## Learning Outcomes

- Explain what a sale and leaseback transaction is and why it is treated as more than a simple disposal.
- Decide whether the transfer of an asset qualifies as a sale using IFRS 15 principles.
- Account for a sale and leaseback where the transfer is a sale and the seller-lessee retains a right of use.
- Calculate the seller-lessee’s right-of-use asset and gain or loss on the rights transferred.
- Explain the accounting by the buyer-lessor after a valid sale and leaseback.
- Account for a failed sale and leaseback as a financing arrangement.
- Avoid common ACCA FR errors involving fair value, carrying amount, lease liability and gain recognition.

## ACCA Financial Reporting (FR) Syllabus

Sale and leaseback transactions are examinable within IFRS 16 Leases and may appear in objective test questions or as an adjustment in a financial statements preparation question. In FR, you need to apply the main principles rather than produce lengthy disclosures. The exam commonly tests whether a sale has occurred, how much gain is recognised, and how the buyer-lessor accounts for the transaction.

- Apply IFRS 16 to transactions where an entity sells an asset and leases it back.
- Use IFRS 15 principles to assess whether the asset transfer is a sale.
- Recognise that, in the FR exam, sale proceeds are assumed to equal fair value for sale and leaseback transactions.
- Measure the seller-lessee’s right-of-use asset as the portion of the previous carrying amount relating to the right retained.
- Recognise only the gain or loss relating to the rights transferred to the buyer-lessor.
- Account for the buyer-lessor’s purchase of the asset and the lease given back to the seller-lessee.
- Identify when a failed sale and leaseback is accounted for as a financing transaction.

## Test Your Knowledge

\_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision.\_1. In a sale and leaseback transaction, why does IFRS 16 require an assessment of whether the transfer is a sale? 2. If an asset with a carrying amount of $800,000 is sold for $1,000,000 and leased back, why is the full $200,000 gain not automatically recognised? 3. How is the seller-lessee’s right-of-use asset measured when the transfer qualifies as a sale? 4. What does the buyer-lessor recognise if the transfer of the asset is not a sale? 5. In the ACCA FR exam, what simplifying assumption is usually made about sale proceeds and fair value in sale and leaseback transactions?

## Introduction

A sale and leaseback occurs when an entity sells an asset to another party and immediately leases the same asset back. Commercially, this may be used to raise finance while allowing the seller to continue using the asset. For example, a company may sell a warehouse to an investor for cash and then rent it back for ten years so it can continue operating from the same site.

Accounting for this transaction is not the same as simply recording a disposal followed by a new lease. IFRS 16 requires the parties to ask a key question first: has the asset genuinely been sold? If the transfer is a sale, the seller-lessee records a leaseback and recognises only the gain relating to the rights transferred. If the transfer is not a sale, the arrangement is treated as financing.

> **Key Term: Sale and leaseback**
> A transaction in which an entity transfers an asset to another party and then leases that same asset back from the buyer.

### Identifying whether the transfer is a sale

The first step is to decide whether the transfer of the asset should be accounted for as a sale. IFRS 16 does not make this decision in isolation. It refers to IFRS 15 Revenue from Contracts with Customers. The transfer is a sale only if the buyer obtains control of the underlying asset.

Control means the ability to direct the use of the asset and obtain substantially all the remaining benefits from it. This is the same core idea used when recognising revenue from the sale of goods. In a sale and leaseback context, the assessment can be more difficult because the seller continues to use the asset after the legal sale. Continued use does not automatically prevent sale accounting. The question is whether the buyer has obtained control and the seller has retained only a right of use through the leaseback.

> **Key Term: Underlying asset**
> The asset that is the subject of a lease, such as a building, machine, vehicle or item of equipment.

For example, suppose Delta Co sells a factory to Investor Co and leases it back for five years. If Investor Co can sell the factory, pledge it as security, and obtain the remaining benefits from the property subject only to Delta Co’s lease rights, the transfer may qualify as a sale. Delta Co still uses the factory, but now only as a lessee.

By contrast, if Delta Co has an obligation or substantive right to repurchase the factory, the buyer may not have obtained control. In substance, Investor Co may have lent money to Delta Co secured on the factory. In that case, sale accounting is not appropriate.

> **Key Term: Control**
> The ability to direct the use of an asset and obtain substantially all of its remaining economic benefits.
>
> **Test Tip:**
> In ACCA FR, always deal with the sale test first. Do not start by calculating a disposal gain unless the scenario says or implies that the transfer qualifies as a sale.

The FR exam often keeps the sale test manageable. A question may state clearly that the transfer satisfies IFRS 15, or it may state that it does not. If it does not qualify as a sale, the accounting is very different, so read the wording carefully.

### Accounting when the transfer qualifies as a sale

If the transfer qualifies as a sale, the accounting is split between the seller-lessee and the buyer-lessor.

The seller-lessee derecognises the original asset because it has sold it. However, it has not given up all economic benefits from the asset. It has retained the right to use the asset during the leaseback period. Therefore, the seller-lessee recognises a right-of-use asset and a lease liability.

> **Key Term: Right-of-use asset**
> An asset representing a lessee’s right to use an underlying asset for the lease term.

The key rule is that the seller-lessee measures the right-of-use asset as the proportion of the previous carrying amount of the asset that relates to the right of use retained. This prevents the seller-lessee from recognising a full gain on an asset it is still using.

The usual FR calculation is:

$$
\text{Right-of-use asset} =
\text{Previous carrying amount}
\times
\frac{\text{Present value of lease payments}}{\text{Fair value of asset}}
$$

The seller-lessee recognises a gain or loss only on the rights transferred to the buyer-lessor. It does not recognise the gain relating to the right of use retained.

A practical way to calculate the gain is:

$$
\text{Total potential gain} =
\text{Fair value of asset}
-
\text{Carrying amount of asset}
$$

$$
\text{Gain recognised} =
\text{Total potential gain}
\times
\frac{\text{Fair value of asset} - \text{Present value of lease payments}}{\text{Fair value of asset}}
$$

The fraction represents the part of the asset transferred to the buyer-lessor. The present value of lease payments represents the part retained as a right of use.

> **Key Term: Lease liability**
> The present value of future lease payments that the lessee is required to make under the lease.

In the ACCA FR exam, sale proceeds in a sale and leaseback transaction are assumed to equal fair value. This avoids complications involving above-market or below-market sale prices. You should therefore normally use the sale proceeds as the fair value of the asset when calculating the proportion retained.

> **Exam Warning:**
> Do not recognise the full difference between sale proceeds and carrying amount as a gain. The seller-lessee recognises only the gain relating to the rights transferred to the buyer-lessor.

Consider this example.

> **Question:**
> Gamma Co owns a building with a carrying amount of $600,000. It sells the building for $1,000,000, which is equal to fair value, and leases it back for five years. The present value of the lease payments is $700,000. The transfer qualifies as a sale. Calculate the right-of-use asset and gain recognised by Gamma Co.

First, calculate the proportion retained:

$$
\frac{\text{Present value of lease payments}}{\text{Fair value}} =
\frac{700,000}{1,000,000} =
70\%
$$

Gamma Co has retained 70% of the asset’s value through the leaseback. The right-of-use asset is:

$$
600,000 \times 70\% = 420,000
$$

The total potential gain is:

$$
1,000,000 - 600,000 = 400,000
$$

Gamma Co has transferred 30% of the asset to the buyer-lessor:

$$
100\% - 70\% = 30\%
$$

The gain recognised is:

$$
400,000 \times 30\% = 120,000
$$

The accounting entry for Gamma Co can be understood as:

- Dr Cash $1,000,000
- Dr Right-of-use asset $420,000
- Cr Building $600,000
- Cr Lease liability $700,000
- Cr Gain on sale $120,000

This balances because debits are $1,420,000 and credits are $1,420,000.

This example shows the central logic of IFRS 16. Gamma Co has sold the building, but because it has leased it back, it has retained part of the asset’s economic benefits. The gain is restricted to the part sold.

### Accounting by the buyer-lessor

The buyer-lessor is the party that buys the asset and leases it back to the seller. If the transfer qualifies as a sale, the buyer-lessor accounts for the purchase of the underlying asset under the relevant IFRS Accounting Standard. For example, a building may be recognised as property, plant and equipment under IAS 16, or as investment property under IAS 40 if the relevant criteria are met.

The buyer-lessor then accounts for the leaseback under IFRS 16 lessor accounting. Lessor accounting under IFRS 16 retains the distinction between finance leases and operating leases.

> **Key Term: Buyer-lessor**
> The party that purchases an asset from the seller and then leases that asset back to the seller.
>
> **Key Term: Seller-lessee**
> The party that sells an asset and then leases that same asset back from the buyer.

If the leaseback is classified as an operating lease by the buyer-lessor, the buyer-lessor keeps the asset in its statement of financial position and recognises lease income over the lease term, usually on a straight-line basis unless another systematic basis is more representative.

If the leaseback is classified as a finance lease by the buyer-lessor, the buyer-lessor derecognises the underlying asset and recognises a lease receivable representing its net investment in the lease. Finance income is then recognised over the lease term to reflect a constant periodic rate of return.

> **Key Term: Operating lease**
> A lease that does not transfer substantially all the risks and rewards incidental to ownership of the underlying asset.
>
> **Key Term: Finance lease**
> A lease that transfers substantially all the risks and rewards incidental to ownership of the underlying asset.

For FR, the buyer-lessor side is usually tested at principle level rather than through long lessor calculations. You may need to identify whether the buyer-lessor recognises an asset, lease receivable, rental income, or finance income.

A simple buyer-lessor example follows from the Gamma Co facts above. Investor Co pays $1,000,000 to buy the building. The transfer qualifies as a sale. Investor Co recognises the building at $1,000,000, assuming it is accounted for as property, plant and equipment. It then assesses the leaseback. If the leaseback is an operating lease, Investor Co continues to recognise the building and records rental income over the lease term. If the leaseback is a finance lease, Investor Co recognises a lease receivable instead.

> **Test Tip:**
> Keep the two parties separate. The seller-lessee recognises a right-of-use asset and lease liability. The buyer-lessor applies lessor accounting and may recognise either the underlying asset or a lease receivable depending on lease classification.

In many exam questions, the focus is on the seller-lessee adjustment because it affects profit, non-current assets and liabilities. However, because this subtopic sits within lessor accounting, you should be ready to state the buyer-lessor treatment.

### Accounting when the transfer is not a sale

If the transfer does not qualify as a sale under IFRS 15, neither party accounts for it as a sale and purchase. Instead, the arrangement is treated as a financing transaction.

For the seller-lessee:

- the original asset remains in the statement of financial position;
- no disposal gain or loss is recognised;
- the cash received is recognised as a financial liability.

For the buyer-lessor:

- no underlying asset is recognised as purchased;
- the cash paid is recognised as a financial asset;
- payments received are accounted for as repayments of principal and finance income.

> **Key Term: Failed sale and leaseback**
> A sale and leaseback arrangement in which the transfer of the asset does not qualify as a sale, so the transaction is accounted for as financing.

The logic is that if the buyer has not obtained control of the asset, the seller has not really sold it. The legal form may involve a transfer of title, but the accounting reflects the substance: the seller has borrowed money and the buyer has provided finance.

For example, Harbour Co owns equipment with a carrying amount of $500,000. It transfers the equipment to Finance Co for $650,000 and leases it back. The contract gives Harbour Co a substantive right to repurchase the equipment at a price that makes repurchase highly likely. The transfer does not qualify as a sale.

Harbour Co does not derecognise the equipment and does not recognise a $150,000 gain. Instead, it records the $650,000 cash received as a financial liability. Finance Co does not recognise the equipment as its asset. It recognises a financial asset for the cash advanced.

This is a common exam trap. Candidates may see sale proceeds above carrying amount and record a gain automatically. That is incorrect if the sale test fails.

> **Exam Warning:**
> A failed sale and leaseback is not an operating lease for the seller-lessee. It is accounted for as financing: asset retained, liability recognised, no sale gain.

### FR calculation approach and exam pitfalls

A clear step-by-step approach will help you avoid most errors.

First, decide whether the transfer is a sale. Use the question wording. If the asset transfer satisfies IFRS 15, proceed with sale and leaseback accounting. If not, use financing treatment.

Second, identify the fair value of the asset. In FR, sale proceeds are assumed to equal fair value for sale and leaseback transactions. This means that if the question says the asset was sold for $900,000, you can normally treat $900,000 as fair value.

Third, calculate the proportion of the asset retained by the seller-lessee:

$$
\text{Proportion retained} =
\frac{\text{Present value of lease payments}}{\text{Fair value of asset}}
$$

Fourth, calculate the right-of-use asset:

$$
\text{Right-of-use asset} =
\text{Carrying amount}
\times
\text{Proportion retained}
$$

Fifth, calculate the gain or loss recognised. For a gain, calculate the total potential gain and multiply it by the proportion transferred:

$$
\text{Proportion transferred} =
1 - \text{Proportion retained}
$$

$$
\text{Gain recognised} =
(\text{Fair value} - \text{Carrying amount})
\times
\text{Proportion transferred}
$$

If there is a total loss because fair value is less than carrying amount, the same principle applies: recognise only the loss relating to the rights transferred. However, also consider whether the asset is impaired under the relevant asset standard before the transaction. At FR level, the question will usually be structured to avoid excessive complexity.

A second worked example will help fix the method.

> **Question:**
> Orion Co sells machinery for $800,000, equal to fair value, and leases it back for four years. The machinery had a carrying amount of $500,000. The present value of lease payments is $320,000. The transfer qualifies as a sale. Calculate the seller-lessee’s right-of-use asset and gain.

Proportion retained:

$$
\frac{320,000}{800,000}=40\%
$$

Right-of-use asset:

$$
500,000 \times 40\% = 200,000
$$

Total potential gain:

$$
800,000 - 500,000 = 300,000
$$

Proportion transferred:

$$
100\% - 40\% = 60\%
$$

Gain recognised:

$$
300,000 \times 60\% = 180,000
$$

Orion Co records:

- cash of $800,000;
- right-of-use asset of $200,000;
- lease liability of $320,000;
- derecognition of machinery of $500,000;
- gain of $180,000.

A useful check is to place the figures into a journal:

- Dr Cash $800,000
- Dr Right-of-use asset $200,000
- Cr Machinery $500,000
- Cr Lease liability $320,000
- Cr Gain $180,000

The journal balances: debits of $1,000,000 and credits of $1,000,000.

Common mistakes in this area include:

- recognising the full gain on sale;
- measuring the right-of-use asset at the present value of lease payments rather than at a proportion of the old carrying amount;
- forgetting to recognise the lease liability;
- treating a failed sale as a disposal;
- confusing seller-lessee accounting with buyer-lessor accounting;
- using carrying amount instead of fair value in the retained proportion fraction.

> ** Test Tip:**
> In a numerical FR question, set out three lines before writing the journal: proportion retained, right-of-use asset, and gain recognised. This keeps the calculation controlled and earns method marks.

Sale and leaseback also affects ratio analysis. A valid sale may reduce owned property, plant and equipment, create a right-of-use asset, add lease liabilities, and recognise a restricted gain. This may affect gearing, asset turnover, profit and return on capital employed. A failed sale increases financial liabilities without removing the asset, which can make gearing worse. If interpreting financial statements, explain the substance rather than only quoting ratio movements.

## Key Point Checklist*This article has covered the following key knowledge points:*

- A sale and leaseback occurs when an entity sells an asset and leases the same asset back.
- The first step is to decide whether the transfer qualifies as a sale using IFRS 15 control principles.
- Continued use by the seller does not automatically prevent sale accounting.
- If the transfer qualifies as a sale, the seller-lessee derecognises the original asset.
- The seller-lessee recognises a right-of-use asset and a lease liability for the leaseback.
- The right-of-use asset is based on the proportion of the previous carrying amount relating to the right retained.
- The seller-lessee recognises only the gain or loss relating to the rights transferred to the buyer-lessor.
- In ACCA FR, sale proceeds are assumed to equal fair value for sale and leaseback transactions.
- The buyer-lessor accounts for the asset purchase and then applies IFRS 16 lessor accounting to the leaseback.
- If the leaseback is an operating lease, the buyer-lessor keeps the underlying asset and recognises lease income.
- If the transfer is not a sale, the seller keeps the asset and records a financial liability.
- In a failed sale and leaseback, the buyer recognises a financial asset rather than the underlying asset.

## Key Terms and Concepts

- Sale and leaseback
- Underlying asset
- Control
- Right-of-use asset
- Lease liability
- Buyer-lessor
- Seller-lessee
- Operating lease
- Finance lease
- Failed sale and leaseback


Lessor accounting - Sale and leaseback transactions