Subleases – Accounting by Intermediate Lessee under ASC 842 and IFRS 16

A sublease occurs when a lessee (the intermediate lessor) leases an asset from a lessor and then leases the same asset—or a portion of it—to a third party (the sublessee). Subleases present unique accounting challenges because the intermediate party acts both as lessee and lessor.

This article explains the accounting treatment of subleases under U.S. GAAP (ASC 842) and IFRS (IFRS 16), focusing on lease classification, recognition, and disclosure by the intermediate lessee.

1. What Is a Sublease?

A sublease is a lease arrangement where:

✦ The original lessee becomes a lessor of the same underlying asset

✦ The intermediate lessee does not derecognize its original lease

✦ The accounting for the head lease and sublease are separate

Subleases must be analyzed independently from the original lease to determine appropriate classification and measurement.

2. Sublease Classification (Finance or Operating)

Under ASC 842, the intermediate lessee classifies the sublease based on the underlying asset, not the terms of the head lease.

ASC 842 Sublease Criteria (for finance lease):

✦ Transfer of ownership to sublessee

✦ Purchase option reasonably certain to be exercised

✦ Sublease term ≥ major part of useful life of the asset

✦ PV of sublease payments ≥ substantially all of the fair value of the asset

✦ Subleased asset is specialized

If none of these are met, classify as an operating lease.

IFRS 16 requires:

✦ Sublease is a finance lease if the head lease is also a finance lease, unless the asset is returned before end of useful life.

3. Initial Recognition – Sublease as Lessor

If the sublease is classified as a finance lease, the intermediate lessee:

✦ Derecognizes the portion of the ROU asset transferred to the sublessee

✦ Recognizes a lease receivable equal to the net investment in the sublease

✦ Recognizes any gain or loss immediately

Example:

✦ ROU asset on books: $100,000

✦ Sublease transfers 80% of asset use

✦ PV of sublease payments: $90,000

Journal entry: Dr. Lease Receivable – $90,000 / Cr. ROU Asset – $80,000 / Cr. Gain on Sublease – $10,000.

If classified as an operating lease, the ROU asset remains intact and lease income is recognized straight-line.

Dr. Cash – $8,000 / Cr. Sublease Income – $8,000.

4. Ongoing Accounting for Subleases

Finance Sublease (Lessor Side):

✦ Recognize interest income over time on lease receivable Dr. Cash – $10,000 / Cr. Interest Income – $2,000 / Cr. Lease Receivable – $8,000.

Operating Sublease:

✦ Recognize lease income straight-line

✦ Continue to amortize ROU asset under the head lease

The intermediate lessee continues accounting for the head lease as usual: depreciation of ROU asset (if finance) and interest expense on lease liability.

5. Disclosures for Intermediate Lessees

Disclosure requirements include:

✦ Classification and description of sublease arrangements

✦ Income from subleases, separated by operating and finance

✦ Interest income (for finance subleases)

✦ Remaining lease obligations under both head lease and sublease

✦ Any gains or losses recognized upon inception

Disclosure example: “The Company entered into a sublease of office space originally leased under a 10-year operating lease. The sublease is classified as a finance lease, and the Company recognized a lease receivable of $1.2 million and a $150,000 gain upon derecognizing part of the right-of-use asset.”