Recognition of a lease
To start for the first time a reporting entity has to review all contracts to see whether a specific contract is a lease only or contains a lease component.
Looking at the definition of a lease the reporting entity has to assess whether, throughout the period of use, the lessee has met the following two rights:
- the right to obtain substantially all of the economic benefits from the use of the identified asset, and Summary IFRS 16 Leases Part 1
- the right to direct the use of the identified asset. Summary IFRS 16 Leases Part 1
There may be a difference between the period of the contract and the period of right to direct the use, the contract contains a lease for the portion of the term of the contract that the customer has the right to control the use of the identified asset.
A few particularities:
- A supplier’s right to substitute an asset is substantive if two options are met (see identified asset). However in situations where the asset is located at the lessee’s premises or elsewhere away from the lessor, the cost to substitute the asset may outweigh any perceived benefit to the lessor (the second option referred to above). Therefore the chance of a substitution right being substantive, and as a result a lease not having to be accounted for as a lease by a lessee, is considered quite remote.
- An asset has to be maintained and during that period a lessee might be considered to NOT have the right to control the asset. No, a supplier’s right to substitute an asset for the purposes of repairs (if the asset is not operating properly) and maintenance (‘preventive’ repairs) or to be upgraded when a technical update becomes due or available, does not mean the lessor has a substantive right of substitution.
- If it is not readily determinable whether the supplier has substantive substitution rights, a lessee must presume that any substitution right is not substantive.
These particularities show IFRS 16 assigns a priority treatment to inclusion of assets and liabilities in the balance sheet rather then going off-balance sheet.
As per IFRS 11 Joint Arrangements, a joint arrangement is the lessee if it is the party in the lease contract. So the joint arrangement may be the party that has the right to control the use of the identified asset throughout the period of use. Summary IFRS 16 Leases Part 1
Portions of assets Summary IFRS 16 Leases Part 1
Some contracts provide the customer with the right to use a capacity portion of an asset. For example, a customer has the right to use 30 percent of a fiber optic cable’s capacity. For a capacity portion of an asset to represent an identified asset, it must represent substantially all (for example 95%) of the cable’s capacity, although it is not distinct.
Other contracts provide a customer with the exclusive right to use a specific capacity portion of an asset. Examples of physically distinct portions of assets are the floor of a multilevel office building or a pipeline lateral that connects an oil-producing property to a main pipeline system. Summary IFRS 16 Leases Part 1
A capacity portion of an asset depends on the remaining capacity of the asset to function (for example, the second floor of a building cannot function without the first floor) and represents only a portion of a larger asset (the second floor of a ten-story building represents approximately one-tenth of the building’s capacity). However, as long as the capacity portion is physically distinct, it could be an identified asset in a lease. Summary IFRS 16 Leases Part 1
Summary IFRS 16 Leases Part 1