A contract is, or 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; this is the definition of a lease in IFRS 16, and the assessment is made at the inception of every contract an entity enters into.
Assessment at Contract Inception
An entity assesses at inception of a contract whether the contract is, or contains, a lease. This assessment turns on the concept of "control over the use of an identified asset," which is the substantive criterion that distinguishes leases from other service arrangements.
The Two Elements of Control Over an Identified Asset
To assess whether a contract conveys the right to control the use of an identified asset throughout the period of use, an entity assesses whether the customer has both of the following:
- The right to obtain substantially all of the economic benefits from use of the identified asset.
- The right to direct the use of the identified asset.
If the customer does not have both of these rights throughout the period of use, the contract does not contain a lease as the Standard defines it, even if the contract otherwise allows the customer to make some use of a particular asset.
Control Over Only Part of the Contract Term
If 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 only, while the remaining part of the contract is accounted for according to its actual nature.
Why This Assessment Matters
Classifying a contract as containing a lease means that the lessee generally recognises a right-of-use asset and a lease liability in its financial statements, unlike arrangements that do not meet the definition of a lease, which are typically accounted for as a service expense as incurred, without recognising an asset or a lease liability in the statement of financial position.
Distinguishing a Lease From a Service Contract
In practice, an entity often encounters contracts that combine the provision of an asset with a service, such as energy-supply, equipment-hosting or data-storage arrangements; if the supplier decides how and when the asset operates and the customer has no genuine right to direct that use, the contract tends to be a service contract rather than a lease. If, however, the customer obtains the genuine right to direct the use of a specifically identified asset throughout the period of use, the contract meets the elements of the lease definition set out in the Standard.
Legal References
- IFRS 16 — Leases, paragraph 9 (definition of a lease).
- IFRS 16, paragraph B9 (the two elements of control over an identified asset).
- IFRS 16, paragraph B10 (control over only part of the contract term).
For questions about your specific situation, you can ask the Accounting Helper (private sector) on Helpers, or consult a licensed chartered accountant.