Does a contract include a lease?

Does a contract include a lease? is a game like type of thing, walk through a few questions 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 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.

Identified assets

IFRS Reference IFRS 16 Definitions (see Identified assets), IFRS 16 9, IFRS 16 B9 – B13IFRS 16 B14 – B19, IFRS 16 B20

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

Criteria

An asset is identifiable if it either: Does a contract include a lease

  1. 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
  2. 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: Does a contract include a lease

Example

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 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

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).

Question 1 – Is there an identified asset? ……………….. Yes / No

Right to obtain substantially all of the economic benefits from use of the identified asset

IFRS Reference IFRS 16 B21 – B23 Does a contract include a lease

To control the use of an identified asset, a customer is required to have the right to obtain substantially all of the economic benefits from use of the identified asset throughout the period of use (e.g., by having exclusive use of the asset throughout that period). The term ‘substantially all’ is not defined in IFRS 16. However, entities might consider the term similarly to how it is used in IAS 17 Accounting for leases (superseded standard) in the context of lease classification.

A customer can obtain economic benefits either directly or indirectly (e.g., by using, holding or subleasing the asset). Economic benefits include the asset’s primary outputs (i.e., goods or services) and any by-products (e.g., renewable energy credits that are generated through the use of the asset), including potential cash flows derived from these items. Does a contract include a lease

Economic benefits also include benefits from using the asset that could be realised from a commercial transaction with a third party (e.g., subleasing the asset). However, economic benefits arising from construction or ownership of the identified asset (e.g., tax benefits related to excess tax depreciation and investment tax credits) are not considered economic benefits derived from the use of the asset. Therefore, they are not considered when assessing whether a customer has the right to obtain substantially all of the economic benefits. Does a contract include a lease

When assessing whether the customer has the right to obtain substantially all of the economic benefits from the use of an asset, an entity must consider the economic benefits that result from use of the asset within the defined scope of the customer’s right to use the asset.

A right that solely protects the supplier’s interest in the underlying asset (e.g., limits on the number of miles a customer can drive a supplier’s vehicle) does not, in and of itself, prevent the customer from obtaining substantially all of the economic benefits from use of the asset and, therefore, are not considered when assessing whether a customer has the right to obtain substantially all of the economic benefits. Does a contract include a lease

If a contract requires a customer to pay the supplier or another party a portion of the cash flows derived from the use of an asset as consideration (e.g., a percentage of sales from the use of retail space), those cash flows are considered to be economic benefits that the customer derives from the use of the asset.

Question 2 – Does the customer have the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use? ……………….. Yes / No

Right to direct the use of the identified asset

IFRS Reference IFRS 16 B24 Does a contract include a lease

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:

  • The customer has the right to direct how and for what purpose the asset is used throughout the period of use.
  • 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 Reference IFRS 16 B25 – B27

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 Does a contract include a lease
  • Operating the asset Does a contract include a lease

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. Does a contract include a lease

– 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 Does a contract include a lease
  • 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. Does a contract include a lease

– Specifying the output of an asset before the period of use

IFRS Reference IFRS 16 B28 – B29

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). Does a contract include a lease

– Protective rights

IFRS Reference IFRS 16 B30

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. Does a contract include a lease

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.

Example – 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.

Question 3 – Does the customer or the supplier have the right to direct how and for what purpose the identified asset is used throughout the period of use? ……………….. Customer / Supplier / Neither1 in case of Neither go to Question 4


Question 4 – Does the customer have the right to operate the asset throughout the period of use without the supplier having the right to change those operating instructions? ……………….. Yes / No


Question 5 – Did the customer design 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? ……………….. Yes / No


The contract contains a lease

What to do know: Does a contract include a lease

Identifying and separating lease and non-lease components of a contract and allocating contract consideration

IFRS Reference IFRS 16 12, IFRS 16 B32 – 33, IFRS 16 16, IFRS 16 B55 – B57 Does a contract include a lease

For contracts that contain the rights to use multiple assets (e.g., a building and equipment, multiple pieces of equipment), the right to use each asset is considered a separate lease component if both of the following criteria are met: Does a contract include a lease

  • The lessee can benefit from the use of the asset either on its own or together with other resources that are readily available to the lessee (i.e., goods or services that are sold or leased separately, by the lessor or other suppliers, or that the lessee has already obtained from the lessor or in other transactions or events).
  • The underlying asset is neither highly dependent on, nor highly interrelated with, the other underlying assets in the contract. If one or both of these criteria are not met, the right to use multiple assets is considered a single lease component. Does a contract include a lease
Example – Identifying and separating lease components

Scenario A
Assume that a lessee enters into a lease of an excavator and the related accessories (e.g., excavator attachments) that are used for mining purposes. The lessee is a local mining company that intends to use the excavator at a copper mine.

Analysis: From the perspective of the lessee, the contract contains one lease component. The lessee would be unable to benefit from the use of the excavator without also using the accessories. Therefore, the excavator is dependent upon the accessories.

Scenario B
Assume the same facts as in Scenario A, except that the contract also conveys the right to use an additional loading truck. This loading truck could be deployed by the lessee for other uses (e.g., to transport iron ores at another mine).

Analysis: From the perspective of the lessee, the contract contains two lease components: a lease of the excavator (together with the accessories) and a lease of the loading truck. Because the loading truck could be deployed for other uses independent of the excavator, the lessee can benefit from the loading truck on its own or together with other readily available resources. The lessee can also benefit from the use of the excavator on its own or together with other readily available resources.

For contracts that involve the right to use land and land improvements (e.g., buildings), IFRS 16 requires a lessor to classify and account for the right to use land as a separate lease component, unless the accounting effect of doing so is immaterial to the lease. For example, separation of the land may not be necessary when the amount that would be recognised for the land lease component is immaterial to the lease. If the lease payments cannot be allocated reliably between the land and the buildings, the entire lease is classified as a finance lease, unless it is clear that both elements are operating leases (i.e., the entire lease is classified as an operating lease).

Note – An entity that leases an entire building (i.e., 100% of the building) is inherently leasing the land underneath the building and would potentially account for the land and the building as separate lease components. However, this would not necessarily be the case when an entity only leases part of the building (e.g., one floor of a multi-storey building). Does a contract include a lease

– Identifying and separating lease from non-lease components of a contract

Many contracts contain a lease coupled with an agreement to purchase or sell other goods or services (non-lease components). The non-lease components are identified and accounted for separately from the lease component in accordance with other standards (except when a lessee applies the practical expedient as discussed in Practical expedient – lessees, below). For example, the non-lease components may be accounted for as executory arrangements by lessees (customers) or as contracts subject to IFRS 15 by lessors (suppliers). Does a contract include a lease

Some contracts contain items that do not relate to the transfer of goods or services by the lessor to the lessee (e.g., fees or other administrative costs a lessor charges a lessee). These items are not considered separate lease or non-lease components, and lessees and lessors do not allocate consideration in the contract to these items. Refer to Allocating the consideration in the contract – lessees (below) on lessee allocation of consideration in the contract and Allocating the consideration in the contract – lessors (below) on lessor allocation of consideration in the contract. Does a contract include a lease

However, if the lessor provides services (e.g., maintenance, supply of utilities) or operates the underlying asset (e.g., vessel charter, aircraft wet lease), the contract would generally contain non-lease components. Does a contract include a lease

– Lessee reimbursements

Under IFRS 16, payments for maintenance activities, including common area maintenance (e.g., cleaning the common areas of a building, removing snow from a car park for employees and customers) and other goods or services transferred to the tenant (e.g., providing utilities or rubbish removal) are considered non-lease components because they provide the lessee with a service. Does a contract include a lease

In some leases, a lessee also may reimburse (or make certain payments on behalf of) the lessor that relate to the leased asset for activities and costs that do not transfer a good or service to the lessee (e.g., payments made for real estate taxes that would be owed by the lessor regardless of whether it leased the building and regardless of who the lessee is, payments made for insurance that protects the lessor’s investment in the asset and the landlord will receive the proceeds from any claim).

Under IFRS 16, such costs are not separate components of the contract because they do not represent payments for goods or services and are considered to be part of the total consideration that is allocated to the separately identified components of the contract (i.e., the lease and non-lease components). Entities also need to evaluate whether such payments are fixed (or in-substance fixed) lease payments or variable lease payments. Does a contract include a lease

Example – Activities that are not components of a lease contract

Scenario A
A lessee enters into a three-year lease of equipment, with fixed annual payments of CU12,000. The contract itemises the fixed annual payments as follows: CU9,000 for rent, CU2,500 for maintenance and CU500 of administrative tasks.

Analysis: The contract contains two components – a lease component (lease of equipment) and a non-lease component (maintenance). The amount paid for administrative tasks does not transfer a good or service to the lessee. Therefore, the total consideration in the contract of CU36,000 will be allocated to the lease component (equipment) and the non-lease component (maintenance).

Scenario B
Assume the fact pattern as in scenario A except that, in addition, the contract requires the lessee to pay for the restoration of the equipment to its original condition.

Analysis: The contract still contains two components – a lease component (lease of equipment) and a non-lease component (maintenance). Similar to the amount paid for administrative tasks, the restoration does not transfer a good or service to the lessee as it is only performed at the end of the lease term.

Therefore, the total consideration in the contract will be allocated to the lease component (equipment) and the non-lease component (maintenance). See the link for further discussion on the inclusion of restoration costs to the initial measurement of the right-of-use asset.

– Practical expedient — lessees

IFRS Reference IFRS 16 15 Does a contract include a lease

IFRS 16 provides 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. Does a contract include a lease

IFRS 16 provides this expedient to alleviate concerns that the costs and administrative burden of allocating consideration to separate lease and non-lease components may not be justified by the benefit of more precisely reflecting the right-of-use asset and the lease liability. Does a contract include a lease

Furthermore, the Board expects the practical expedient to most often be used when the non-lease components of a contract are not significant when compared with the lease components of a contract. The practical expedient does not allow lessees to account for multiple lease components of a contract (refer to Identifying and separating lease components of a contract above) as a single lease component. Use the links to go to discussion of measurement of right-of-use assets and lease liabilities.

Although it is not explicitly stated, it seems reasonable that non-lease components also relate to services contained within the lease contract. Paragraphs BC133 and BC135 of the Basis for Conclusions to IFRS 16 refer to non-lease components being service components. Does a contract include a lease

Therefore, when a lease includes a component related to the purchase of inventory or another asset such as property, plant and equipment or an intangible asset, it is common practice that an entity should separate these asset components from other lease and non-lease components, even if it has elected to apply the practical expedient to the class of underlying asset to which the lease relates. Does a contract include a lease

For example, if a contract contains a lease as well as non-lease components related to a service and the purchase of sheet metal to be used in the construction of inventory, it is common practice that the purchase of the sheet metal should be accounted for as a component of inventory rather than together with the lease component as the purchase of a physical good is not a ‘non- lease component associated with that lease component’. Does a contract include a lease

Lessees that make the policy election to account for each separate lease component of a contract and any associated non-lease components as a single lease component allocate all of the contract consideration to the lease component. Therefore, the initial and subsequent measurement of the lease liability and right-of-use asset is higher than if the policy election was not applied. Does a contract include a lease

Determining and allocating the consideration in the contract – lessees

– Determining the consideration in the contract – Lessees

IFRS 16 does not define ‘consideration’ in a lease contract, nor is ‘consideration’ defined in the IFRS Glossary. However, we believe that the consideration in a lease contract for a lessee would include all the payments described in Lease payments as well as any fixed payments (e.g., monthly service charges) or in substance fixed payments, variable payments that depend on an index or a rate, initially measured using the index or rate at the commencement date, less any incentives paid or payable to the lessee, other than those included in lease payments. Does a contract include a lease

– Allocating the consideration in the contract – lessees

IFRS Reference IFRS 16 13 – 14  Does a contract include a lease

Lessees that do not make an accounting policy election (by class of underlying asset) to use the practical expedient (see Practical expedient — lessees above) to account for each separate lease component of a contract and any associated non-lease components as a single lease component are required to allocate the consideration in the contract to the lease and non-lease components on a relative stand-alone price basis. Does a contract include a lease

Lessees are required to use observable stand-alone prices (i.e., prices at which a customer would purchase a component of a contract separately) when available. If observable stand-alone prices are not readily available, lessees estimate stand-alone prices, maximising the use of observable information. Although a contractually stated price may be the stand-alone price for a good or service, it is not presumed to be for accounting purposes.

Example – Allocating contract consideration to lease and non-lease components – lessees
A lessee enters into a lease of equipment. The contract stipulates the lessor will perform maintenance of the leased equipment and receive consideration for that maintenance service. The contract includes the following fixed prices for the lease and non-lease component:
Lease CU80,000
Maintenance CU10,000
Total CU90,000

Assume the stand-alone prices cannot be readily observed, so the lessee makes estimates, maximising the use of observable information, of the lease and non-lease components, as follows:

Lease CU85,000
Maintenance CU15,000
Total CU100,000

Analysis: The stand-alone price for the lease component represents 85% of total estimated stand-alone prices. The lessee allocates the consideration in the contract (CU90,000), as follows:

Lease  85% of CU90,000 CU76,500
Maintenance 15% of CU90,000 CU13,500
Total (as per above first table) CU90,000

 

Determining and allocating the consideration in the contract – lessors

– Determining the consideration in the contract – lessors

As discussed in determining the consideration in the contract – Lessees above, IFRS 16 does not define ‘consideration’ in a lease contract, nor is ‘consideration’ defined in the IFRS Glossary. However, we believe that the consideration in a lease contract for a lessor would include the following:

  • Lease payments in Lease payments Does a contract include a lease
  • Any other fixed payments (e.g., monthly service charges, non-lease components such as maintenance) or in-substance fixed payments made during the lease term, less any incentives paid or payable to the lessee Does a contract include a lease
  • Any other variable payments that depend on an index or a rate made during the lease term and initially measured using the index or rate at the commencement date (refer to Commencement date of the lease) Does a contract include a lease
  • Any other variable payment amounts that would be included in the transaction price in accordance with the requirements on variable consideration in IFRS 15 that specifically relate to either of the following: Does a contract include a lease
    • The lessor’s efforts to transfer one or more goods or services that are not leases Does a contract include a lease
    • An outcome from transferring one or more goods or services that are not leases Does a contract include a lease

Variable consideration is defined broadly in IFRS 15 and can take many forms. Consideration can vary because of discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties or other similar items. It is important for lessors to appropriately identify the different types of variable consideration included in the contract because estimating variable consideration requires lessors to apply a constraint to each type of variable consideration (as per IFRS 15 regarding the forms of variable consideration, estimating variable consideration and constraining estimates of variable consideration).

– Allocating the consideration in the contract – lessors

IFRS Reference IFRS 16 17

When applying IFRS 16, lessors are required to apply IFRS 15 73–86 to allocate the consideration in the contract between the lease and non-lease components on a relative stand-alone selling price basis. In addition, lessors are required to apply IFRS 15 87-90 to allocate any subsequent changes in the consideration of the contract between the lease and non-lease components. Does a contract include a lease

The stand-alone selling price is the price at which an entity would sell a promised good or service separately to a customer. When stand-alone selling prices are not directly observable, the lessor must estimate the stand-alone selling price. IFRS 15 79 provides suitable methods for estimating the stand-alone selling price (estimating the standalone selling price and the possible estimation methods). Does a contract include a lease

Example – Identifying and separating components of a contract and determining and allocating the consideration in the contract

Lessee allocation of consideration to lease and non-lease components of a contract

Lessor leases a bulldozer, a truck and a long-reach excavator to Lessee to be used in Lessee’s mining operations for four years. Lessor also agrees to maintain each item of equipment throughout the lease term. The total consideration in the contract is CU600,000(a), payable in annual instalments of CU150,000, and a variable amount that depends on the hours of work performed in maintaining the long-reach excavator. The variable payment is capped at 2 per cent of the replacement cost of the long-reach excavator. The consideration includes the cost of maintenance services for each item of equipment.

Lessee accounts for the non-lease components (maintenance services) separately from each lease of equipment applying paragraph 12 of IFRS 16. Lessee does not elect the practical expedient in IFRS 16 15. Lessee considers the requirements in IFRS 16 B32 and concludes that the lease of the bulldozer, the lease of the truck and the lease of the long-reach excavator are each separate lease components. This is because:

  1. Lessee can benefit from use of each of the three items of equipment on its own or together with other readily available resources (for example, Lessee could readily lease or purchase an alternative truck or excavator to use in its operations); and
  2. Although Lessee is leasing all three items of equipment for one purpose (ie to engage in mining operations), the machines are neither highly dependent on, nor highly interrelated with, each other.

Lessee’s ability to derive benefit from the lease of each item of equipment is not significantly affected by its decision to lease, or not lease, the other equipment from Lessor.

Consequently, Lessee concludes that there are three lease components and three non-lease components (maintenance services) in the contract. Lessee applies the guidance in IFRS 16 13-14 to allocate the consideration in the contract to the three lease components and the non-lease components.

Several suppliers provide maintenance services for a similar bulldozer and a similar truck. Accordingly, there are observable standalone prices for the maintenance services for those two items of leased equipment. Lessee is able to establish observable stand-alone prices for the maintenance of the bulldozer and the truck of CU32,000 and CU16,000, respectively, assuming similar payment terms to those in the contract with Lessor.

The long-reach excavator is highly specialised and, accordingly, other suppliers do not lease or provide maintenance services for similar excavators. Nonetheless, Lessor provides four-year maintenance service contracts to customers that purchase similar long-reach excavators from Lessor.

The observable consideration for those four-year maintenance service contracts is a fixed amount of CU56,000, payable over four years, and a variable amount that depends on the hours of work performed in maintaining the long-reach excavator.

That variable payment is capped at 2 per cent of the replacement cost of the long-reach excavator. Consequently, Lessee estimates the stand-alone price of the maintenance services for the long-reach excavator to be CU56,000 plus any variable amounts.

Lessee is able to establish observable stand-alone prices for the leases of the bulldozer, the truck and the long-reach excavator of CU170,000, CU102,000 and CU224,000, respectively.

Lessee allocates the fixed consideration in the contract (CU600,000) to the lease and non-lease components as follows:

CU Bulldozer Truck Longreach
Excavator
Total
Lease 170,000 102,000 224,000 496,000
Non-lease 104,000
Total fixed consideration 600,000

Lessee allocates all of the variable consideration to the maintenance of the long-reach excavator, and, thus, to the non-lease components of the contract. Lessee then accounts for each lease component applying the guidance in IFRS 16, treating the allocated consideration as the lease payments for each lease component.

The contract does not contain a lease

There is no need to apply IFRS Leases to the contract. Does a contract include a lease

Does a contract include a lease?

Does a contract include a lease?

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