Restaurant leases

How does IFRS 16 apply to restaurant leases?

For each leased site, the restaurant group recognises a lease liability at the present value of the fixed payments over the lease term, discounted at the rate implicit in the lease or, more often, its incremental borrowing rate, and a right-of-use asset at the same amount adjusted for incentives, initial direct costs and the estimated cost of restoring the site. Periods covered by extension options are included if the group is reasonably certain to use them, which depends on factors such as the investment in the fit-out and the site's trading. Kitchen equipment and delivery vehicles are leased too, though low-value items can use the IFRS 16 exemption. See lessee accounting and hospitality accounting.

How are turnover rent and concession guarantees treated?

Many restaurant leases charge a percentage of sales, sometimes on top of a fixed rent. Payments that vary with sales are not included in the lease liability; they are expensed in the period the sales occur. Airport, railway and motorway concessions commonly charge the higher of a minimum annual guarantee and a percentage of sales: the guarantee is an in-substance fixed payment, included in the liability, and only the excess is variable. For example, a concession with a guarantee of US$ 300 thousand and a rent of 10% of sales of 3,600 thousand includes 300 thousand a year in the liability and expenses the 60 thousand excess. See retail store leases.

Restaurant leases: a franchisor's sublease

A restaurant franchisor leases a site for 20 years at US$ 100 thousand a year, paid annually in arrears, with an incremental borrowing rate of 6%. On the same day, it subleases the whole site to a franchisee for the full 20 years at 140 thousand a year. The rate implicit in the sublease cannot be readily determined, so IFRS 16 allows the franchisor to use the discount rate of the head lease.

The head lease gives a lease liability and right-of-use asset of 1,147.0 thousand. Because the sublease covers the whole remaining term of the head lease, it transfers substantially all the risks and rewards of the right-of-use asset, so it is a finance sublease. The franchisor derecognises the right-of-use asset and recognises a net investment in the sublease of 1,605.8 thousand, the present value of the sublease payments, with the 458.8 thousand difference as a gain. It keeps the head lease liability. In the first year it recognises interest income of 96.3 thousand on the net investment and interest expense of 68.8 thousand on the liability, rather than rental income and depreciation.

What if the sublease is shorter?

If the franchisee subleases the site for only part of the head lease term, for example 10 of the 20 years, the sublease usually does not transfer substantially all the risks and rewards of the right-of-use asset, so it is an operating sublease. The franchisor keeps the right-of-use asset, depreciates it, recognises interest on the liability, and recognises the sublease rent as income on a straight-line basis. Where the franchise agreement combines the sublease with the brand licence, the franchisor also allocates the consideration between the lease and the franchise fees. See lessor accounting and franchise fees.

How are drive-thrus on leased land treated?

Restaurant chains often lease land and build their own drive-thru restaurant on it. The land lease is a lease under IFRS 16, while the building is the chain's own property, plant and equipment, depreciated over the shorter of its useful life and the lease term, including extension periods that are reasonably certain. The obligation to remove the building at the end of the lease, if any, is a provision included in the cost of the building.

What happens when a restaurant closes?

Closing a restaurant is an indication that its right-of-use asset may be impaired, and the asset is tested as part of the restaurant's cash-generating unit. If the site is vacated but the lease continues, the group may sublease it, recognising income, or hold an asset with little remaining value. Costs of closing that are not part of the lease, such as fixed service charges for an empty unit, may be onerous contract provisions under IAS 37. See hotel impairment for a similar test for hotels.

How does US GAAP differ?

Under ASC 842, a sublease is classified by reference to the underlying property, not the right-of-use asset. A 20-year sublease of a building with a long economic life is therefore usually an operating sublease, so a US franchisor keeps the right-of-use asset, recognises a single straight-line lease cost for an operating head lease, and reports franchisee rents as revenue. That is why large US restaurant franchisors show substantial rental income from franchisees. Turnover rent and minimum guarantees are treated in the same way as under IFRS 16. See ASC 842 leases.

This guide is general information. It is not tax or legal advice for your situation.