, because the intermediate lessor cannot determine the fair value of the right-of-use asset. The intermediate lessor therefore uses the discount rate in the head lease of 5% p.a. (IFRS 16.68). This is an effective annual rate, converted to a quarterly rate of 1.2272%. The intermediate lessor estimates that the asset cannot be leased out in year 10 and sets the residual value at zero. If the carrying amount of the right-of-use asset is EUR 760,000, the figures are as follows:
| 1 January, year 1 | Remaining quarters | Quarterly amount (EUR) | Annual rate | Value (EUR) |
|---|---|---|---|---|
| Lease liability | 40 | 25,000 | 5.0% | 796,157 |
| Right-of-use asset | 760,000 | |||
| Lease payments receivable | 36 | 25,000 | 5.0% | 732,859 |
| Residual value | 4 | 0 | 5.0% | 0 |
| Net investment | 732,859 | |||
| Gain/loss (-) | -27,141 |
The intermediate lessor derecognises the right-of-use asset, recognises a net investment in the lease of EUR 732,859 instead, and recognises a loss of EUR 27,141. In subsequent periods, the intermediate lessor recognises finance income on the net investment (IFRS 16.75). The intermediate lessor still has the lease liability in its balance sheet, and its subsequent accounting is unchanged.
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