How are intercompany leases eliminated in consolidation under IFRS 16 / ASC 842?

Intercompany leases present a unique consolidation challenge under IFRS 16 / ASC 842 because both entities record significant balance sheet items that must be unwound in consolidation.

The Setup:

Parent Co. owns a building and leases it to Subsidiary Co. (100% owned).

In Subsidiary's separate statements (lessee):

• Right-of-Use (ROU) Asset: $2,400,000
• Lease Liability: $2,400,000
• Depreciation expense on ROU asset: $480,000/year
• Interest expense on lease liability: Varies by period

In Parent's separate statements (lessor):

• Lease receivable (if finance lease) or underlying asset retained (if operating lease)
• Lease/rental revenue

From the Consolidated Perspective:

The group simply owns a building that one of its divisions uses. There is no lease — it is an internal arrangement. The consolidation must show:

• The building at its original cost (in parent's books) with normal depreciation
• No ROU asset, no lease liability, no lease receivable
• No lease revenue or lease expense

Elimination Entries (Operating Lease by Lessor):

Entry	Debit	Credit
1. Eliminate lease revenue	Lease Revenue (Parent)	Lease Expense/Depr. + Interest (Sub)
2. Eliminate ROU asset	Lease Elimination Adjustment	ROU Asset
3. Eliminate lease liability	Lease Liability	Lease Elimination Adjustment

Worked Example — Greenfield Holdings and Greenfield Logistics:

Greenfield Holdings leases a warehouse to Greenfield Logistics. 5-year lease, $500,000 annual payments. Present value (lessee):$2,100,000.

Subsidiary books:

• ROU Asset: $2,100,000 (amortized over 5 years:$420,000/year)
• Lease Liability: $2,100,000 (declining balance as payments made)
• Year 1: Depreciation $420,000 + Interest ~$126,000 = $546,000 total expense

Parent books (operating lease classification):

• Building remains on parent's books at cost $3,800,000 (depreciating$190,000/year over 20 years)
• Rental revenue: $500,000

Consolidation eliminations (Year 1):

Elimination	Debit	Credit
Rental revenue (parent)	$500,000
ROU asset depreciation (sub)		$420,000
Interest expense (sub)		$126,000
Adjustment to parent depreciation		($46,000)*

*Net adjustment ensures consolidated depreciation equals the parent's building depreciation of $190,000, not the subsidiary's ROU depreciation of$420,000.

Additionally:

• Eliminate the ROU asset entirely from consolidated balance sheet
• Eliminate the lease liability entirely
• The parent's building remains at its historical carrying value

Key Exam Points:

1. The consolidated entity shows the underlying asset (building), not the ROU asset.
2. All intercompany lease revenue and expense are eliminated.
3. The consolidation adjustments can be complex because the lessee and lessor may classify the lease differently.
4. The net income impact of the elimination depends on whether the parent's building depreciation differs from the subsidiary's ROU depreciation.

Explore more IFRS 16 consolidation topics in our CFA Level II materials.