IFRS 16: Leases replaces the guidance currently found within IAS 17: Leases, IFRIC 4 Determining whether an Arrangement contains a Lease and SIC 27 Evaluating the Substance of Transactions in the Legal Form of a Lease.
In a majority of cases, it is not expected that the new and additional guidance in IFRS 16 will affect conclusions about whether contracts contain a lease (ie a lease applying IAS 17 is generally expected to be a lease applying IFRS 16). Contracts that are most likely to be affected are those that had previously been assessed under IFRIC 4 and where the judgement made was marginal.
The definition of a lease in IFRS 16
“A contract, or part of a contract, that conveys a right to use the asset (the underlying asset) for a period of time in exchange for consideration”.
In applying this definition, IFRS 16 sets out three criteria to be met (see table) - all three criteria must be met in order to conclude that a contract contains a lease.
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Criteria |
Commentary |
Examples |
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1. Is there an identified asset that the customer has the right to use? |
Typically, an asset will be explicitly identified in the contract. However, an asset may be implicitly specified. An asset is likely to be implicitly specified if the supplier either does not have the practical ability to substitute alternative assets during the period of use or if there are economic disincentives for the supplier to exercise its right to substitute assets. |
Explicitly specified assets may include a car where the registration, make and model are specified. Implicitly specified assets may include assets such as machinery where the lessor has a contractual right to substitute the asset during the contract but the lessor has no other comparable assets with which it could substitute the leased asset. In this scenario, there is likely to be a practical barrier which prevents the lessor exercising its ability to substitute the asset. |
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2. Does the lessee obtain substantially all the economic benefits? |
A customer may have a right to obtain substantially all the economic benefits by having exclusive use of the asset throughout the period or by having a right to sub-lease the asset. |
Where a customer enters into a contract to purchase 100% capacity of a waste recycling facility and the contract specifies that the waste must be processed at the particular facility, the customer will be obtaining substantially all the economic benefits of that facility. |
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3. Does the lessee have the right to direct use of the asset? |
An assessment must be made of who directs, how and for what purpose the asset is used throughout the contract period. Where the customer has the right to direct use, or where the use is pre-determined this criteria will be met. |
The use of the asset will be pre-determined in scenarios such as:
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Transition
IFRS 16 includes a practical expedient so that an entity is not required to reassess whether a contract is, or contains, a lease at the date of initial application. Instead, an entity is permitted to:
- Apply IFRS 16 to contracts that were previously identified as leases applying IAS 17 and IFRIC 4, and
- Not to apply IFRS 16 to contracts that were not previously identified as containing a lease applying IAS 17 and IFRIC 4.
If applied, the practical expedient must be applied to all of the entity’s contracts entered into before the date of initial application.
Separation of lease components
IFRS 16 contains guidance and a practical expedient where a contract contains both a lease and a non-lease component. We will look at this in more detail next month.
For help and advice on lease accounting please contact Richard Matthews.
See also IFRS 16 – a closer look at ‘low value’
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