The lessee’s side of a lease changed completely under International Financial Reporting Standard (IFRS) 16. The lessor’s side did not. A lessor still asks one question: has this lease passed on substantially all the risks and rewards of owning the asset? If yes, the lessor has in substance sold the asset on credit and records a receivable. If no, the lessor still has the asset and records rent.
This topic covers lessors: classification into finance and operating leases, the indicators, land and buildings, finance lease accounting (net investment, finance income), manufacturer and dealer lessors, operating lease accounting and incentives, lessor disclosures, and sale and leaseback transactions. The earlier topic covered lessees. No lessor question appeared in the two latest Pathfinder diets, but sale and leaseback and classification are regular exam themes.
In 30 seconds
A lessor classifies each lease at inception as a finance lease (substantially all risks and rewards of ownership pass to the lessee) or an operating lease (they do not). In a finance lease the lessor removes the asset and records a receivable, the net investment in the lease, and earns finance income at a constant rate on it. A manufacturer or dealer also books a selling profit at the start.
In an operating lease the lessor keeps the asset, depreciates it, and recognises rent on a straight-line basis. In a sale and leaseback, the seller-lessee first tests whether the transfer is a sale under IFRS 15. If it is, the seller derecognises the asset, records a right-of-use asset (a proportion of the old carrying amount) and a lease liability, and recognises a gain only on the rights actually transferred.
If it is not a sale, the seller keeps the asset and records a financial liability for the cash.
Key terms in plain English
| Term | What it means |
|---|---|
| Finance lease | A lease that passes substantially all the risks and rewards of ownership to the lessee |
| Operating lease | Any lease that is not a finance lease |
| Net investment in the lease | The lessor’s receivable: the gross investment discounted at the rate implicit in the lease |
| Gross investment in the lease | Lease payments receivable plus any unguaranteed residual value |
| Unearned finance income | Gross investment less net investment |
| Interest rate implicit in the lease | The rate that makes the present value of lease payments and the unguaranteed residual equal to the fair value of the asset plus the lessor’s initial direct costs |
| Unguaranteed residual value | The part of the end-of-lease value of the asset that the lessor is not assured of receiving |
| Sale and leaseback | An entity sells an asset and immediately leases it back |
Syllabus check
IFRS 16 is examinable under syllabus area B (reporting of performance and position, non-financial assets and liabilities). This topic covers:
- lease classification by lessors and the accounting for finance and operating leases;
- manufacturer or dealer leases;
- sale and leaseback transactions, including above-market terms;
- lessor disclosures.
CAMA 2020 and lessors
The Companies and Allied Matters Act 2020 (CAMA 2020) requires statements that follow IFRS and give a true and fair view.
| Section | What it says | Link to lessor accounting |
|---|---|---|
| s. 377(1) and s. 378 | Directors prepare statements that follow IFRS and give a true and fair view | Classification must follow substance, not the label in the contract |
| s. 374(1) | The company keeps accounting records | Lease agreements, residual value estimates and rate calculations support the figures |
| s. 385 | The directors’ report covers performance and risk | A lessor’s residual value risk is a matter for the report |
| s. 404(7) | The audit committee reviews policies and internal control | It reviews classification judgements and sale and leaseback gains |
Lessor classification
A lessor may be a finance company, a hire company (tools, plant, cars), a manufacturer or dealer that offers leasing as an alternative to sale, or a property company. Every lease is classified at inception.
A finance lease transfers substantially all the risks (idle capacity, obsolescence, changes in economic conditions) and rewards (profitable use, gains in value or on disposal) of ownership. Substance matters more than legal form: the lessor is the legal owner, but the lessee has the benefits and costs of ownership, as if it had borrowed to buy the asset.
These situations normally point to a finance lease, alone or together:
- ownership passes to the lessee at the end of the lease;
- the lessee has an option to buy at a price substantially below expected fair value, so it will probably use it;
- the lease term is for a major part of the economic life of the asset;
- at inception the present value of lease payments is substantially all of the fair value of the asset;
- the asset is so specialised that only the lessee can use it without major change;
- if the lessee can cancel, the lessor’s cancellation losses fall on the lessee;
- gains or losses from changes in the fair value of the residual fall on the lessee; and
- the lessee can renew for a secondary period at a rent substantially below market.
The list is not conclusive. Look at all the facts. In each case the lessor sets the rentals so that it recovers the cost of the asset plus interest within the lease term, which is why the lessee is, in substance, paying for the whole asset.
Classification is made at inception and is not changed for changes in estimates (such as the residual value) or circumstances (such as default). A change in the agreement that would have changed the classification is treated as a new lease from that date.
Land and buildings
A property lease is classified as two leases. Land normally has an indefinite life, so its lease is usually an operating lease unless the term is very long (for example 999 years). The building is classified by the usual indicators. The rent is split in proportion to the relative fair values of the leasehold interests (not the freehold values).
If the split cannot be made reliably, the whole lease is a finance lease unless both parts are clearly operating. If the land is immaterial, the whole may be treated as one unit using the building’s life.
Finance lease: lessor accounting
The lessor does not show the asset. It records a receivable, the net investment in the lease, which at the start equals the fair value of the asset plus the lessor’s initial direct costs (for a lessor that is not a manufacturer or dealer). Including the costs in the receivable spreads them over the lease through lower finance income.
- Each receipt reduces the receivable. It is part finance income and part repayment.
- Finance income = opening net investment × the implicit rate, a constant periodic return on the net investment.
- Total finance income = total receipts (rentals + residuals) + initial direct costs − amount recognised at the start.
- The receivable is also subject to impairment under IFRS 9.
Manufacturer or dealer lessors
Two kinds of income arise: a selling profit (as on an outright sale at normal prices) and finance income over the lease.
- Revenue at the start = the lower of the fair value of the asset and the present value of the lease payments at a market rate of interest.
- Cost of sale = the carrying amount of the asset less the present value of the unguaranteed residual value (which has not been sold and moves to the receivable).
- Costs of negotiating and arranging the lease are expensed when the selling profit is recognised, and are not part of the net investment.
- If the dealer charges artificially low interest, the selling profit is restricted to what a market rate would give.
Operating lease: lessor accounting
The lessor keeps the asset in its statement of financial position, depreciates it under its normal policy (International Accounting Standard (IAS) 16 or IAS 38), and recognises rental income on a straight-line basis unless another systematic basis fits the pattern of benefit better. Initial direct costs are added to the carrying amount of the asset and expensed over the lease term on the same basis as the income.
A manufacturer or dealer recognises no selling profit on an operating lease, because there is no sale.
Incentives (rent-free periods, cash contributions, relocation costs) are part of the net consideration and are spread over the lease term on a straight-line basis.
Lessor disclosures
- Finance leases: finance income on the net investment, selling profit or loss, income from variable payments not in the net investment, an explanation of significant changes in the net investment, and a maturity analysis of undiscounted receipts for at least each of the first five years and a total for later years, reconciled to the net investment by deducting unearned finance income.
- Operating leases: lease income (with variable payments not based on an index or rate shown separately), IAS 16 disclosures for assets under operating leases shown separately from owned assets, and a maturity analysis of undiscounted receipts.
- Qualitative information on the nature of the leasing activities and how the lessor manages the risk in the rights it keeps in the assets.
Sale and leaseback
The seller (lessee) sells an asset to a buyer (lessor), often a bank, and leases it back. It raises cash and keeps the use of the asset. The first step is to decide whether the transfer is a sale, by applying the IFRS 15 test: has the buyer obtained control of the asset?
When the transfer is a sale: seller-lessee
The seller:
- derecognises the asset and records the proceeds;
- records a lease liability at the present value of the leaseback payments (at the implicit rate or its incremental borrowing rate); and
- records a right-of-use asset equal to the proportion of the old carrying amount that relates to the right retained:
Right-of-use asset = carrying amount of the asset × (lease liability ÷ fair value of the asset).
The gain or loss is the balancing figure and covers only the rights actually transferred to the buyer. The right-of-use asset is not stated at fair value. The buyer-lessor accounts for the purchase as an ordinary asset purchase and classifies the leaseback as a finance or operating lease.
Above-market terms
If the sale price is above fair value, or the leaseback payments are above market rates, the excess is additional financing. The seller records a financial liability for the extra amount, and the lease liability covers only the lease proper. If the sale price is below fair value, or payments are below market, the shortfall is treated as a prepayment of lease payments.
The adjustment uses the more readily determinable of the difference between fair value and the price and the difference between the contractual and market lease payments.
When the transfer is not a sale
The seller keeps the asset in its books, continues to depreciate it and records a financial liability equal to the cash received (IFRS 9). The buyer-lessor records a financial asset (a receivable) for the amount it paid.
The rules in more depth
Why a finance lease is a sale in substance
If the lessor receives, through rentals, the cost of the asset and interest, and the lessee bears the risks and rewards, the lessor has in substance lent money. Showing a receivable, not the asset, reflects that.
Why the gain on a sale and leaseback is only part of the difference
The seller sold some rights and kept others. Only the gain on the rights sold is recognised. The proportion kept is measured by the lease liability relative to fair value, and its gain stays in the carrying amount of the right-of-use asset.
Why dealers deduct the residual from cost of sale
The dealer keeps the asset’s end-of-lease value, so that part of cost has not been sold. It stays in the receivable as part of the net investment.
Worked examples
Example 1: classification. X Plc leases a cement lorry with a cash price of ₦3,000,000 for 6 years at ₦600,000 a year in arrears. The economic life is 7 years, the implicit rate is 7% and X Plc maintains and insures the lorry.
- Lease term.
6 ÷ 7 = about 86% of the life: a major part. - Present value of payments.
₦600,000 × 4.766 = ₦2,859,600, which is about 95% of fair value: substantially all. - X Plc bears maintenance and insurance, consistent with owning the risks.
- Conclusion: finance lease.
Example 2: land and buildings. A property is leased for ₦450,000 a year. The fair values of the leasehold interests are land ₦1,000,000 and building ₦500,000.
- Land share.
1,000 ÷ 1,500 = 2/3, so rent for land = ₦300,000. - Building share.
1/3, so rent for the building = ₦150,000.
Example 3: finance lease with residual value (lessor). Ready Finance Plc leases a machine for 6 years at ₦18,000 a year in arrears. Fair value is ₦80,000 and initial direct costs are ₦2,000. The residual value at the end is ₦10,000, of which the lessee guarantees ₦8,000. The implicit rate is 10.798%.
- Net investment at the start.
₦80,000 + ₦2,000 = ₦82,000. - Total finance income.
(6 × ₦18,000) + ₦8,000 + ₦2,000 − ₦80,000 − ₦2,000 = ₦36,000.
| Year | Opening | Income at 10.798% | Receipts | Closing |
|---|---|---|---|---|
| 1 | 82,000 | 8,854 | (18,000) | 72,854 |
| 2 | 72,854 | 7,867 | (18,000) | 62,721 |
| 3 | 62,721 | 6,773 | (18,000) | 51,494 |
| 4 | 51,494 | 5,560 | (18,000) | 39,054 |
| 5 | 39,054 | 4,217 | (18,000) | 25,271 |
| 6 | 25,271 | 2,729 | (26,000) | 2,000 |
The ₦26,000 in Year 6 is the last rental plus the guaranteed residual. The ₦2,000 left is the unguaranteed residual.
Example 4: dealer lease. Best Cars Plc sells a car for ₦200,000 cash (cost ₦150,000). Under a lease it charges ₦80,423 a year for 3 years in arrears at 10%, with no residual. Costs of arranging the lease are ₦2,000.
- Revenue = lower of ₦200,000 and ₦80,423 × 2.487 = ₦200,000.
- Cost of sale = ₦150,000. Arrangement costs ₦2,000 are expensed. Selling profit = ₦48,000.
- Year 1 finance income = ₦200,000 × 10% = ₦20,000.
Closing receivable = ₦200,000 + ₦20,000 − ₦80,423 = ₦139,577.
With a residual value of ₦13,310 not guaranteed and rentals of ₦76,402, revenue = ₦76,402 × 2.487 = ₦190,000, the present value of the residual = ₦13,310 × 0.751 = ₦10,000, cost of sale = ₦150,000 − ₦10,000 = ₦140,000, selling profit = ₦50,000 − ₦2,000 = ₦48,000. The opening net investment is ₦190,000 + ₦10,000 = ₦200,000.
Example 5: operating lease incentive. A lessor leases an asset for 20 years. The first year is rent free and the rent is ₦30,000 a year in arrears afterwards.
- Total rent.
19 × ₦30,000 = ₦570,000. - Annual income.
₦570,000 ÷ 20 = ₦28,500 every year. - In Year 1 there is no cash, so a receivable of ₦28,500 builds up. In Years 2 to 20 the cash is ₦30,000 and ₦1,500 reduces the receivable.
Example 6: sale and leaseback at fair value. X Plc sells an asset with a carrying amount of ₦1,000,000 for ₦1,300,000, which is its fair value. The transfer is a sale. It leases the asset back for 20 annual payments of ₦83,951.48 in arrears, at an implicit rate of 5% (annuity factor 12.4622).
- Lease liability.
₦83,951.48 × 12.4622 = ₦1,046,221. - Right-of-use asset.
₦1,000,000 × 1,046,221 ÷ 1,300,000 = ₦804,785. - Gain (balance)
(₦1,300,000 + ₦804,785) − (₦1,000,000 + ₦1,046,221) = ₦58,564. - Check.
gain = ₦300,000 × (₦1,300,000 − ₦1,046,221) ÷ ₦1,300,000 = ₦58,564.
Example 7: above-market sale price. The same asset is sold for ₦1,500,000 against a fair value of ₦1,300,000. The leaseback is 20 annual payments of ₦100,000 at 5%.
- Extra finance.
₦1,500,000 − ₦1,300,000 = ₦200,000, a financial liability. - Total liability.
₦100,000 × 12.4622 = ₦1,246,220.
Lease liability proper = ₦1,246,220 − ₦200,000 = ₦1,046,220. - Right-of-use asset and gain are as in Example 6: ₦804,785 and ₦58,564. The only difference is cash ₦1,500,000 and an extra liability of ₦200,000.
How to score full marks
- Classify first, using the indicators that apply, and give the percentage for the life and present value tests.
- For a finance lease, show net investment at the start, the schedule and total finance income.
- For a dealer, show revenue, cost of sale, selling profit and the expensing of arrangement costs.
- For an operating lease, show depreciation and straight-line income, with incentives spread.
- For a sale and leaseback, say whether it is a sale, then show the liability, the right-of-use proportion and the gain as the balancing figure.
- Separate any extra finance if terms are above market.
Common mistakes in the exam
- Classifying a lease by its legal label instead of its substance.
- Leaving the lessor’s asset in the statement of financial position for a finance lease.
- Putting the dealer’s arrangement costs into the net investment.
- Booking selling profit on an operating lease.
- Recognising the full gain on a sale and leaseback instead of only the part on rights transferred.
- Measuring the right-of-use asset at fair value instead of the proportion of the old carrying amount.
- Forgetting the extra finance when terms are above market.
- Treating land as depreciating.
Quick revision
- Finance lease: substantially all risks and rewards pass. Receivable at fair value plus initial direct costs. Finance income at a constant rate.
- Dealer: revenue is the lower of fair value and present value of payments at a market rate. Cost of sale = cost less present value of unguaranteed residual. Arrangement costs expensed.
- Operating lease: keep the asset, depreciate, straight-line rent, incentives spread, no selling profit.
- Land and buildings: separate leases, rent split by leasehold interest values.
- Sale and leaseback: test for a sale. Right-of-use asset = carrying amount × liability ÷ fair value. Gain is the balance. Above market: extra financing. Not a sale: financial liability.
- CAMA 2020: ss. 377(1), 378, 374(1), 385, 404(7).
Practice questions
These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.
Recall check: multiple choice
The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.
Question 1. A lease is a finance lease when it:
- Is legally called a finance lease
- Transfers substantially all the risks and rewards of ownership
- Lasts more than one year
- Has monthly payments
Show the answer
B. Substance over form.
Question 2. The lessor’s receivable in a finance lease is the:
- Fair value only
- Net investment in the lease
- Gross investment
- Rental for one year
Show the answer
B. The gross investment discounted at the implicit rate.
Question 3. A dealer lessor’s costs of arranging a finance lease are:
- Added to the net investment
- Expensed when the selling profit is recognised
- Deferred over the lease
- Ignored
Show the answer
B. They are excluded from the net investment.
Question 4. A lessor recognises rent on an operating lease:
- On receipt
- On a straight-line basis
- At the start
- At the end
Show the answer
B. Unless another systematic basis fits better.
Question 5. A dealer recognises selling profit on an operating lease:
- Yes, at the start
- No
- Yes, over the term
- Only for cars
Show the answer
B. There is no sale.
Question 6. Which is a finance lease indicator?
- Short lease term
- Ownership transfers at the end
- Lessor bears all risks
- Lessee can return the asset at any time
Show the answer
B. Others include a major part of the life and present value of substantially all fair value.
Question 7. In a sale and leaseback that is a sale, the right-of-use asset is:
- Fair value
- Carrying amount × lease liability ÷ fair value
- Sale proceeds
- Nil
Show the answer
B. The gain is the balancing figure.
Question 8. If the sale price exceeds fair value in a sale and leaseback, the excess is:
- Gain
- A financial liability for additional financing
- Revenue
- Deferred income
Show the answer
B. The lease liability covers only the lease proper.
Question 9. If a sale and leaseback transfer is not a sale, the seller:
- Derecognises the asset
- Keeps the asset and records a financial liability
- Records a gain
- Records a lease receivable
Show the answer
B. Under IFRS 9.
Question 10. Which section of CAMA 2020 requires the statements to follow IFRS?
- Section 378
- Section 400
- Section 405
- Section 409
Show the answer
A. IFRS 16 is part of IFRS.
Written questions
Question 11 (10 marks). (a) State the situations that normally lead to a lease being classified as a finance lease. (5 marks) (b) Explain how a manufacturer or dealer lessor measures revenue and cost of sale on a finance lease. (5 marks)
Question 12 (20 marks). (a) Explain how a property lease is classified and how the rent is split. (5 marks) (b) On 1 January Year 1, Fola Finance leases a machine with fair value ₦300,000 for 5 years at ₦79,139 a year in arrears, with no residual value and no initial direct costs. The implicit rate is 10%. Show the initial entry and the receivable at the end of Years 1 and 2.
(5 marks) (c) Explain the accounting for an operating lease by a lessor, including incentives. (4 marks) (d) Beta Ltd sells an asset with a carrying amount of ₦800,000 for ₦1,000,000, its fair value, in a transfer that is a sale, and leases it back for 10 years at ₦120,000 a year in arrears. The rate is 6% (annuity factor 7.3601). Calculate the lease liability, the right-of-use asset and the gain. (6 marks)
Question 13 (10 marks). (a) Explain how the seller decides whether a sale and leaseback is a sale. (3 marks) (b) Describe the seller-lessee accounting if it is a sale, including above-market terms. (4 marks) (c) Describe the accounting if it is not a sale. (3 marks)
Model answers
Show the model answer to Question 11
(a) Finance lease indicators (5 marks). Ownership passes to the lessee at the end. (0.5) A bargain purchase option the lessee will probably use. (0.5) The term is for a major part of the economic life. (0.5) The present value of lease payments is substantially all the fair value of the asset. (1) The asset is specialised. (0.5) Lessee bears the lessor’s cancellation losses. (0.5) Residual value gains or losses fall on the lessee.
(0.5) The lessee can renew at a rent far below market. (0.5) The indicators are not conclusive and substance decides. (0.5)
(b) Dealer lessor (5 marks). Revenue is the lower of the fair value of the asset and the present value of the lease payments at a market rate. (2) Cost of sale is the carrying amount less the present value of the unguaranteed residual value. (2) Costs of arranging the lease are expensed when the selling profit is recognised. (1)
Show the model answer to Question 12
(a) Property (5 marks). Land and buildings are classified separately. (1) Land normally has an indefinite life, so it is usually an operating lease unless the term is very long. (1.5) The building is tested by the usual indicators. (1) The rent is split in proportion to the relative fair values of the leasehold interests. (1) If the split cannot be made, the whole is a finance lease unless both are clearly operating. (0.5)
(b) Finance lease (5 marks).
- Initial entry: Dr net investment ₦300,000; Cr asset (or cash) ₦300,000. (1)
- Year 1 income = ₦300,000 × 10% = ₦30,000.
- Closing = ₦300,000 + ₦30,000 − ₦79,139 = ₦250,861. (2)
- Year 2 income = ₦25,086.
- Closing = ₦250,861 + ₦25,086 − ₦79,139 = ₦196,808. (2)
(c) Operating lease (4 marks). The lessor keeps the asset and depreciates it under its policy. (1) Rent is straight-line over the lease term unless another basis is more representative. (1) Initial direct costs are added to the asset and expensed on the same basis as income. (1) Incentives are spread over the lease term. (1)
(d) Sale and leaseback (6 marks).
- Lease liability.
₦120,000 × 7.3601 = ₦883,212. (2) - Right-of-use asset.
₦800,000 × 883,212 ÷ 1,000,000 = ₦706,570. (2) - Gain = (₦1,000,000 + ₦706,570) − (₦800,000 + ₦883,212) = ₦23,358. (2)
Show the model answer to Question 13
(a) Is it a sale? (3 marks). Apply IFRS 15: has the buyer obtained control of the asset? (1.5) The test looks at whether a performance obligation to transfer the asset has been satisfied, taking account of the leaseback. (1.5)
(b) If a sale (4 marks). Derecognise the asset and record the proceeds. (1) Record a lease liability at the present value of the leaseback payments, and a right-of-use asset at the carrying amount multiplied by liability over fair value. (1.5) The gain or loss is the balance and relates only to the rights transferred.
(0.5) If terms are above market, the excess is additional financing recorded as a financial liability, and the lease liability covers the lease proper. (1)
(c) If not a sale (3 marks). The seller keeps the asset and continues to depreciate it. (1) It records a financial liability equal to the cash received under IFRS 9. (1) The buyer records a financial asset for the amount paid. (1)
Pathfinder on IFRS 16 lessors and sale and leaseback
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
The latest Pathfinder diets have no lessor question. The leases question (7(b)) tests the lessee. Study this topic for classification, dealer leases and sale and leaseback, which ICAN practice material covers.
Revise first: Worked examples
Source: ICAN Pathfinder, Strategic Business Reporting. Diets covered: No lessor question in the November Diet, 2025 or May Diet, 2026 Pathfinders.
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