Financial Accounting and Reporting-CPA Practice Exam

According to IFRS, how is profit recognition for a sale-leaseback determined?

1. Whether it's a deferred gain

2. Whether it's an operating or finance lease

3. Based on market trends

4. Presence of contractual obligations

The correct answer is: Whether it's an operating or finance lease

Profit recognition for a sale-leaseback transaction under IFRS is driven primarily by the classification of the lease as either an operating lease or a finance lease. This classification affects how profits are recognized when the asset is sold and then leased back. If the lease is classified as an operating lease, any gain from the sale is generally recognized immediately. This is because the seller-lessee retains the risks and rewards of ownership, albeit indirectly through the lease, thus aligning with the concept of recognizing profit in a conventional sale. Conversely, if the lease is classified as a finance lease, the recognition of profit may be tailored depending on the specific terms of the finance arrangement. Under a finance lease, the asset's economic underlying risk is transferred to the lessee, potentially requiring a more complex evaluation of profit recognition, as the proceeds from the sale may be treated differently, factoring in the lease obligations that are now on the balance sheet. By focusing on whether the lease is classified as operating or finance, companies can accurately determine when and how much profit to recognize in financial statements, adhering closely to the principles outlined in IFRS 16, which governs leases. Understanding this classification is essential for compliance and for providing clarity to stakeholders about the financial health of the organization