The new lease accounting standard, IFRS 16, is set to change what we recognise as a lease. The new definition is a ’catch all’ that may mean some common forms of service contract fall within its scope.
So what is a lease according to IFRS?
A contract contains a lease if:
“the contract conveys the right to control the use of an identified asset for a period of time in exchange for a consideration”.
Defined asset + defined time period + defined payment = lease.
So what’s excluded?
There are two exclusions:
- Short-term leases (<12 months)
- Leases for low value assets (< $5,000)
Sounds simply enough, right?
Wrong. A plethora of contracting structures have evolved across asset classes and geographies. In many countries, contracting structures are to a large extent freely defined by the individuals who contract under them. As such, no two leases are the same.
Some contracts will very obviously fall into the above definition, for others it may be more difficult to determine. Each contract will have to be assessed to identify whether a lease (under IFRS 16) exists and it all comes down to who has control over the asset. It is therefore likely that a number of service contracts will be viewed as a lease rather than a service.
Some illustrative examples below.
Company A enters into a contract to operate a concession stand within a shopping centre. The contract sets out the asset, time period and amount payable.
However, the shopping centre owner has the right to dictate where the stand is located within the shopping centre and may require the stand to move during the course of the contract due to planned refurbishment.
Company A does not have control over the asset for the duration of the contract. Company A does not have a lease.
Company B enters into a contract over a unit within a serviced office complex. The contract sets out the asset, time period and amount payable.
Company B is the sole occupant of the unit, but shares reception, kitchen and printing facilities. Company B pays an inclusive rent. The contract states that the operator has the right to substitute the unit for another in the same building.
Company B may have a lease, depending on whether the operator is viewed to have the practical ability and/or an economic incentive to substitute the asset.
Company C enters into a third party logistics (3PL) contract with a service provider, who will distribute goods for Company C. The warehouse operated by the service provider is solely used for the fulfilment of this 3PL contract and is necessarily located adjacent to Company C’s manufacturing plant. The contract does not identify an asset, but sets out the time period and amount payable.
Company C is likely to have a lease. An asset is implicitly identified. The only question is whether Company C has control over that asset.
There are no shortcuts to the application of IFRS 16, occupiers will need to assess each contract in detail to determine where ultimate control lies. For some contracts this will be a judgement call, and one that will need to be sufficiently evidenced to satisfy the auditor.
Call it what you will, but under IFRS 16, a lease by any other name… really is still a lease.
Hannah Coleman is an Associate in Strategic Consulting EMEA at Cushman & Wakefield.
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