Repossessed and returned leased assets

A bank that repossesses collateral acquires an asset it did not own; a leasing company that repossesses a leased vehicle or machine already holds legal title. That difference tempts lessors to think nothing happens on repossession. In accounting terms, however, a finance lessor has carried a receivable, not the asset: when the lease is terminated and the asset comes back, the net investment must be derecognised and the physical asset recognised for the first time on the balance sheet, at an amount that does not create an artificial gain. For operating leases, the asset never left the balance sheet, but returned assets that will be sold rather than re-leased must be reclassified. Errors here produce phantom gains, stale asset values and receivables that remain open long after the contract has ended.

When a finance lease is terminated for default and the asset is recovered, is the net investment derecognised and the asset recognised, or does the receivable stay on the books while the asset sits in a yard? Was the ECL allowance updated to reflect expected recovery before derecognition, so that the asset is not recognised at more than its recoverable value? Does the lessor retain an enforceable claim against the lessee for any shortfall, and is it expected to collect it? Is the recovered asset held for sale in the ordinary course (inventory), for re-lease under an operating lease (property and equipment), or as a non-current asset held for sale? For operating lease assets returned at the end of the term and routinely sold, are they transferred to inventory at carrying amount, with sale proceeds presented as revenue?

1. Finance lease terminated on default: immediately before termination, update the ECL on the net investment so that the net carrying amount reflects the expected recovery (asset value less costs to repossess and sell, plus any cash expected from the lessee).
2. On termination and recovery of the asset, derecognise the net investment (the contractual rights to the lease cash flows have expired or been replaced by the asset), and recognise the underlying asset.
3. Measure the recognised asset at an amount not exceeding its fair value less costs to sell (or recoverable amount if it will be re-leased); in practice this is usually the net carrying amount of the receivable after the ECL update, and any excess of the receivable over the asset value is a credit loss, not a loss on the asset.
4. If the lessee still owes a shortfall that is legally enforceable and expected to be collected, keep that portion as a separate receivable subject to ECL; otherwise write it off.
5. Classify the recovered asset by intended use: inventory if the lessor routinely sells such assets, property and equipment if it will be leased under an operating lease, or a new net investment if it is immediately leased under a new finance lease; apply IFRS 5 only if the criteria are met and the asset is outside the ordinary-course sale pattern.
6. Operating lease assets returned at the end of a lease: if the lessor routinely sells such assets, transfer them to inventory at carrying amount when they cease to be rented and recognise sale proceeds as revenue under IFRS 15; otherwise they remain in property and equipment, with gains or losses on disposal.
7. Recognise subsequent decreases in value (inventory write-down to net realisable value, or IAS 36 impairment) in profit or loss.

IFRS 16 does not prescribe the amount at which a repossessed finance lease asset is recognised, so the lessor needs a documented policy. The approach commonly applied is: (a) update ECL so that the net receivable equals expected recoveries; (b) recognise the asset at that amount, capped at fair value less costs to sell; (c) no gain is recognised on repossession. As inventory, the asset is then carried at the lower of cost and net realisable value; as property and equipment for re-lease, it is depreciated over its remaining useful life to the lessor and tested for impairment. Repair and refurbishment costs are capitalised only if they meet the relevant Standard's criteria (for inventory, costs to bring it to saleable condition).

Disclose: (1) the accounting policy for repossessed and returned leased assets, including the measurement basis on recognition; (2) the carrying amount of repossessed assets held at the reporting date by class (vehicles, equipment, property) and the line items in which they are presented; (3) the nature and carrying amount of assets obtained by taking possession of leased assets during the period; (4) write-downs and impairment recognised; (5) the policy for disposing of such assets or using them in operations.

• Leaving the full net investment on the books after the asset has been recovered and the lease terminated
• recognising the asset at its original cost or the receivable balance before ECL, creating an overstated asset
• recording a 'gain on repossession' when the asset's estimated value exceeds the written-down receivable
• keeping a shortfall receivable from a lessee who has no realistic ability to pay
• leaving returned vehicles in leased assets and continuing to depreciate them while they wait for sale
• presenting proceeds from the routine sale of ex-lease assets as other gains when IAS 16 requires them to be revenue after transfer to inventory