Short-term lease Truck rental – a case, the question is a lease or not a lease, obtain a thorough understanding on how to assess and identify a lease in line with IFRS 16 Leases.
Customer enters into a contract with Supplier for the use of a truck for one week to transport cargo from New York to San Francisco. Supplier does not have substitution rights. Only cargo specified in the contract is permitted to be transported on this truck for the period of the contract. The contract specifies a maximum distance that the truck can be driven. Customer is able to choose the details of the journey (speed, route, rest stops, etc.) within the parameters of the contract. Customer does not have the right to continue using the truck after the specified trip is complete.
The cargo to be transported, and the timing and location of pick-up in New York and delivery in San Francisco, are specified in the contract.
Customer is responsible for driving the truck from New York to San Francisco.
The contract contains a lease of a truck. Customer has the right to use the truck for the duration of the specified trip. Because the duration of the contract is one week, this lease meets the definition of a short-term lease (see below). The term is of importance because short-term lease stay off-balance.
|The contract contains a lease of a truck. Customer has the right to use the truck for the duration of the specified trip.
There is an identified asset. The truck is explicitly specified in the contract, and Supplier does not have the right to substitute the truck.
Customer has the right to control the use of the truck throughout the period of use because:
IFRS 16 contains a practical expedient that allows a lessee the choice of keeping short-term leases ‘off-balance sheet’. Many entities are taking advantage of this practical expedient; however, entities may tend to have a ‘once short-term, always short-term’ mentality. In other words, once a lease is classified as a short-term lease, it tends to fall off management’s radar and subsequent changes thereto that might result in its failing the short-term lease definition are often overlooked. Short-term lease Truck rental
Exercising an extension option
When a lease contains an extension option that is exercisable by the lessee, the lease term can change if there are changes to the reasonable certainty of exercise of the option (IFRS 16 20) or upon actual exercise of the option if it was not previously included in the determination of the lease term (IFRS 16 21(a)).
A lessee first assesses whether it is reasonably certain to exercise an extension option or a termination option on the commencement date of the lease. A lessee revisits the ‘reasonably certain’ assessment only upon the occurrence of a significant event or a significant change in circumstances that: Short-term lease Truck rental
- is within the control of the lessee; and Short-term lease Truck rental
- affects its previous assessment of the lease term.
‘Reasonable certainty’ is a high hurdle and its assessment may require significant judgement in some cases. Entities are encouraged to consult their auditors and accounting advisors in such cases.
When there is a change in the lease term of a short-term lease, the lease is accounted for as a new lease on the date of the change (IFRS 16 7(b)). This means the lessee must assess the lease term of the new lease on the date of change.
Lessee has a short-term lease that runs from 1 January 2019 to 31 December 2019 with an option to extend the lease for one year to 31 December 2020. On the commencement date of the lease (1 January 2019), Lessee is not reasonably certain to exercise the extension option. The lease term is therefore only 12 months and the lease meets the definition of a short-term lease.
On 1 October 2019, Lessee exercises the option to extend the lease.
Lessee elects to apply the short-term lease recognition exemption in accordance with IFRS 16 5 to all short-term leases.
Since the original lease is a short-term lease to which Lessee has elected to apply the short-term lease exemption, IFRS 16.6-8 applies. In accordance with IFRS 16.7(b), the lease is considered a new lease if there is a change in the lease term. There is a change in the lease term on 1 October 2019 because
Lessee exercises an extension option that was not previously included in the determination of the lease term. Consequently, the new lease for the purposes of IFRS 16.7(b) has a commencement date of 1 October 2019 and a lease term of 15 months, thus it does not meet the definition of a short-term lease.
As such, Lessee should recognise a RoU asset and a lease liability for the new 15-month lease on 1 October 2019. The RoU asset and the lease liability will appear in the 2019 annual financial statements. Short-term lease Truck rental
Conclusion: the lease is a short-term lease and stays off-balance sheet from 1 January 2019 to 30 September 2019; it fails the short-term lease definition from 1 October 2019 and is recognised on-balance sheet from that date. Short-term lease Truck rental
Short-term lease Truck rental
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