Separating components of a contract Summary IFRS 17 Leases – Part 2
Some contracts contain a lease coupled with an agreement to purchase or sell other goods or services (non-lease components). These non-lease components are identified and accounted for separately from the lease component. Under IFRS 16 there is a practical expedient that permits lesses to make an accounting policy election, by class of underlying asset, to account for each separate lease component of a contract and any associated non-lease components as a single lease component.
However it is also possible to separate such lease and non-lease components. For example, a contract for a car may combine a lease with maintenance services. In addition, many contracts contain two or more lease components. For example, a single contract may include leases of land, buildings and equipment.
Separate lease components Summary IFRS 17 Leases – Part 2
IFRS 16 contains requirements for determining whether a contract that contains a lease has only one lease component or a number of lease components. The identification of separate lease components in a lease contract is similar to the identification of performance obligations in a revenue contract—in both circumstances, an entity is trying to identify whether a customer or a lessee is contracting for a number of separate deliverables or contracting for one deliverable that may incorporate a number of different assets. The indicators used to see if lease components need to be separated are based on the criteria relating to IFRS 15 Revenue from contracts with customers.
A promised good or service is ‘distinct’ if both of the following criteria are met:
- the customer can benefit from the good or service either on its own or with other resources readily available to them. A readily available resource is a good or service that is sold separately (by the entity or by another entity) or that the customer has already obtained;
- it is separately identifiable from other promises in the contract (i.e. the good or service is distinct within the context of the contract).
Indicators that an entity’s promises to transfer goods or services are not separately identifiable include:
- significant integration services are provided (i.e. the entity is using the goods or services merely as inputs to produce the specific output called for in the contract);
- the goods or services significantly modify or customise other promised goods or services in the contract (or are modified by them);
- the goods or services are highly dependent on, or interrelated with, other promised goods or services in the contract.
Separating non-lease components Summary IFRS 17 Leases – Part 2
Some contracts contain a lease coupled with an agreement to purchase or sell other goods or services (non-lease components). These non-lease components are identified and accounted for separately from the lease component. Under IFRS 16 there is a practical expedient that permits lessees to make an accounting policy election, by class of underlying asset, to account for each separate lease component of a contract and any associated non-lease components as a single lease component.
Lessees that do not make an accounting policy election to use this practical expedient are required to allocate the consideration in the contract to the lease and non-lease components on a relative stand-alone price basis. If observable stand-alone prices are not readily available, tenants estimate stand-alone prices, maximising the use of observable information.
IFRS 16 is written in the context of accounting for the lease of a single asset. However, as a practical expedient to treating the unit of account as the lease of a single asset, an entity may apply IFRS 16 to a portfolio of leases with similar characteristics if the entity reasonably expects that the effects on the financial statements of applying the standard to the portfolio would not differ materiality from applying the standard to the individual lease contracts within the portfolio.
If it accounts on a portfolio basis, an entity is then able to make estimates and assumptions that reflect the size and composition of the portfolio.
Therefore, if an entity leases 1,000 vehicles under 1,000 separate contracts (i.e. each contract is for a single vehicle) it may be possible to consider the portfolio of leases as a single right to use 1,000 vehicles, rather than 1,000 rights to use a single vehicle.
It will depend on how similar the features of each contract are (such as the specification of the vehicles) and the extent to which they were entered into at or around the same time.