Accounting of a temporary transfer (loan) without any call-back option under IFRS: Brahim Diaz (Real Madrid and AC Milan)

Brahim Diaz's name was in the news in the previous weeks due to the player's return to Real Madrid, after a couple of seasons playing for AC Milan. For those who do not know him, Brahim is a technically gifted Spanish attacking midfielder with excellent dribbling, vision, and creativity. At the age of 23, he has already played for three of the top clubs in Europe: Manchester City, Real Madrid and AC Milan. And I am proud to say that I am one of the first few hundreds of people outside Andalucia to have seen Brahim's talent. In Easter 2011, my dad and I went to watch the final of the Mediterranean International Cup (MIC) for under-12 players in my hometown, Palamós. Malaga played against Athletic Club, and the Andalusians won 4-1. There was a super talented player, Malaga's number 10, who was much better than everyone else. You could tell he was going to make it big. His name was Brahim. Brahim Diaz.

While attending the match at the stadium, we heard rumors that he might join either FC Barcelona or Real Madrid. However, to our surprise, the president of Malaga offered the player more favorable conditions, leading Brahim to remain in Andalucia until 2015. It was at that time when Manchester City secured the signing of the player, in exchange of 200,000 pounds plus variable fees. The following year, he made his debut with Manchester City's senior team, and after a couple of seasons, he played his first Champions League match. Despite his talent, he didn't receive many opportunities in a team filled with renowned players. Consequently, he made the decision to transfer to Real Madrid before his contract expired, in January 2019, in exchange of a fee of 17 million euros.

However, his playing time remained limited at Real Madrid, causing an agreement between the Spanish club and AC Milan for a one-season loan. 

Following the conclusion of the initial loan, AC Milan expressed their desire to retain the services of the Spanish player for an extended period. Consequently, Real Madrid agreed to a second loan for two additional seasons in exchange for a total of 4 million euros for both years. In addition, AC Milan was responsible for covering the player's salary for both years. As a result, Brahim Diaz was set to play with the Italian team for the 2021/2022 and 2022/2023 seasons.

As far as we know, Madrid did not keep a call back option. Additionally, AC Milan did not have a option to permanently purchase the player at the end of the loan. At the time of the second loan, Brahim's market value (according to Transfermarkt) was about 15 million euros, and his contract with Real Madrid expired in 2025.

In this case, we're discussing a temporary transfer in football, which is informally called a loan. When a player is loaned, their registration rights are temporarily transferred to another club for a fixed period. Think of it like your landlord leasing his/her apartment to you for two years in exchange for rent price. Similarly, Real Madrid loans out a player like Brahim to AC Milan for a couple of years in exchange for a fee. These operations align with the concept of lease, and therefore we should refer to IFRS 16 - Leases. 

How should AC Milan and Real Madrid record the operation in their books?

Accounting for AC Milan (lessee)

According to IFRS 16 - Leases, player's registration rights are not part of the exemption from the standard, as stated in paragraph 3. The only type of intangible assets that are exempt of the application of the standard are rights held by a lessee under licensing agreements. However, as a lessee of an intangible asset, AC Milan has the option to choose not to apply lease accounting to this contract, as permitted by paragraph 4 of IFRS 16.

Therefore, the accounting treatment of the operation would vary depending on whether AC Milan chooses to adopt IFRS 16 or not. In the event that the club decides to implement IFRS 16, the recording of the transaction will differ based on whether it makes the payment for the two-year loan in advance on the day of signing or if it pays in two installments.

If AC Milan applies IFRS 16 - Loan amount paid at signing day

When applying IFRS 16, AC Milan should register 4 million euros as a right-of-use asset at initial recognition and subsequently amortize this amount over the two year contract. No liability needs to be recorded, since AC Milan is paying for its two-year loan fees upfront. 

The amount should be amortized over the two-years, as follows:

As you can see, this does not varies from the accounting of a permanent transfer, except for the name of the asset ("right-of-use asset" instead of "intangible asset", and some disclosure requirements).

If AC Milan applies IFRS 16 - Loan amount paid in two installments

In this scenario, let's suppose that AC Milan pays the loan fee in two installments: one at signing day and one at the beginning of the second season of the loan. The main difference with respect to the previous case is that half of the fee is not paid on the signing day, so a lease liability is generated. 

In this case, AC Milan should also register the right-of use asset at cost. This cost of the right-of-use asset shall be comprised of the amount of the initial measurement of the lease liability, plus any lease payments made at or before the commencement date, and other amounts that are not relevant in this example. 

When applying IFRS 16, AC Milan should recognize the lease liability at the present value of the lease payments that are not paid at the initial recognition date. To calculate this present value, AC Milan should discount the lease payments using either the interest rate implicit in the lease (if determinable) or the lessee's incremental borrowing rate.

Before starting playing with numbers, let's summarize all the journal entries that we expect during the Brahim's loan period:

• Initial recognition:
• amount of the right-of-use asset, against:
• Cash, for the amount paid at the signing day
• and lease liability, calculated as present value of the future lease payments
• Subsequent measurement:
• Amortization expense of the right-of-use asset, and accumulated amortization
• Interest expense of the lease liability
• and payment of the lease liability.

Let's discount the lease payments to obtain the amount to be initially recognized, assuming that the AC Milan's incremental borrowing rate is 3%.

The amount to be initially recognized as a right-of-use is 3,941,747.57 euros, 2,000,000 euros are paid at the signing day and 1,941,747.57 corresponds to the amount to be paid after one year, before the start of Brahim's second season. See journal entry:

Next step is construct the lease amortization schedule:

As we can see, the lease generates an interest expense of 58,252.43 euros, which is the difference between the present value of the lease payments and the actual payment. At the end of the first season, the outstanding amount is 0 and, as a consequence, during the second season no interest expense will be registered in the income statement.

Next step is to calculate the amortization expense. The monthly amortization expense will be 164,239 euros (3,941,747 euros divided by 24 months).

See below all the journal entries that have to be recorded from the commencement date to the end of the loan:

If we examine the total of the amortization expense and interest expense, it amounts to 4,000,000 euros. This means that whether you pay the entire loan amount on the signing day or in installments, there is no difference in the impact on the income statement. The only difference is that in case of paying in installments, the expense is divided between the amortization and interest components.

If AC Milan does not apply IFRS 16

As we mentioned above, AC Milan has the option not to register Brahim's loan using IFRS 16. How should the club register the operation in this case?

In this case, AC Milan should account the transaction using IAS 38 - Intangible Assets. Therefore, the Italian club should recognize the 4,000,000 euros cost as an intangible asset, and this amount would be amortized over the two years (that is, the loan term). At the end of the loan, Milan should derecognize the asset. 

Here you have the journal entries to be registered, considering that the loan fee is paid upfront:

Accounting for Real Madrid (lessor)

The accounting treatment for lessors is a bit different according to IFRS 16.

First of all, Real Madrid, as a lessor, should determine if Brahim's loan is a finance lease or operating lease. According to the standard, a lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset. And a lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset. If the temporary transfer is classified as a finance lease, Real Madrid should reclassify his asset as a receivable, valued at the net investment in the lease. If it classifies it as a operating lease, it should recognize income on a straight-line basis or another systematic basis.

Now we are left with the question of whether the loan of Brahim from Real Madrid to AC Milan is a financial or operating lease. Based on IFRS 16.63, I consider that Brahim's loan should not be considered a financial lease and, as a consequence, should be classified as an operating lease, due to the following:

• the lease does not transfer ownership of Brahim's registration rights to AC Milan by the end of the loan term.
• the lessee does not grant to AC Milan any option to purchase the Brahim's registration rights.
• Expiration of Brahim's contract with Real Madrid was on June 2025. Loan to Milan was until June 2023. Therefore, the loan term is not for the major part of the economic life of Brahim's rights.

Take into account that, unlike the lessees, the lessors have the obligation to record their leases using IFRS 16. 

In this case, we agreed that Brahim's loan to Milan is an operating lease. As a consequence, Real Madrid should continue to recognize its intangible asset, which should continue to be amortized. On the other hand, it should register a lease income on a straight-line basis over the lease term. The payments received in advance are a credit to deferred income.

Find below the journal entries to be registered by Real Madrid during the first year of the loan. For determining the amounts we will be taking into account the following:

• Considering that Brahim Diaz was acquired from Manchester City in January 2019  in exchange of 17 million euros with a six-and-a-half year contract. His annual amortization is 2,615,384 euros.
• Loan fee of 4,000,000 is paid by AC Milan in one installment, at signing date.

As a consequence of the loan, the impact of Brahim in Real Madrid's income statement would be an expense of 615,384 euros, instead of the 2.6M expense that the club should have had if Brahim had stayed in Real Madrid.

In case that Brahim's loan were considered a financial lease (which is not), Real Madrid should account for finance leases by initially derecognizing the asset and recognizing a receivable for the net investment in the lease.

We've come to the end of the article, and I know it's been a bit longer than usual! Now, why not take a moment to relax and enjoy watching the highlights of a young Brahim during his time with Malaga? Enjoy!

This article is part of the series Accounting Treatment of Football Transfers under IFRS. Click here to access the rest of the articles.