IFRS 16 Sale and Leaseback: Accounting Treatment & Journal Entries Explained

Does the "sale" leg actually qualify as a sale?

This is the first and most important question in every sale and leaseback, and it decides everything that follows. Under IFRS 16.99, a seller-lessee must apply the requirements of IFRS 15 to determine whether the transfer of the asset is accounted for as a sale. If the IFRS 15 control-transfer test is met, one accounting model applies (IFRS 16.100); if it is not met, a completely different model applies (IFRS 16.103). There is no in-between.

The test is the same one IFRS 15 uses for any performance obligation satisfied at a point in time. Control passes to the buyer-lessor only when the buyer has the ability to direct the use of the asset and obtain substantially all of its remaining benefits — assessed through the IFRS 15.38 indicators (present right to payment, legal title, physical possession, risks and rewards of ownership, and customer acceptance). A leaseback by itself does not prevent a sale; the seller retaining the right to use the asset for a period is not the same as retaining control of the asset (IFRS 16.99, IFRS 15.31–38).

The classic disqualifier is a repurchase agreement. IFRS 15.B66 states that if the seller has an obligation or a right to repurchase the asset (a forward or a call option), the customer has not obtained control, because the customer is limited in its ability to direct the use of, and obtain benefits from, the asset. So a sale and leaseback that comes bundled with a seller call option to buy the building back at a fixed price is, in substance, financing — and IFRS 16.103 will apply, not IFRS 16.100. A buyer put option at fair value, by contrast, does not usually defeat the sale.

How does a seller-lessee account for a qualifying sale and leaseback?

When the transfer qualifies as a sale, the seller-lessee does not defer the gain over the lease term — that was the abolished IAS 17 approach. Under IFRS 16.100(a), the seller-lessee derecognises the whole asset, recognises a right-of-use asset measured at the proportion of the previous carrying amount that relates to the right of use it retains, and recognises a gain or loss only on the rights transferred to the buyer-lessor. This is the single change that trips up most preparers migrating from IAS 17.

The right-of-use proportion of carrying amount

Two measurements drive the seller-lessee entry (IFRS 16.100(a)). First, the right-of-use asset is not measured at the present value of lease payments (the normal IFRS 16.24 basis for an ordinary lease) and not at fair value; it is measured at the previous carrying amount multiplied by the retained proportion. Second, the gain recognised is the total gain multiplied by the proportion of the asset transferred to the buyer — the mirror image. Because the retained right of use is carried at old book cost rather than fair value, the gain attributable to that retained slice never hits the profit or loss; it is effectively absorbed into the lower carrying value of the right-of-use asset.

The retained proportion is normally computed as the present value of the lease payments divided by the fair value of the asset. The proportion transferred is the balance. Formally (IFRS 16.100(a)):

• Retained proportion = PV of lease payments ÷ fair value of the asset.
• Right-of-use asset = previous carrying amount × retained proportion.
• Gain recognised now = total gain × (1 − retained proportion).

Worked example: qualifying head-office sale and leaseback

Applying IFRS 16.100(a): the retained proportion is £4,000,000 ÷ £10,000,000 = 40%. The rights transferred to the buyer-lessor are therefore 60%.

The single day-one journal for the seller-lessee brings all of this together (IFRS 16.100(a)). Note that it is one combined entry, not a "record the sale" step followed by a "set up the lease" step — the derecognition and the leaseback recognition happen simultaneously:

The entry balances at £12,400,000 on each side. Contrast this with the old IAS 17 answer, which would have put the whole £10m as cash, credited a £4m deferred gain, and released it at £266,667 a year over 15 years. Under IFRS 16 there is no deferred-gain liability at all: £2.4m goes straight to profit or loss, and the other £1.6m is quietly reflected in the fact that the right-of-use asset is carried at £2.4m rather than at the £4.0m present value of the payments (IFRS 16.100(a)(iii)–(iv)).

The buyer-lessor side

The buyer-lessor's accounting is more conventional. Under IFRS 16.100(b), if the transfer is a sale, the buyer-lessor recognises the asset it has purchased at cost, then applies lessor accounting to the leaseback — classifying it as a finance lease or an operating lease using the IFRS 16.61–66 risk-and-reward indicators. For a long leaseback of specialised property the buyer often retains the asset as investment property (operating lease); for a full-payout aircraft leaseback it may be a finance lease with a net investment in the lease. The buyer-lessor does not proportion anything — the IFRS 16.100(a) proportion rule is a seller-lessee mechanic only.

What happens when the sale leg fails the test?

If the transfer does not qualify as a sale, IFRS 16.103 switches off sale accounting entirely for both parties. The seller-lessee keeps the asset on its balance sheet, continues to depreciate it, and recognises a financial liability equal to the transfer proceeds, accounted for under IFRS 9 (IFRS 16.103(a)). The buyer-lessor does not recognise the asset; it recognises a financial asset for the amount it paid (IFRS 16.103(b)). Economically it is a secured loan dressed up as a sale, and the accounting says so.

This is the outcome whenever a repurchase option or other feature means control never passed under IFRS 15 (IFRS 16.99, IFRS 15.B66). It is also the outcome when the "sale" is, in substance, financing — for example where the leaseback is a finance lease covering essentially the whole economic life of the asset, so the seller never really let go of the risks and rewards.

Worked example: failed sale (financing arrangement)

The seller-lessee's day-one entry is simply the recognition of financing (IFRS 16.103(a)). No gain, no derecognition, no right-of-use asset:

The £6,000,000 building stays in property, plant and equipment and keeps depreciating. The £4,000,000 that would have been a gain under the sale model is never recognised — there was no disposal. Each "lease" payment is split into interest expense and repayment of the financial liability under the effective-interest method (IFRS 9.5.4.1). The buyer-lessor mirrors this with a financial asset (IFRS 16.103(b)):

The difference between the two models is stark: under a qualifying sale, Company A recognises a £2.4m gain and moves a £6m asset off the balance sheet; under a failed sale, it recognises nothing in profit or loss and keeps the asset and a matching £10m liability. The only structural difference between the two fact patterns was a single repurchase clause — which is exactly why auditors scrutinise those clauses so hard.

How do you adjust for an off-market sale price?

Sale and leasebacks are frequently priced away from fair value, because the two legs are negotiated as a package — a higher sale price is often traded for higher rents, and vice versa. IFRS 16.101 requires the seller-lessee and buyer-lessor to adjust for these off-market terms so that the sale is measured at fair value and the lease reflects market rentals. There are two directions:

• Sale price below fair value: the shortfall is treated as a prepayment of lease payments. It increases the right-of-use asset (the seller has effectively pre-funded some rent) (IFRS 16.101(a)).
• Sale price above fair value: the excess is treated as additional financing provided by the buyer-lessor to the seller-lessee, and is added to the lease liability rather than the gain (IFRS 16.101(b)).

IFRS 16.102 tells you how to measure the adjustment: use the more readily determinable of (i) the difference between the sale price and the asset's fair value, and (ii) the difference between the present value of the contractual payments and the present value of market-rate payments. The practical effect is that an inflated sale price cannot be converted into an inflated day-one gain — the excess is quarantined into the liability and unwound as interest over the lease term.

Auditor red flags and the relevant ISAs

Sale and leasebacks concentrate three audit risks: the sale/no-sale judgement, the fair-value and proportion estimates, and the completeness of related terms. Each maps to a specific standard.

A practical fourth check: recompute the seller-lessee's day-one entry and confirm the right-of-use asset is lower than the lease liability. If they are equal, the client has applied ordinary lease measurement and skipped IFRS 16.100(a) — a recognised gain that is too large usually follows (ISA 540).

Real-company case study: easyJet aircraft sale and leasebacks

Aircraft are the textbook sale and leaseback asset, and airlines disclose enough to see IFRS 16.101 in action. During its 2020 financial year easyJet raised liquidity through a series of aircraft sale and leaseback transactions. In one tranche it sold five A321neo aircraft for aggregate proceeds of around US$266m (approximately £203m), and across the wider programme the net book value of aircraft sold was roughly £167m, generating lease obligations of about £122m (source: easyJet regulatory announcements and Annual Report and Accounts, 2020).

The instructive feature is the pricing. easyJet disclosed that certain of these transactions were completed on terms below market — the sale proceeds were less than the fair value of the aircraft. Under IFRS 16.101(a), the shortfall between fair value and sale price is not a loss; it is treated as a prepayment of future lease payments, which increases the right-of-use asset and reduces the lease liability accordingly. Because the sales were measured at fair value with the off-market element stripped out, there was no material day-one gain recognised in the income statement — exactly the result IFRS 16.100–101 is designed to produce. This is a real, filed illustration of why headline cash proceeds tell you almost nothing about the gain: the gain depends on the fair value split and the off-market adjustment, not on the cheque size.

Figures are drawn from easyJet's publicly filed 2020 regulatory announcements and Annual Report and Accounts and are stated on an approximate, as-reported basis (US$/£ conversions are indicative). The mechanical link between the below-market pricing and the IFRS 16.101 prepayment treatment is an illustrative bridge for teaching purposes; it does not reproduce easyJet's transaction-level ledgers.

Usman Qureshi (ACCA)

The single most common error I see on sale and leasebacks is a carry-over from IAS 17: booking the full gain and "deferring" it straight-line. IFRS 16 killed that. The right-of-use asset is a slice of the old carrying amount, the gain is only the transferred portion, and half the audit battle is confirming the sale even happened. This guide reflects real file findings.

Frequently asked questions