Lease identification in Business

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Identifying a lease It is usually straightforward to identify a leasing contract. However, some contracts might not have the legal form of a lease but still might convey a right to use an asset in return for a payment or series of payments.

Such contracts (either in whole or in part) are subject to the rules in IFRS 16. Examples of such contracts might include:  certain outsourcing arrangements;  arrangements in the telecommunications industry where suppliers of network capacity sell rights to capacity

The issues addressed by IFRS 16 are as follows:  how to determine whether an arrangement is (or contains) a lease as defined; and

 if an arrangement is (or contains) a lease, how the payments for the lease should be separated from payments for any other elements in the arrangement. Existence of a lease

A contract that gives the lessee the right to control the use of an identified asset for a period of time in exchange for consideration is (or contains) a lease. A period of time may be described in terms of usage.

For example, a contract might allow for the use of a vehicle for 20,000 km. A contract conveys the right to control the use of an identified asset

 

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All well said, it will be better done, when a customer has both of the following:

 the right to obtain substantially all of the economic benefits from use of the identified asset; and

 the right to direct the use of the identified asset. This assessment of whether the contract is (or contains a lease is made at the made at the inception of the contract and this is only reassessed if the terms and conditions of the contract are changed.

Identified asset The determination of whether a contract is (or contains) a lease is based on the substance of the arrangement.

This requires an assessment of whether:  fulfilment of the contract depends on the use of a specific asset(s);

 

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 whether the supplier could use another asset to fulfil his obligation the arrangement does not contain a lease.

An asset might be specified explicitly in a contract or specified implicitly at the time that it is made available for use by the customer.

If a supplier has a substantive right to substitute the asset throughout the period of use, the customer does not have the right to use an identified asset. Such a right is substantive when the supplier:

 has the practical ability to substitute alternative assets throughout the period of use; and  would benefit economically from the exercise this right

 

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The evaluation of whether a supplier’s substitution right is substantive is based on facts and circumstances at inception of the contract.

The evaluation must exclude consideration of future events are not considered likely to occur. A right to substitute an asset after a particular event or date is not a substantive right as the lessee would have the use of an identified asset up until that event or date.

If a contract allows the supplier to provide a substitute asset in the event of the original asset needing to be repaired, the supplier does not have a substantive right of substitution.