IFRS 16 Right To Direct The Use Of The Identified Asset – FAQ | IFRS

IFRS 16 Right to direct the use of the identified asset

[IFRS 16 B24] IFRS 16 Right to direct the use of the identified asset 

Requiring a customer to have the right to direct the use of an identified asset is a change from IFRIC 4. A contract may have met IFRIC 4’s control criterion if, for example, the customer obtained substantially all of the output of an underlying asset and met certain price-per-unit-of-output criteria even though the customer did not have the right to direct the use of the identified asset as contemplated by IFRS 16. Under IFRS 16, such arrangements would no longer be considered leases.

A customer has the right to direct the use of an identified asset throughout the period of use when either: IFRS 16 Right to direct the use of the identified asset 

  • The customer has the right to direct how and for what purpose the asset is used throughout the period of use. IFRS 16 Right to direct the use of the identified asset 

  • The relevant decisions about how and for what purpose an asset is used are predetermined and the customer either: (1) has the right to operate the asset, or to direct others to operate the asset in a manner that it determines, throughout the period of use, without the supplier having the right to change those operating instructions; or (2) designed the asset, or specific aspects of the asset, in a way that predetermines how and for what purpose the asset will be used throughout the period of use.

The right to direct how and for what purpose an asset is used throughout the period of use

[IFRS 16 B25 – B27] IFRS 16 Right to direct the use of the identified asset 

A customer has the right to direct the use of an identified asset whenever it has the right to direct how and for what purpose the asset is used throughout the period of use (i.e., it can change how and for what purpose the asset is used throughout the period of use). How and for what purpose an asset is used is a single concept (i.e., ‘how’ an asset is used is not assessed separately from ‘for what purpose’ an asset is used).

When evaluating whether a customer has the right to change how and for what purpose the asset is used throughout the period of use, the focus should be on whether the customer has the decision-making rights that will most affect the economic benefits that will be derived from the use of the asset. The decision-making rights that are most relevant are likely to depend on the nature of the asset and the terms and conditions of the contract.

The IASB indicated in the Basis for Conclusions (BC120) that decisions about how and for what purpose an asset is used can be viewed as similar to the decisions made by a board of directors. Decisions made by a board of directors about the operating and financing activities of an entity are generally the most relevant decisions rather than the actions of individuals in implementing those decisions.

IFRS 16 provides the following examples of decision-making rights that grant the right to change how and for what purpose an asset is used:

  • The right to change the type of output that is produced by the asset (e.g., deciding whether to use a shipping container to transport goods or for storage, deciding on the mix of products sold from a retail unit)
  • The right to change when the output is produced (e.g., deciding when an item of machinery or a power plant will be used)
  • The right to change where the output is produced (e.g., deciding on the destination of a truck or a ship, deciding where a piece of equipment is used or deployed)
  • The right to change whether the output is produced and the quantity of that output (e.g., deciding whether to produce energy from a power plant and how much energy to produce from that power plant)

IFRS 16 also provides the following examples of decision-making rights that do not grant the right to change how and for what purpose an asset is used:

  • Maintaining the asset IFRS 16 Right to direct the use of the identified asset 
  • Operating the asset IFRS 16 Right to direct the use of the identified asset 

Although the decisions about maintaining and operating the asset are often essential to the efficient use of that asset, the right to make those decisions, in and of itself, does not result in the right to change how and for what purpose the asset is used throughout the period of use.

The customer does not need the right to operate the underlying asset to have the right to direct its use. That is, the customer may direct the use of an asset that is operated by the supplier’s personnel. However, as discussed below, the right to operate an asset will often provide the customer the right to direct the use of the asset if the relevant decisions about how and for what purpose the asset is used are predetermined.

The relevant decisions about how and for what purpose an asset is used are predetermined

In some cases, it will not be clear whether the customer has the right to direct the use of the identified asset. This could be the case when the most relevant decisions about how and for what purpose an asset is used are predetermined by contractual restrictions on the use of the asset (e.g., the decisions about the use of the asset are agreed to by the customer and the supplier in negotiating the contract, and those decisions cannot be changed). This could also be the case when the most relevant decisions about how and for what purpose an asset is used are, in effect, predetermined by the design of the asset. The IASB indicated in the Basis for Conclusions (BC121) that it would expect decisions about how and for what purpose an asset is used to be predetermined in few cases. In such cases, a customer has the right to direct the use of an identified asset throughout the period of use when the customer either:

  • Has the right to operate the asset, or direct others to operate the asset in a manner it determines, throughout the period of use without the supplier having the right to change those operating instructions
  • Designed the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset will be used throughout the period of use

Significant judgement may be required to assess whether a customer designed the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset will be used throughout the period of use. See Example 9 in IFRS 16 Leases Illustrative Examples, for an example of the evaluation of whether a customer designed the asset in a way that predetermines how and for what purpose the asset will be used throughout the period of use.

Specifying the output of an asset before the period of use

[IFRS 16 B28 – B29] IFRS 16 Right to direct the use of the identified asset 

If a customer can only specify the output from an asset before the beginning of the period of use and cannot change that output throughout the period of use, the customer does not have the right to direct the use of that asset unless it designed the asset, or specific aspects of the asset, as contemplated in paragraph B24(b)(ii) of IFRS 16. If the customer did not design the asset or aspects of it, the customer’s ability to specify the output in a contract that does not give it any other relevant decision-making rights relating to the use of the asset (e.g., the ability to change when, whether and what output is produced) gives the customer the same rights as any customer that purchases goods or services in an arrangement (i.e., a contract that does not contain a lease).

Protective rights IFRS 16 Right to direct the use of the identified asset 

[IFRS 16 B30] IFRS 16 Right to direct the use of the identified asset 

A supplier’s protective rights, in isolation, do not prevent the customer from having the right to direct the use of an identified asset. Protective rights typically define the scope of the customer’s right to use the asset without removing the customer’s right to direct the use of the asset. Protective rights are intended to protect a supplier’s interests (e.g., interests in the asset, its personnel, compliance with laws and regulations) and might take the form of a specified maximum amount of asset use, a restriction on where an asset may be used or a requirement to follow specific operating instructions.

Right to direct the use of an asset

Customer X enters into a contract with Supplier Y to use a vehicle for a three-year period. The vehicle is identified in the contract. Supplier Y cannot substitute another vehicle unless the specified vehicle is not operational (e.g., it breaks down).

Under the contract:

  • Customer X operates the vehicle (i.e., drives the vehicle) or directs others to operate the vehicle (e.g., hires a driver).

  • Customer X decides how to use the vehicle (within contractual limitations, discussed below). For example, throughout the period of use, Customer X decides where the vehicle goes, as well as when or whether it is used and what it is used for. Customer X can also change these decisions throughout the period of use.

  • Supplier Y prohibits certain uses of the vehicle (e.g., moving it overseas) and modifications to the vehicle to protect its interest in the asset.

Analysis: Customer X has the right to direct the use of the identified vehicle throughout the period of use. Customer X has the right to direct the use of the vehicle because it has the right to change how the vehicle is used, when or whether the vehicle is used, where the vehicle goes and what the vehicle is used for.

Supplier Y’s limits on certain uses for the vehicle and modifications to it are considered protective rights that define the scope of Customer X’s use of the asset, but do not affect the assessment of whether Customer X directs the use of the asset.

Leave a comment