How does an intermediate lessor classify a sublease under IFRS 16?

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AcadiFi · Accepted Answer

Under IFRS 16, an intermediate lessor classifies a sublease by reference to the right-of-use asset arising from the head lease, NOT the underlying asset itself...

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**Worked Example -- Cascade Office Solutions (fictional)**

Cascade leases office space for 10 years (head lease) and subleases it to Meridian Consulting for 8 years (sublease).

**Classification against the underlying asset (wrong approach):**
- Building useful life = 40 years, sublease = 8 years → 20% of useful life → Operating lease

**Classification against the ROU asset (correct IFRS 16 approach):**
- Head lease ROU remaining term = 10 years, sublease = 8 years → 80% of ROU term → Finance lease

| Classification Basis | Sublease Term / Reference Term | Ratio | Result |
|---|---|---|---|
| Underlying asset (40 yr) | 8 / 40 | 20% | Operating |
| ROU asset (10 yr) | 8 / 10 | 80% | **Finance** |

When classified as a **finance lease**, Cascade:
1. Derecognizes the relevant portion of the ROU asset
2. Recognizes a net investment in the sublease (receivable)
3. Recognizes interest income over the sublease term
4. Continues to account for the head lease liability as before

When classified as an **operating lease**, Cascade would keep the ROU asset, continue depreciating it, and recognize sublease rental income on a straight-line basis.

The IFRS 16 approach increases the likelihood of finance classification for subleases, which shifts the intermediate lessor's balance sheet from asset-heavy (ROU) to receivable-heavy (net investment).

How does an intermediate lessor classify a sublease under IFRS 16?

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