Whether a contract contains a lease

Learning objectives

• Explain that a contract contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration, and when that assessment is reconsidered.L1
• Analyse whether there is an identified asset: explicit or implicit specification, a capacity portion that is physically distinct, the supplier's substantive substitution right (practical ability and economic benefit).L2, L3
• Assess whether the customer obtains substantially all of the economic benefits and directs the use (how and for what purpose), including when decisions are predetermined or the supplier holds protective rights.L3, L4

Normative references

• IFRS 16 §9At inception of a contract, the entity assesses whether the contract is, or contains, a lease, i.e. whether it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Paragraphs B9 to B31 set out guidance on this assessment.
• IFRS 16 §10A period of time may be described in terms of the amount of use of an identified asset, for example the number of production units that an item of equipment will be used to produce.
• IFRS 16 §11The entity reassesses whether a contract is, or contains, a lease only if the terms and conditions of the contract are changed.
• IFRS 16 §B9To assess whether a contract conveys the right to control the use of an identified asset for a period of time, the entity assesses whether, throughout the period of use, the customer has both the right to obtain substantially all of the economic benefits from use of the asset and the right to direct its use.
• IFRS 16 §B10If the customer has the right to control the use of an identified asset for only a portion of the term of the contract, the contract contains a lease for that portion of the term.
• IFRS 16 §B11Where a contract to receive goods or services is entered into by or on behalf of a joint arrangement within the meaning of IFRS 11, the joint arrangement is considered to be the customer; the assessment of whether the contract contains a lease therefore focuses on the control exercised by the joint arrangement throughout the period of use.
• IFRS 16 §B12The entity assesses whether a contract contains a lease for each potential separate lease component, referring to paragraph B32 for guidance on identifying those components.
• IFRS 16 §B13An asset is typically identified by being explicitly specified in a contract, but it can also be identified implicitly at the time that it is made available for use by the customer.
• IFRS 16 §B14Even if an asset is specified, the customer does not have the right to use an identified asset if the supplier has a substantive right to substitute the asset throughout the period of use. That right is substantive if the supplier has the practical ability to substitute alternative assets (the customer cannot prevent it and alternative assets are readily available or could be sourced within a reasonable period of time) and would benefit economically from the substitution.
• IFRS 16 §B15A right or obligation to substitute that can be exercised only on or after a particular date or the occurrence of a specified event is not substantive, because the supplier does not have the practical ability to substitute throughout the period of use.
• IFRS 16 §B16Whether the substitution right is substantive is assessed on the basis of facts and circumstances at inception of the contract, excluding future events that are not considered likely to occur at that time, for example a future customer willing to pay an above-market rate or a technology not yet substantially developed.
• IFRS 16 §B17If the asset is located at the customer's premises or elsewhere, the costs associated with substitution are generally higher than when located at the supplier's premises, and are therefore more likely to exceed the benefits of substitution.
• IFRS 16 §B18The supplier's right or obligation to substitute the asset for repairs or maintenance, if the asset is not operating properly or if a technical upgrade becomes available, does not preclude the customer from having the right to use an identified asset.
• IFRS 16 §B19If the customer cannot readily determine whether the supplier has a substantive substitution right, it presumes that any substitution right is not substantive.
• IFRS 16 §B20A capacity portion of an asset that is physically distinct, such as a floor of a building, can be an identified asset. A capacity portion that is not physically distinct, such as a portion of the capacity of a fibre optic cable, is not an identified asset, unless it represents substantially all of the capacity of the asset.
• IFRS 16 §B21The customer must have the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use, for example by having exclusive use of it. Those benefits, obtained directly or indirectly (using, holding or subleasing the asset), include its primary output, by-products (including potential cash flows derived from them) and other economic benefits that could be realised from a commercial transaction with a third party.
• IFRS 16 §B22The assessment considers the economic benefits within the defined scope of the customer's right to use the asset: if the use of a vehicle is restricted to a territory or a mileage, only the benefits from use within those limits are considered.
• IFRS 16 §B23If the customer is required to pay the supplier or another party a portion of the cash flows derived from use of the asset as consideration, those cash flows are part of the economic benefits it obtains; a rent calculated as a percentage of sales from a retail unit therefore does not prevent the customer from obtaining substantially all of the economic benefits.
• IFRS 16 §B24The customer has the right to direct the use of an identified asset only if it can direct how and for what purpose the asset is used throughout the period of use or, if those relevant decisions are predetermined, it has the right to operate the asset (or to direct others to operate it in a manner it determines) without the supplier having the right to change those operating instructions, or it designed the asset or specific aspects of it in a way that predetermines how it will be used.
• IFRS 16 §B25The customer directs how and for what purpose the asset is used if, within the scope of its right of use defined in the contract, it can change them throughout the period of use. The relevant decision-making rights are those that affect the economic benefits derived from use; they differ depending on the nature of the asset and the terms of the contract.
• IFRS 16 §B26Depending on the circumstances, rights to change how and for what purpose the asset is used include: the right to change the type of output produced, when the output is produced, where it is produced, and whether it is produced and the quantity of that output.
• IFRS 16 §B27Rights that are limited to operating or maintaining the asset, although often essential to its efficient use, are not rights to direct how and for what purpose the asset is used and are often dependent on those decisions.
• IFRS 16 §B28The relevant decisions about how and for what purpose the asset is used can be predetermined in a number of ways, for example by the design of the asset or by contractual restrictions on its use.
• IFRS 16 §B29In assessing the right to direct the use, the entity considers only rights to make decisions about the use of the asset during the period of use, unless the customer designed the asset or specific aspects of it as described in B24(b)(ii).
• IFRS 16 §B30Terms intended to protect the supplier's interest in the asset, its personnel or its compliance with laws and regulations are protective rights: they typically define the scope of the customer's right of use but do not, in isolation, prevent the customer from having the right to direct the use of the asset within that scope.
• IFRS 16 §B31A flowchart helps determine whether a contract is, or contains, a lease, by sequencing the questions on the identified asset (B13 to B20), the right to obtain substantially all of the economic benefits (B21 to B23) and the right to direct the use (B24 to B30).

Original summaries of the paragraphs (reference register), never a quotation of the standard.

24 questions

• The inception date of the lease is the date on which the lessee recognises the right-of-use asset and the lease liability.L1
• Which of the following operations take place at the commencement date of the lease, and not at the inception date? (several answers)L2
• True or false? At the inception date of a logistics services contract, Orvalis must assess whether the contract is, or contains, a lease. This is the case if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration.L1
• True or false? Brevane has established that a supply contract does not contain a lease. It must reconsider this conclusion at each reporting date, even if the terms and conditions of the contract have not been changed.L1
• Kelmor makes a specified press available to Alvane for the manufacture of 200,000 parts, without setting a calendar duration. How does the notion of a period of time apply to the analysis of a possible lease?L1
• Ternis enters into a contract with a supplier for a storage tank, with no serial number or other specification. On the day it is put into service, the supplier installs a particular tank in the Ternis plant; the contract gives the supplier no right to replace it. Does Ternis have an identified asset?L2
• The contract of Sylcor provides that the supplier may replace the specified self-propelled truck made available to it. Which of the following statements on whether this substitution right is substantive are correct? (several answers)L2
• True or false? The contract making a specified server available to Nolvane allows the supplier to replace it, but only from the third year of the contract onwards. This substitution right is not substantive.L2
• The contract of Pradel allows the supplier to replace the specified compressor installed at its site. Pradel has no information on the supplier's fleet or replacement costs and cannot readily determine whether this substitution right is substantive. What should it conclude?L2
• The Marzel group is reviewing three contracts. In which one does the customer have an identified asset?L2
• The Vantelle group is analysing five contracts, which contain no substitution rights other than those described. In which ones does the customer have an identified asset? (several answers)L3
• The controller of Morvan is analysing a four-year contract for a specified industrial printer installed at the Morvan premises. The memo contains four steps. Which step contains an error?L3
• Ferlane enters into a five-year contract with a carrier for the transport of a specified volume of goods by railcars. The contract specifies the type of railcars, but for each journey the carrier chooses the railcars used from a large pool available nearby; it can replace them at any time without Ferlane's consent, and this flexibility allows it to optimise the use of its pool at low cost. Between journeys, the railcars stay at the carrier's sites. What conclusion should be reached?L3
• A supplier makes a specified bottling line available to Dorlan for six years; the line is installed and fixed in the Dorlan plant. The contract allows the supplier to replace it with an equivalent line. A replacement would require costly dismantling and transport, with no identifiable gain for the supplier. The supplier nevertheless points to the possibility that a future customer might one day agree to pay an above-market price for this line, a possibility considered unlikely at the inception date. Which analysis should be retained?L3
• Under a ten-year contract, Halbrec has exclusive use of a specified cogeneration plant. It receives all the electricity produced, which it consumes, as well as the residual heat, which it sells to a neighbouring network. Which benefits does Halbrec take into account in assessing whether it obtains substantially all of the economic benefits from use of the plant?L3
• True or false? The retailer Lumira has exclusive use of a specified retail unit. The consideration comprises a fixed part and a part equal to 3% of the sales made in the unit, paid to the owner. This payment prevents Lumira from obtaining substantially all of the economic benefits from use of the unit.L3
• Rivelo has exclusive use of a specified truck for three years, but the contract limits its use to a defined region and to 60,000 km a year. Rivelo uses the truck fully within those limits. How should it assess whether it obtains substantially all of the economic benefits from use?L3
• The contract entered into by Ostral for a specified machine tool provides for several rights. Which of them are rights to direct how and for what purpose the machine is used?L3
• The Calvène group obtains exclusive use of a specified vessel for eight years, with no substitution right for the supplier. Calvène decides which goods are carried, which ports are served and the departure dates, subject to clauses that prohibit sailing in high-risk areas and carrying hazardous materials. The supplier provides the crew and maintains the vessel. The internal auditor concludes that the contract does not contain a lease. Which statement in the auditor's memo is wrong and distorts the conclusion?L4
• Before signing the contract, Solenne designed a solar farm (location, capacity, panel orientation) that the supplier builds and then operates for it for twenty years, with no substitution right. This design, supplemented by contractual restrictions, predetermines how and for what purpose the farm is used; no relevant decision remains to be made during the period of use. The supplier handles operation and maintenance. Does Solenne have the right to direct the use of the farm?L4
• Ardance signs a six-year contract with a crane supplier. For the first two years, a specified crane is made available for its exclusive use, with no substitution right, and Ardance alone decides how it is used on its construction sites. For the following four years, the supplier performs lifting operations on demand with its own cranes: it chooses the crane, its deployment and when it is used. What conclusion should be reached?L4
• Nexalis signs a five-year contract with a hosting provider. The contract specifies 12 server racks, identified by their number and located in a room reserved for Nexalis; the provider can replace them only in the event of a breakdown. Nexalis decides which applications are installed, how much capacity it devotes to them and the processing schedules. The provider imposes security and temperature rules designed to protect its equipment, and it carries out the maintenance. Write a memo concluding, step by step, on whether there is a lease at the inception date.L4
• The joint arrangement Boréa, as defined in IFRS 11, is jointly controlled by Altis and Corva. It signs on its own behalf a three-year contract for a specified drilling vessel, with no substitution right for the supplier, and has exclusive use of it. The joint arrangement's committee decides the drilling sites, the schedule and the drilling depth; the supplier provides the crew, which follows these instructions, and may prohibit access to areas of armed conflict. Altis argues that, as neither company controls the vessel alone, there is no lease. Write a judgement memo.L4
• A trainee at Pelvane has to apply the flowchart provided in IFRS 16 to determine whether a contract is, or contains, a lease. In what order does the flowchart sequence the questions?L1