Classification of subleases
AASB 16 extract:
Subleases are to be classified by the sublessor as operating or finance leases, based on whether the sublease transfers substantially all the risks and rewards of ownership of the underlying asset. Subleases are:
- operating leases, where substantially all the risks and rewards of ownership of the head lease ROU asset are not transferred to the sublessee. Where the sublease is classified as an operating lease:
- lease income is recognised on either a straight-line or another systematic basis
- costs related to the head lease ROU asset, such as depreciation and impairment, continue to be recognised by the sublessor as expenses.
- finance leases, where substantially all the risks and rewards of ownership of the head lease ROU asset are transferred to the sublessee. Where the sublease is classified as a finance lease:
- the head lease asset is effectively transferred to the sublessee (derecognised by the sublessor and recognised by the sublessee)
- instead of the head lease ROU asset, the sublessor recognises a net investment in the sublease, being the discounted lease payments receivable and any unguaranteed residual value
- any difference between the head lease ROU asset transferred and the net investment in sublease recognised, should be recorded as a gain or loss in the sublessor’s income statement
- the sublessor recognises finance income on the outstanding balance of the investment in the sublease.
Indications that a sublease could be classified as a finance sublease include that the:
- sublease term is for the majority of the head lease term
- present value of sublease payments amounts to substantially all of the head lease ROU asset’s fair value
- sublease transfers ownership of the underlying asset to the sublessee by the end of the lease term (i.e. the lessee has a bargain purchase option).
A sublease should only be considered by the sublessor as a potential finance sublease when the ROU asset transferred comprises of 75 per cent or more of the underlying head lease ROU asset.
AASB 16 extract:
- if the head lease is a short-term lease that the entity, as a lessee, has accounted for applying paragraph 6, the sublease shall be classified as an operating lease.
- otherwise, the sublease shall be classified by reference to the right-of-use asset arising from the head lease, rather than by reference to the underlying asset (for example, the item of property, plant or equipment that is the subject of the lease).
The ROU asset transferred under the sublease should be assessed against the head lease ROU asset, rather than the physical underlying asset. Sublessors must classify short-term head leases as operating leases. In other circumstances, accounting judgement is to be applied and documented for audit purposes.
For requirements in considering lessor classification and accounting for leases, see paragraphs 61-87 of AASB 16 Leases (AASB 16). Worksheets C1 and C2 in the Example lease journals also illustrate accounting for sublease arrangements.
Note 16: Classification of subleases
A sublease must only be considered by the sublessor as a potential finance sublease when the ROU asset transferred comprises 75 per cent or more of the head lease ROU.
Consolidation of Commonwealth subleases
Subleases within the Commonwealth create related party transactions. As a result, Commonwealth entities are required to identify and report related party sublease transactions to Finance to allow elimination as part of the whole-of-government consolidation process.
Commonwealth entities must consult with each other to ensure related party information is consistent.
Note 17: Consolidation of Commonwealth subleases
Memorandums of understanding
Under the definitions at Appendix A of AASB 16, a:
- lease is a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration
- contract is an agreement between two or more parties that creates enforceable rights and obligations.
AASB 15 Revenue from Contracts with Customers (AASB 15) states that contracts can be written, oral or implied by an entity’s customary business practices.
Under paragraph F11 of AASB 15, a Commonwealth MOU would be considered an enforceable agreement where, outside the legal system, it establishes the right of a separate party to oblige the entity to act in a particular way or be subject to consequences. Where an MOU contains such conditions or other penalties to the other party, the arrangement would generally be considered a contract for the purposes of AASB 16.
Note 18: Memorandums of understanding
Commonwealth MOUs would generally be considered contracts under AASB 16. Where relevant, entities should review and document whether terms should be incorporated into MOUs or shared service agreements which correspond to those in typical lease contracts, including the identified asset, the period for which the right to use is provided, the consideration payable and cancellation fees.