Page 113 - FR Integrated Workbook 2018-19

Leases

Example 4

Sale and leaseback – transfer is a sale

On 1 January 20X1, Painting sells an item of machinery to Collage for its fair
value of $3 million. The asset had a carrying amount of $1.2 million prior to
the sale. This sale represents the satisfaction of a performance obligation, in
accordance with IFRS 15 Revenue from Contracts with Customers. Painting
enters into a contract with Collage for the right to use the asset for the next
five years. Annual payments of $500,000 are due at the end of each year.
The interest rate implicit in the lease is 10%.

The present value of the annual lease payments is £1.9 million. The
remaining useful life of the machine is much greater than the lease term.

Explain how Painting will account for the transaction on 1 January
20X1. Painting must remove the carrying amount of the machine from its
statement of financial position. It should instead recognise a right-of-use
asset. This right-of-use asset will be measured as the proportion of the
previous carrying amount that relates to the rights retained by Painting:

(1.9m/3m) × $1.2 million = $0.76 million.

The entry required is as follows:
$m

Dr Cash 3
Dr Right-of-use asset 0.76

Cr Machine 1.2
Cr Lease liability 1.9

Cr Profit or loss (bal. fig.) 0.66

Note: The gain in profit or loss is the proportion of the overall $1.8 million gain
on disposal ($3m – $1.2m) that relates to the rights transferred to Collage.
This can also be calculated as follows:

((3m – 1.9m)/3m) × $1.8m = $0.66 million.

The right-of-use asset and the lease liability will then be accounted for using
normal lessee accounting rules.

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