Last update 24/11/2019
Does a contract include a lease? is a game like type of thing, walk through a few pages and you have decided whether a contract includes a lease or not.
As from 1 January 2019, the lessee is required to recognise almost all lease contracts on the balance sheet. The distinction between operating lease and finance lease has almost been vanished. The only optional exemptions are for certain short-term leases and leases of low-value assets. Does a contract include a lease
IFRS 16 defines a lease as a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.
This walk through decision model may assist in determining if a contract contains a lease within the scope of IFRS 16 Leases. Does a contract include a lease
| The first question that comes to mind in IFRS 16 is: Is there an identified asset? |
Consider the explanations in Identified asset (in short provided below), before answering the question yes or no. You will be going to the next question or come to a conclusion.
Yes / No Does a contract include a lease
| This is part of the walk through decision model that may assist in determining if a contract contains a lease within the scope of IFRS 16 Leases. |
Even if an asset is specified, a customer does not have the right to use an identified asset if, at inception of the contract, a supplier has the substantive right to substitute the asset throughout the period of use (i.e., the total period of time that an asset is used to fulfil a contract with a customer, including the sum of any non-consecutive periods of time).
A substitution right is substantive if the supplier has the practical ability to substitute alternative assets throughout the period of use and the supplier would benefit economically from exercising its right to substitute the asset. Does a contract include a lease
In many cases, it will be clear that the supplier will not benefit from the exercise of a substitution right because of the costs associated with substituting an asset. The physical location of the asset may affect the costs associated with substituting an asset. For example, if an asset is located at the customer’s premises, the cost associated with substituting it is generally higher than the cost of substituting a similar asset located at the supplier’s premises. However, simply because a supplier concludes that the cost of substitution is not significant does not automatically mean that it would economically benefit from the right of substitution. Does a contract include a lease
IDENTIFIED ASSET
An asset is identifiable if it either: Does a contract include a lease
- Is separable, i.e., is capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the entity intends to do so; or Does a contract include a lease
- Arises from binding arrangements (including rights from contracts or other legal rights), regardless of whether those rights are transferable or separable from the entity or from other rights and obligations. Does a contract include a lease
Note: Even though the definition given requires an intangible asset to be identifiable to distinguish it from goodwill, any goodwill recognised in an acquisition is an asset.
An asset is typically identified by being explicitly specified in a contract. However, an asset can also be identified by being implicitly specified at the time that the asset is made available for use by the customer. Does a contract include a lease
Implicitly specified asset
As mentioned above, under IFRS 16, an identified asset can be either implicitly or explicitly specified in a contract. Here are two examples of an implicitly identified asset in a contract.:
| Example |
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Customer X enters into a five-year contract with Supplier Y for the use of rolling stock specifically designed for Customer X. The rolling stock is designed to transport materials used in Customer X’s production process and is not suitable for use by other customers. The rolling stock is not explicitly specified in the contract, but Supplier Y owns only one rolling stock that is suitable for Customer X’s use. If the rolling stock does not operate properly, the contract requires Supplier Y to repair or replace the rolling stock. Assume that Supplier Y does not have a substantive substitution right. Refer to section 2.1.3 Substantive substitution rights. Analysis: The rolling stock is an identified asset. While the rolling stock is not explicitly specified in the contract (e.g., by serial number), it is implicitly specified because Supplier Y must use it to fulfil the contract. |
| Implicitly specified at the time the asset is made available for use by the customer |
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Customer X enters into a five-year contract with Supplier Y for the use of a car. The specification of the car is specified in the contract (brand, type, colour, options etc.). At inception of the contract the car is not yet built. Analysis: The car is an identified asset. Although the car cannot be identified at inception of the contract, it is apparent that it will be identifiable at the commencement of the lease. The car is identified by being implicitly specified at the time that it is made available for use by the customer (i.e., at the commencement date). |
See also: The IFRS Foundation