Separate lease and non-lease components for real estate under IFRS 16

Separate lease and non-lease components

Many real estate leases contain multiple lease and non-lease components, which landlords need to identify and account for separately.

1 Overview

IFRS 16 requires a landlord to separate the lease and non-lease components of a contract. (IFRS 16.12, IFRS 16.BC135(b))

In practice, real estate contracts may contain:

  • one or more lease components: e.g. the right to use land and/or a building; and
  • one or more non-lease components: e.g. maintenance, cleaning and provision of utilities.

For lessors, identifying components and allocating consideration will determine the split of lease income vs revenue from contracts with customers. These amounts are often presented and have to be disclosed separately. For example, a real estate company will need to distinguish lease income from revenue for other property related services – e.g. common area maintenance (CAM). (IFRS 15.110, IFRS 15.114, IFRS 16.90)

The key steps in accounting for the components of a contract are as follows.

Identify separate lease components (go here)

Identify non-lease components (go here)

Allocate consideration (go here)

Reallocate consideration on lease modification (go here)

2 Typical lease components in real estate contracts

A landlord considers the right to use an asset as a separate lease component if it meets the following criteria:

  • the tenant can benefit from using that underlying asset either on its own or together with other resources that are readily available; and
  • the asset is neither highly dependent on nor highly inter-related with the other assets in the contract. (IFRS 16.B32–B33)

For example, there is a single lease component when a heating or air conditioning system is integrated in a building and cannot be removed and used in another building without incurring substantial costs.

However, when an office building is rented fully furnished, the office furniture is a distinct lease component if it is readily available and not integrated in the office building.

A contract with multiple leases may contain one or many separate lease components.

Typical lease components

The following cases show common scenarios that landlords may encounter when identifying and accounting for components in a real estate contract.

Case – Multiple lease components: Separation criteria met

Landlord X enters into a 15-year lease with Tenant T for five floors of a building. (IFRS 16.B32)

The floors are accessed via common lifts and stairs, but each floor has separate access controls. Each floor is equipped with necessary facilities (e.g. washrooms) to allow it to be used separately. T can sub-lease each floor without significant work.

X concludes that the right to use each individual floor is a separate lease component because:

  • T can benefit from the use of an individual floor on its own; and
  • the use of an individual floor is neither dependent on nor highly inter-related with the use of other floors in the building. T can control access to each individual floor separately. In addition, each floor can be sub-leased without significant work.

Case – Multiple lease components: Land and building: Separation criteria not met

Landlord Q leases a single-storey industrial building to Tenant T for 20 years.

T has exclusive use of the property, which includes a driveway. In addition to the explicit lease of the building, there is an implied lease of the underlying land.

Q concludes that there is a single lease component in the contract because:

  • T cannot derive any benefit from using the land without the building; and
  • the assets (i.e. building, driveway and land under the building) are highly dependent on each other.

However, if the lease contract included an adjacent piece of land that T could use for a number of different purposes (e.g. to redevelop into a garden or a car park), then there might be multiple lease components – one component for the building and underlying land, and another component for the adjacent land.

Additional considerations may apply to Q’s assessment of whether to account for the land and building elements separately – see Additional considerations for leases of land and buildings for landlords in Separating components of a contract.

Food for thought – Is identifying lease components under IFRS 16 consistent with identifying a performance obligation under IFRS 15?

Yes, in broad terms. Identifying separate lease components in a lease contract under IFRS 16 is similar to identifying performance obligations in a revenue contract under IFRS 15. (IFRS 16.BC134)

Under both standards, a company determines whether a customer or a lessee is contracting for a number of separate deliverables or for one deliverable.

Therefore, IFRS 16’s requirements on separating lease components are similar to those in IFRS 15 on the identification of performance obligations.

However, IFRS 16 does not simply cross-refer to IFRS 15. Instead, it contains guidance that is similar to, but less extensive than, that in IFRS 15. In addition,

IFRS 16 contains additional guidance for lessors on separation of the land and building elements of a lease of real estate (see Additional considerations for leases of land and buildings for landlords in Separating components of a contract). In theory, different conclusions could be reached under IFRS 15 and IFRS 16.

Case – How should a landlord interpret ‘readily available’ when applying the first criterion?

The first criterion for considering whether a right-of-use asset is a separate lease component is based on the ‘capable of being distinct’ test in IFRS 15. This test is based on the characteristics of the underlying asset itself. (IFRS 15.27(a), IFRS 15.28)

Resources are considered ‘readily available’ when they are sold or leased separately by the lessor or other suppliers, or when the lessee has already obtained them from the lessor or from other transactions or events. (IFRS 16.B32(a))

The fact that the lessor or other companies regularly lease an asset separately indicates that a customer can benefit from the lease of that asset on its own or with other readily available resources.

For a discussion of identifying a performance obligation in a revenue contract, see Identify performance obligations.

Food for thought – How should a landlord interpret ‘highly dependent or highly inter-related’ when applying the second criterion?

The second criterion for considering whether a right-of-use asset is a separate lease component is based on part of the ‘distinct in the context of the contract’ test in IFRS 15. (IFRS 15.27(b), IFRS 15.29(c))

An asset might be highly dependent on, or highly inter-related with, the other assets if the lessee could not lease the asset without significantly affecting its rights to use other assets in the contract. (IFRS 16.B32(b))

IFRS 15 provides an example of when two or more goods or services are ‘significantly affected by each other’. It states that this would be the case when the company would not be able to fulfil its promise to the customer by transferring each of the goods or services independently – i.e. the fulfilment of each promise depends on the other.

For a discussion of identifying a performance obligation in IFRS 15, see Identify performance obligations.

2.1 Additional considerations for leases of land and buildings for landlords

The general guidance on identifying separate lease components is the same for lessees and lessors. A lessor then classifies each lease component as a finance or an operating lease, based on the extent to which the lease transfers the risks and rewards incidental to ownership of the underlying assets (this guidance is not relevant to lessees). (IFRS 16.12, IFRS 16.B53)

When a lease includes both land and building elements, the lessor assesses the classification of each element separately, unless the value of the land at inception of the lease is deemed immaterial. In this case, the lessor may treat the land and building as a single unit to classify it as either a finance or an operating lease, applying the criteria in IFRS 16. (IFRS 16.B55, IFRS 16.57)

If separating the land element would have no effect on the lease classification, then the lessor does not need to separate it because the accounting impact would be insignificant. However, if the land and building elements are classified differently – e.g. operating lease for the land and finance lease for the building – then the lessor accounts for the two elements separately.

When accounting for the land and building separately, the lessor allocates lease payments between the two elements in proportion to the relative fair values of the leasehold interests in the land and building elements at the lease inception date. This is different from the general allocation requirements. (IFRS 16.B56)

If the lease payments cannot be allocated reliably between the two elements, then the entire lease is classified as a finance lease, unless both elements are clearly operating leases. (IFRS 16.B56)

Case – Classification of land and building: No separation

Landlord Q leases a single-storey industrial building to Tenant T for five years. (IFRS 16.61–63, IFRS 16.B32, IFRS 16.B55)

T has exclusive use of the property, which includes a driveway. In addition to the explicit lease of the building, there is an implied lease of the underlying land.

T and Q conclude that there is only one separate lease component in the contract because:

  • T cannot derive any benefit from using the land without the building; and
  • the assets (i.e. building, driveway and land under the building) are highly dependent on each other.

However, Q is required to assess the classification of the land and building elements separately. Q concludes that both land and building elements are clearly operating leases. This is because Q does not transfer substantially all of the risks and rewards incidental to ownership of either the land or building. Therefore, separating the land and building elements would have no effect on lease classification and would be insignificant from an accounting perspective.

Q classifies the entire lease as an operating lease.

Case – Classification of land and building: Separation required

Modifying above case Classification of land and building: No separation, Landlord Q leases the building to Tenant T for 30 years. (IFRS 16.61–63, IFRS 16.B32, IFRS 16.B55–B56)

The remaining economic life of the building at lease inception is expected to be 30 years.

T and Q again conclude that there is only one separate lease component in the contract because:

  • T cannot derive any benefit from using the land without the building; and
  • the assets (i.e. building, driveway and land under the building) are highly dependent on each other.

However, Q is required to assess the classification of the land and building elements separately.

Q concludes that:

  • the land element is classified as an operating lease; but
  • the building element is classified as a finance lease, because the lease term is for the major part of the economic life of the building.

Therefore, Q accounts for the land and building elements separately. To do this, Q allocates the lease payments between the land and building elements in proportion to the relative fair value of their respective leasehold interests.

Food for thought – Why does IFRS 16 include additional guidance on separating land and building leases for landlords?

This guidance is brought forward from IAS 17 to minimise changes to landlord accounting. However, it is inconsistent with the general guidance on separating components in a number of respects. For example, it requires separate lease classification of land and building elements even when they would be a single lease component. In addition, it requires lease payments to be allocated based on the relative fair values of the leasehold interests, rather than using the principles in IFRS 15 that landlords are required to apply in other cases. (IFRS 16.B55, IFRS 16.BC58)

Food for thought – How small does the relative value of the land element need to be in relation to the total value of the lease to avoid separation?

The test here is whether the value of the land element at inception of the lease is deemed immaterial. There is no bright-line test – e.g. no specific percentage threshold. (IFRS 16.BCZ250)

Generally, materiality as a concept is applied at the level of the financial statements. However, this test – which is brought forward from IAS 17 – typically considers the significance of the land element in relation to the lease, not the financial statements as a whole.

Food for thought – Why does the landlord allocate the lease payments between the land and building components based on the relative fair values of the respective leasehold interests?

An allocation based on the relative fair values of the land and building elements – rather than based on the relative fair values of the respective leasehold interests in the land and building elements – is not generally appropriate because the land often has an indefinite economic life and is likely to maintain its value beyond the lease term. Therefore, the landlord would not normally need compensation for ‘using up’ the land. In contrast, the future economic benefits of a building are likely to be ‘used up’ to some extent over the lease term (which is reflected via depreciation). (IFRS 16.B56, IFRS 16.BCZ245–BCZ247)

Therefore, when allocating the lease payments between the land and the building elements, it is reasonable to assume that the lease payments relating to the:

  • building element (depreciable asset) are set at a level that enables the landlord not only to make a return on its initial investment, but also to recover the part of the value of the building ‘used up’ over the lease term; and
  • land element (non-depreciable asset) (assuming a residual value that equals its value at inception of the lease) are set at a level that enables the landlord to make only a return on the initial investment.

Food for thought – How does the guidance on classification apply when a lease contract contains both land and building elements that are highly interdependent and highly inter-related?

When a lease contract contains both land and building elements, a landlord considers the specific guidance described above, notwithstanding the fact that the land and building might be highly interdependent and highly inter-related. (IFRS 16.B32, IFRS 16.B55–B57)

As mentioned above, if a lease of a building (or space in a multi-tenant property) includes a land element, then it is accounted for separately by the landlord unless it is deemed to be immaterial or separation would have no effect on the lease classification. Consequently, in such a lease the landlord determines:

  • whether the tenant obtains a right to use the land on which the building is located; and if so
  • whether the accounting for that right of use is immaterial or the classification for both components would differ.

Determining whether a lease of a building (or space in a multi-tenant property) includes a right to use the underlying land includes determining:

  • whether the land represents an identified asset; and if so
  • whether the tenant has the right to control its use.

The evaluation will depend on property law in the relevant jurisdiction. However, it will often differ for leases of single-tenant properties and leases of space in multi-tenant properties. Although leases of single-tenant properties will generally include a lease of the underlying land, leases of space in multi-tenant properties often will not.

Food for thought – Does a landlord of a multi-tenant building separate land and building lease elements?

Generally, no. When a landlord owns a high-rise apartment building and leases apartments to individual tenants, the landlord first needs to determine whether there is a lease of the underlying land. If there is not, then the landlord does not need to evaluate the separation criteria. (IFRS 16.B9, IFRS 16.B55)

In this case, the entire underlying land is an identified asset. Each tenant has only shared use of the land – i.e. no tenant has a right of use over a physically distinct portion of the underlying land.

This is similar to the conclusion under IFRS 15 that in a sale of an apartment in a multi-tenant building, the promise to transfer the apartment and the related land can be a single performance obligation.

In contrast, a lease component may exist for the land if the tenant is leasing substantially all of the building. In this case, the entire underlying land is likely to be a single, identified asset and the tenant may have the right to control its use.

If that is the case, then the landlord is required to account for it as a separate lease component unless it is immaterial or both components (i.e. the land and the building leases) would have the same classification.

3 Common area maintenance and other non-lease components

A lease contract often includes non-lease components. For example, a lease of a building often includes provision of common area maintenance (CAM) and similar services. A lessor always accounts for non-lease components separately from the lease components. (IFRS 16.12)

Only activities or costs that transfer a good or service to the lessee are identified as separate non-lease components. Examples of separate non-lease components in real estate contracts include repairs or maintenance, cleaning, landscaping, security services and management services. (IFRS 16.B33)

Food for thought – Are CAM services a non-lease component?

Yes. It is common in a real estate lease for the landlord to provide CAM services – e.g. cleaning services, common area repairs or maintenance of the building. (IFRS 16.Ex12)

It appears that CAM services are generally a separate non-lease component (or components) because they transfer a service to a tenant that is separate from the right to use the underlying asset. Therefore, they are accounted for separately from the lease components, under other applicable standards.

Food for thought – Are CAM services a single non-lease component or do they include multiple non-lease components?

A landlord assesses the goods and services promised in a contract and determines whether the series of goods and services is a single performance obligation based on the guidance in IFRS 15.

CAM may include various activities. However, to the extent that they are performed over time and a single measure of progress applies, there will be no material difference between accounting for them separately or as a single non=lease component.

However, the provision of utilities – e.g. heating, electricity and water – is distinct from CAM and is generally a separate non-lease component because it does not relate to the maintenance of the common areas. The performance of non-routine maintenance will typically be a separate performance obligation and have a different measure of progress, and therefore will be accounted for separately.

Facts and circumstances will need to be considered when assessing what activities are part of the CAM and what services need to be accounted for separately.

4 Property taxes and insurance

Amounts payable for activities and costs that do not transfer a good or service to the tenant do not give rise to a separate component. They are part of the total consideration that the landlord allocates to the lease and non-lease components identified in the contract. Common examples of activities or costs of the landlord included in real estate contracts that do not transfer a good or service to the tenant include administrative costs to initiate the lease and the tenant’s payments for administrative tasks, insurance costs and property taxes. (IFRS 16.B33)

Real estate is often subject to property taxes, calculated as a tax ‘rate’ multiplied by an assessed value of the property.

Depending on the jurisdiction, the legal obligation to pay the property tax is either levied on the property owner or on the occupier. This distinction is important in determining how to account for taxes levied on leased properties.

The identity of the party who makes the cash payment to the tax authority is less relevant.

Who has the statutory obligation to pay property tax?

Landlord

Tenant

When the landlord has a statutory obligation to pay the property taxes, the landlord accounts for the property taxes as levies under IFRIC 21 Levies.

It appears that if the owner has the statutory obligation to pay the property taxes, but the lease agreement requires it to be reimbursed, or paid, by the tenant, then the landlord should account for the reimbursement of property taxes by the tenant as part of the total consideration that is allocated to the separately identified components of the contract.

If property taxes are determined as a percentage of an ‘assessed value’ of the property, then reimbursements thereof are typically variable payments that do not depend on an index or rate – see Payments that depend on an index or rate in Lease payments. (IFRS 16 Definitions, IFRS 16.28, IFRS 16.B33)

It appears that if the statutory obligation for the payment of property taxes lies with the tenant, then the tenant should account for the property taxes under IFRIC 21.

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Case – Property taxes reimbursed by the occupier

Landlord L enters into a five-year lease for an apartment with Tenant B. The lease payments are 100,000 per year. The contract includes additional maintenance costs of 4,000 per year.

In this jurisdiction, property taxes are levied on property owners, with the annual tax calculated as 0.2% of the assessed value of the property. The tax authority determines the assessed value at irregular intervals. That value of the property for tax purposes is currently 5 million. (IFRS 16.B33)

Under the lease agreement, B is contractually obliged to reimburse the landlord for property taxes.

To determine how to account for the property taxes, L considers the following.

  • Annual lease payments of 100,000 are fixed.
  • The non-lease component for maintenance services of 4,000 is also fixed.
  • Property taxes are levied on the owner and reimbursed by B.
  • Payment of property taxes does not transfer a distinct good or service to B and therefore it is not a separate component.
  • The property taxes are variable payments that do not depend on an index or rate, because neither the tax rate (i.e. 0.2%) nor the assessed property value as determined by the tax authority (i.e. 5 million) typically represents an index or rate (see Payments that depend on an index or rate in Lease payments).

Accordingly, L allocates the variable property tax payments from B (e.g. 10,000, calculated as 0.2% of 5 million in Year 1) to the lease and non-lease components identified in the contract.

Because L has a statutory obligation to pay the property taxes, it accounts for the property taxes as levies under IFRIC 21.

Food for thought – What if the landlord and tenant are jointly liable for property tax?

In some jurisdictions, the landlord and tenant may be ‘jointly liable’ for the property taxes – i.e. both parties are equally liable to pay the full amount.

This may be the case if:

  • joint liability is specified by law; or
  • liability is initially placed on the landlord but, in the event of non-payment, there are legal mechanisms in place that allow the tax authority to demand payment from the tenant.

When both parties are jointly liable, we believe that the landlord and tenant should account for the property taxes in the same way as they would if they were solely liable for them.

Food for thought – If a tenant reimburses a landlord’s general insurance costs, then is this a non-lease component?

Generally, no. In practice, a landlord may obtain an insurance policy to cover damage to the underlying asset and a tenant reimburses the landlord’s insurance costs during the lease term. The payment could be identified separately and determined based on the landlord’s actual costs, or included in a fixed, gross payment to the landlord.

Under either payment mechanism, the insurance does not represent a service provided by the landlord to the tenant because it serves to protect and benefit the landlord, not the tenant, and therefore it is not a separate component. The payment is included in the consideration of the contract, which is allocated to the components.

5 Allocation of consideration lease and non-lease

Landlords allocate the consideration in the contract to the identified components using the allocation guidance in IFRS 15. Under that standard, consideration is allocated on a relative stand-alone selling price basis. However, when specified criteria are met a discount or variable consideration is allocated to one or more, but not all, of the performance obligations in the contract. (IFRS 16.17, IFRS 15.76, IFRS 15.81–86)

Stand-alone selling price is determined at inception of the contract and is the price at which a company would sell a promised good or service separately to a customer. It is best evidenced by the observable price of the same good or service when the company (lessor) sells (or leases) that good or service separately. A contractually stated price is not presumed to be a stand-alone selling price. (IFRS 15.76–77)

A lessor considers all information that is reasonably available when estimating a stand-alone selling price – e.g. market conditions, company-specific factors and information about the customer or class of customers. It also maximises the use of observable inputs and applies consistent methods to estimate the stand-alone selling price of other goods or services with similar characteristics. IFRS 15 does not preclude or prescribe any particular method for estimating the stand-alone selling price for a good or service when observable prices are not available, but describes the estimation methods listed in the following flowchart as possible approaches. (IFRS 15.78–79, IFRS 15.BC268)

Separate lease and non-lease components

A practical issue arises if the contract contains a renewal option covering the lease and non-lease components, because the lessor may determine that the contract period under IFRS 15 differs from the lease term under IFRS 16. The lease term as determined under IFRS 16 includes optional renewal periods over which the lessee is reasonably certain to extend, whereas the contract term under IFRS 15 includes periods during which the parties have presently enforceable rights and obligations.

In these cases, it appears that a company should allocate the consideration to each component based on the lease term as determined under IFRS 16 (see the case – Landlord allocation to lease and non-lease components based on the lease term).

Reallocation of the consideration is required on a lease modification (see Lease modifications).

A lessor allocates consideration in a contract to the separate lease and non-lease components by applying IFRS 15. Under IFRS 15, consideration is allocated on a relative stand-alone selling price basis. Stand-alone selling price is determined at inception of the contract and is the price at which a company would sell a promised good or service separately to a customer. It is best evidenced by the observable price of the same good or service when the company (lessor) sells (or leases) that good or service separately. (IFRS 16.17, IFRS 15.74–77)

Separate lease and non-lease components

Case – Landlord allocation to lease and non-lease components based on the lease term

Landlord R leases a property to Tenant T under an operating lease. Under the arrangement, R is also required to provide maintenance services for the building throughout the entire lease term.

The original contract term is five years, with a renewal option that would apply to both the lease and the maintenance for another two years. Annual payments, including maintenance, are determined at 160 for the initial five years. For the extension period, annual payments including maintenance are reduced to 150.

Therefore, if the contract runs for five years then the total consideration will be 800, whereas if the contract runs for seven years then the total consideration will be 1,100.

The stand-alone selling price of the lease without maintenance is estimated at 120 per year, and the stand-alone selling price for the maintenance is 50 per year.

At the commencement date, R and T conclude that the lease term is seven years, because it is reasonably certain that T will exercise the renewal option.

If the contract were wholly accounted for under IFRS 15, then the contract term would be five years because this is the period for which the two parties are contractually committed.

We believe that R should allocate the consideration to the lease component and maintenance services based on the lease term as determined under IFRS 16 – i.e. seven years. Therefore, R allocates the total consideration based on seven years (1,100) to the lease and non-lease components as follows.

Stand-alone selling price

%

Allocation

Building lease

120 x 7 = 840

70.59%

779

Maintenance

50 x 7 = 350

29.41%

324

1,190

1,100

Food for thought – Can a lessor elect to combine lease and non-lease components?

No – a lessor always accounts for lease and non-lease components separately. (IFRS 16.17, IFRS 16.BC135–BC136)

As a practical expedient, a lessee can elect to combine lease and associated non-lease components, and account for the combined component as a lease component. However, there is no equivalent practical expedient for lessors.

The Board believes that lessors will generally have the information required to allocate consideration between lease and non-lease components. It therefore considers that a practical expedient similar to that offered to lessees is not necessary for lessors.

Food for thought – How does a landlord estimate the stand-alone selling prices of lease and non-lease components?

The stand-alone selling price is a price that the landlord would charge a tenant for that component or a similar component. The estimation of a stand-alone selling price would reflect the economic return that a landlord would require for each separate component. (IFRS 16.14)

For example, a stand-alone selling price for a lease component would reflect compensation for the cost of the leased asset and administrative tasks, taxes and insurance that landlords would reasonably incur.

For non-lease components – e.g. cleaning services – the price would include compensation for the actual costs, an appropriate profit margin and compensation for certain administrative tasks.

Food for thought – Should the stand-alone selling price of CAM include a profit margin, even if the landlord provides CAM at a loss?

Yes. The stand-alone selling price is the price at which a company would sell a promised good or service separately to a customer. CAM is a service that would not generally result in a loss.

Food for thought – How is an observable stand-alone price for a tenant different from an observable stand-alone selling price for a landlord?

For the tenant, observable stand-alone prices include those charged not only by the landlord but also by other suppliers for the same or a similar component – e.g. the price charged for the lease of a similar property or for similar services. (IFRS 16.14, IFRS 15.77–78)

For the landlord, the definition of observable stand-alone selling price is more specific. Taken from IFRS 15, an observable stand-alone selling price is the price for which the company sells that good or service separately in similar circumstances and to similar customers.

However, applying a market assessment approach under IFRS 15 might include referring to prices from the landlord’s competitors for similar goods or services (and adjusting those prices as necessary to reflect the landlord’s costs and margins) as an acceptable technique for estimating the stand-alone selling price. Therefore, although the landlord might use similar information to the tenant, its stand-alone selling price of a component may be considered ‘estimated’, whereas the tenant’s stand-alone price may be considered ‘observable’.

Food for thought – Does the landlord need to allocate consideration when the allocation does not have an impact on income recognition?

Yes, the landlord allocates the consideration to each of the lease and non-lease components, even if there is no impact on the profile of income recognised. This is necessary for presentation and disclosure purposes – i.e. IFRS 16 requires a landlord to disclose lease income. IFRS 15 also requires a company to disclose revenue from contracts with customers separately. (IFRS 16.90, IFRS 15.110, IFRS 15.114, IFRS 15.B87–B89 )

For example, when the lease is classified as an operating lease and the non-lease component is a service satisfied over time using a time-based measure, the income from both the lease and non-lease components is recognised over the period, and the allocation does not impact the income recognised during the period. However, separate disclosure is required.

Food for thought – How does the allocation of the consideration to each component differ between landlords and tenants?

Landlords allocate the consideration in the contract to each separate lease and non-lease component, based on the relative stand-alone selling price of each component, under IFRS 15. (IFRS 16.13, IFRS 15.76)

Tenants allocate the consideration in the contract on the basis of the relative stand-alone price of each separate lease component and the aggregate stand-alone price of the non-lease components.

One of the differences is that the non-lease components are aggregated by the tenant to determine the initial allocation of amounts allocated to the lease components.

The tenant then accounts for the non-lease components within a lease contract under other applicable standards, which may have different measurement or allocation requirements.

6 Allocation of variable consideration

If the contract contains more than one component and includes both variable and fixed payments, then a question arises about how to allocate the variable payments – e.g. whether the variable payments can be allocated to one or more, but not all, of the components. This could be more relevant when the payment is dependent on the performance of, or changes in, one of the components.

Under IFRS 15, variable consideration is allocated entirely to one or more, but not all, performance obligations in the contract if the following criteria are met: (IFRS 15.84–86)

  • the terms of a variable payment relate specifically to the company’s efforts to satisfy the performance obligation; and
  • allocating the variable amount of consideration entirely to the performance obligation is consistent with the allocation objective when considering all of the performance obligations and payment terms in the contract.

This guidance applies directly to lessors.

Case – Landlord’s allocation: Variable payments allocated between all components

Landlord D enters into a property lease for five years with Tenant L, including maintenance services. L’s payments for five years comprise:

  • total fixed payments of 500 for five years (i.e. 100 per year); and
  • variable payments based on 2% of sales each year – estimated to be 100 for five years.

D concludes that the contract includes two components – the lease of a property, and the maintenance services (non-lease component). The stand-alone selling prices for both components are as follows:

  • observable stand-alone selling price for the lease: 500; and
  • estimated stand-alone selling price for the maintenance, based on the expected costs plus an appropriate margin: 200.

D allocates the total contract consideration of 600 (fixed payments of 500 and variable payments of 100) to the components as follows.

Component

Stand-alone selling price

%

Allocation of fixed consideration

Allocation of variable consideration

Lease of property

500

71.43%

357

72

Maintenance

200

28.57%

143

28

700

500

100

In this case, the variable payments based on 2% of sales each year do not represent a stand-alone selling price for the maintenance. Therefore, both fixed and variable payments are allocated to the lease and non-lease components based on the relative stand-alone selling prices for the two components.

Variable payments are recognised as income as the related sales occur for both lease and non-lease components.

In contrast, the variable lease payments would be allocated only to the non-lease component if they would represent the stand-alone selling price of the maintenance.

Case – Allocation of property taxes

Landlord D enters into a five-year lease for an apartment with Tenant B. (IFRS 16.B33)

The lease payments are 100,000 per year. The contract includes additional maintenance costs of 4,000 per year.

Under the lease agreement, B is contractually obliged to reimburse D for property taxes levied on property owners. Annual property tax is determined at 0.2% of the assessed value.

Payment of property taxes does not transfer a good or service to B and is therefore not a component. Therefore, D includes the reimbursement of property taxes in the consideration that it allocates to the lease and non-lease components identified in the contract.

D concludes that:

  • the stand-alone selling price of the lease is 100,000 per year plus reimbursement of property taxes; and
  • the stand-alone selling price of the maintenance services is a fixed payment of 4,000 per year.

D allocates 100,000 and any reimbursement of property taxes to the lease component and 4,000 to the non-lease component.

Food for thought – Can a landlord allocate costs that do not transfer a good or service to the tenant (e.g. property tax) entirely to the lease component?

(IFRS 16.17, IFRS 16.B33, IFRS 15.85)

It depends.

A real estate lease contract often requires the tenant to compensate the landlord for costs relating to the asset – e.g. property tax and insurance cost.

A question arises over whether the property tax and insurance cost can be allocated fully to the lease component when the contract also includes a non-lease component. IFRS 16 does not provide any exception to the allocation requirements, which means that the total fixed consideration (including property tax or insurance) is allocated to all identified components based on the relative stand-alone selling prices.

However, if all components in the contract are priced at stand-alone selling prices and the stand-alone selling price of the lease component includes property tax and insurance cost, then a relative stand-alone selling price basis allocation would result in these fixed payments being allocated entirely to the lease component (see the Case – Allocation of property taxes).

On the other hand, property taxes and insurance may be variable. Under IFRS 15 variable consideration is allocated to only part of the contract if the terms of a variable payment relate directly to that part of the contract and allocating the variable payment to only that part of the contract is consistent with the allocation objective.

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Separate lease and non-lease components

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