IFRS 16 Leases and joint arrangements – Entities often enter into joint arrangements with other entities for certain activities (e.g., exploration of oil and gas fields, development of pharmaceutical products).
A contract for the use of an asset by a joint arrangement might be entered into in a number of different ways, including:
- Directly by the joint arrangement, if the joint arrangement has its own legal identity IFRS 16 Leases and joint arrangements
- By each of the parties to the joint arrangement (i.e., the lead operator and the other parties, commonly referred to as the non-operators) individually signing the same arrangement
- By one or more of the parties to the joint arrangement on behalf of the joint arrangement. Generally, this would be evidenced in the contract and the parties to the joint arrangement would have similar rights and obligations as they would if they individually signed the arrangement. In these situations, the facts and circumstances, as well as the legal position of each entity, need to be evaluated carefully
- By the lead operator of the joint arrangement in its own name, i.e., as principal. This may occur when the lead operator leases equipment which it then uses in fulfilling its obligations as the lead operator of the joint arrangement and/or across a range of unrelated activities, including other joint arrangements with unrelated activities, such as with other joint operating parties
A contract to receive goods or services may be entered into by a joint arrangement or on behalf of a joint arrangement, as defined by IFRS 11 Joint Arrangements. In this case, the joint arrangement is considered to be the customer in the contract. Accordingly, in determining whether such a contract contains a lease, an assessment needs to be made as to which party (e.g., the joint arrangement or the lead operator) has the right to control the use of an identified asset throughout the period of use. IFRS 16 Leases and joint arrangements
If the parties to the joint arrangement collectively have the right to control the use of an identified asset throughout the period of use as a result of their collective control of the operation, the joint arrangement is the customer to the contract that may contain a lease. IFRS 16 Leases and joint arrangements
It would be inappropriate to conclude that the contract does not contain a lease on the grounds that each of the parties to the joint arrangement either has rights to a non-physically distinct portion of an underlying asset and, therefore, does not have the right to substantially all of the economic benefits from the use of that underlying asset or does not unilaterally direct its use.
Determining if the parties to the joint arrangement collectively have the right to control the use of an identified asset throughout the period of use would require a careful analysis of the rights and obligations of each party.
In the scenarios 1, 2, and 3 above, if it has been determined that a contract is, or contains, a lease, each of the parties to the joint arrangement (i.e., the joint operators comprising the lead operator and the non-operators) will account for their respective interests in the joint arrangement (including any leases) under paragraphs 20-23 of IFRS 11. Therefore, they will account for their individual share of any right-of-use assets and lease liabilities, and associated depreciation and interest. IFRS 16 Leases and joint arrangements
In scenario 4 (i.e., where the lead operator enters the arrangement in its own name), the lead operator will need to assess whether the arrangement is, or contains, a lease. If the lead operator controls the use of the identified asset, it would recognise the entire right-of-use asset and lease liability on its balance sheet. This would be the case even if it is entitled to bill the non-operator parties their proportionate share of the costs under the joint operating agreement.
If the lead operator determines that it is the lessee, it would also evaluate whether it has entered into a sublease with the joint arrangement (as the customer to the sublease). For example, the lead operator may enter into a five-year equipment lease with a supplier, but may then enter into a two-year arrangement with one of its joint arrangements, thereby yielding control of the right to use the equipment to the joint arrangement during the two-year period.
In many cases, the lead operator will not meet the requirements to recognise a sublease because the arrangement does not create legally enforceable rights and obligations that convey the right to control the use of the asset to the joint arrangement. However, the conclusion as to whether the joint arrangement is a customer, i.e., the lessee in a contract with a lead operator, by virtue of the joint operating agreement, would be impacted by the individual facts and circumstances. IFRS 16 Leases and joint arrangements
If there is a sublease with the lead operator, IFRS 11 would require the non-operators to recognise their respective share of the joint arrangement’s right-of-use asset and lease liability and the lead operator would have to account for its sublease to the joint arrangement separately. However, if no sublease existed, the non-operators would recognise joint interest payables when incurred for their share of the costs incurred by the lead operator in respect of the leased asset. IFRS 16 Leases and joint arrangements
In limited cases, the lead operator and non-operators will enter into a contract directly with the supplier, in which the lead operator and non-operators are proportionately liable for their share of the arrangement. In this case, the parties with interests in the joint operation would recognise their proportionate share of the leased asset, liability and lease expense in accordance with IFRS 11.
There has been, and continues to be, considerable debate as to how the term “on behalf of the joint arrangement” should be interpreted and applied in practice. In September 2018, the IFRS Interpretations Committee (IFRS IC) discussed the fact pattern that one of the joint operators (the lead operator) in an unincorporated joint arrangement (i.e., a joint operation), enters into a lease contract as the sole signatory with a third-party lessor on an item of property, plant and equipment that will be operated jointly as part of the joint operating agreement. IFRS 16 Leases and joint arrangements
In addition, the lead operator has the right to recover a share of the lease costs from the other joint operators in accordance with the contractual arrangement to the joint operation. The submitter asked if the lead operator should recognise in full the lease liability for the lease contract, of which the lead operator alone has the primary obligation to make payment to the lessor.
The staff noted that paragraph B11 of IFRS 16 was developed by the Board to apply only when assessing whether a contract contains a lease, and has no further effect on the required accounting for the lease or the joint arrangement.
In the tentative agenda decision about the submission, the IFRIC noted that, in accordance with paragraph 20(b) of IFRS 11, a joint operator is required to recognise both (a) liabilities that it incurs in relation to its interest in the joint operation, and (b) its share of any liabilities incurred jointly with other parties to the joint arrangement. It further observed that “the liabilities that a joint operator recognises include those for which it has primary responsibility. At the time of writing, the tentative agenda decision is open for comment. IFRS 16 Leases and joint arrangements
Depending on the conclusions reached, a lead operator may observe differences in the recognition patterns in profit or loss between the head lease costs (which will have more of a front-loaded expense profile) and the income received from billing the non-operators (either through a sublease or joint interest billings). IFRS 16 Leases and joint arrangements
IFRS 16 Leases and joint arrangements
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