International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

by International GAAP 2019 (pdf)

  They may combine rights to use assets and the provision of services or outputs, for

  agreed periods of time in return for a payment or series of payments, e.g. outsourcing

  arrangements that include the provision of assets and services. Entities have to consider

  the substance of these arrangements to see if they are, or contain, leases. If so, then the

  elements identified as a lease will be subject to the requirements of IAS 17 – Leases.

  The objective of IAS 17 is to prescribe, for lessees and lessors, the appropriate

  accounting policies and disclosure to apply in relation to leases. [IAS 17.1].

  IAS 17 has been in place for many years, having been originally issued in September 1982.

  So has its equivalent standard in the US, FAS 13 – Accounting for Leases (1976) – (now

  ASC 840). For several years, the IASB and the Financial Accounting Standards Board

  (FASB) worked on a joint project to develop a new approach to lease accounting. In

  January 2016, the IASB issued IFRS 16 – Leases – which will replace IAS 17, and in

  February 2016, the FASB issued its new lease accounting standard, ASU 2016-02 – Leases

  (ASC 842). Whilst the IASB and FASB reached the same conclusions on many areas of

  lease accounting, there are some areas for which they did not reach the same conclusions.

  Therefore differences do exist between the new IASB and FASB standards.

  IFRS 16 is effective for annual periods beginning on or after 1 January 2019, and is

  discussed in Chapter 24.

  2

  WHAT IS A LEASE?

  IAS 17 defines a lease as ‘an agreement whereby the lessor conveys to the lessee in

  return for a payment or series of payments the right to use an asset for an agreed period

  of time.’ [IAS 17.4]. The standard applies to agreements that transfer the right to use assets

  even though substantial services by the lessor may be called for in connection with the

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  operation or maintenance of such assets. It does not apply to agreements that are

  contracts for services that do not transfer the right to use assets from one contracting

  party to the other. The definition of a lease includes contracts for the hire of an asset

  that contain a provision giving the hirer an option to acquire title to the asset when

  agreed conditions have been complied with, sometimes known as hire purchase

  contacts. [IAS 17.6].

  There are types of arrangements that do not take the legal form of leases. They take

  many forms, and may combine rights to use assets and the provision of services or

  outputs, for agreed periods of time in return for a payment or series of payments.

  These issues are dealt with in IFRIC 4 – Determining whether an Arrangement

  contains a Lease – which is considered further in 2.1 below. Some of the

  arrangements under service concession arrangements give rise to further accounting

  issues that have been separately addressed by the Interpretations Committee;

  service concessions have been excluded from the scope of lease accounting and are

  discussed in Chapter 26.

  The SIC had previously considered whether all transactions in the legal form of a lease

  should be considered under IAS 17. The results of these deliberations, SIC-27 –

  Evaluating the Substance of Transactions Involving the Legal Form of a Lease, are

  covered in 2.2 below.

  2.1

  Determining whether an arrangement contains a lease

  IFRIC 4 notes that there are arrangements that do not take the legal form of a lease

  but that nevertheless convey rights to use items for agreed periods of time in return

  for a payment or series of payments. [IFRIC 4.1]. IFRIC 4 has the objective of dealing

  with the practical issues that arise when applying IAS 17 to arrangements that are

  not (or do not contain) leases in form: how to identify an arrangement that is in

  substance a lease, when to make the assessment and how to measure the lease

  element. [IFRIC 4.5]. The Interpretation does not provide any guidance for

  determining lease classification under IAS 17, [IFRIC 4.2], in other words, it could be a

  finance lease or an operating lease under IAS 17, nor does it expect the guidance to

  extend the scope of that standard.

  If an arrangement turns out to contain a lease or licence of a type excluded from the

  scope of IAS 17 (see 3.1.1 below), the Interpretation does not apply. Service concession

  arrangements to which IFRIC 12 – Service Concession Arrangements – applies are also

  out of scope (see Chapter 26). [IFRIC 4.4]. However, in some service concession

  arrangements, the operator of a service concession arrangement may be required to

  make contractual payments to the grantor that are linked to a right to use a tangible

  asset that is separate from the infrastructure. The Interpretations Committee observed

  that, in such cases, the operator should assess whether the arrangement contains a lease

  of that tangible asset. If the arrangement contains a lease, that portion of the

  arrangement would be in scope of IAS 17.1

  Leases (IAS 17) 1607

  IFRIC 4 considers the accounting implications of arrangements such as the following,

  in all of which an entity (the supplier) conveys a right to use an asset to another entity

  (the purchaser), together with related services or outputs:

  • outsourcing arrangements, including outsourcing of the data processing functions

  of an entity;

  • arrangements in the telecommunications industry, where suppliers of network

  capacity enter into contracts to provide purchasers with rights to capacity; and

  • take-or-pay and similar contracts, in which purchasers must make specified

  payments regardless of whether they take delivery of the contracted products or

  services (e.g. where purchasers are committed to acquiring substantially all of the

  output of a supplier’s power generator). [IFRIC 4.1].

  The Interpretations Committee concluded that an arrangement of one of these types

  could be within the scope of IAS 17 if it met the definition of a lease, i.e. if it conveyed

  to the lessee the right to use an asset for an agreed period of time in return for a payment

  or series of payments. [IFRIC 4.BC2]. IAS 17 applies to the lease element of the

  arrangement notwithstanding the related services or outputs because IAS 17 applies to

  ‘agreements that transfer the right to use assets even though substantial services by the

  lessor may be called for in connection with the operation or maintenance of such

  assets.’ [IAS 17.3]. This is regardless of the fact that the arrangement is not described as a

  lease and is likely to grant rights that are significantly different from those in a formal

  lease agreement.

  2.1.1

  Identification of an asset

  The first condition that must be met to determine whether an arrangement is, or

  contains a lease is that fulfilment of the arrangement depends on a specific asset or

  assets. [IFRIC 4.6].

  IAS 17 applies only to an arrangement in which there is a ‘right to use an asset’, so an

  arrangement will not contain a lease unless it depends on a specific asset or assets.

  A specific asset that is explicitly identified by the arrangement will not be the subject of

  a lease if the arrangement is not dependent on the asset. If the seller is required under

  the arran
gement to deliver a specified quantity of goods or services and has the right or

  ability to provide those goods using other assets not specified in the agreement, the

  arrangement will not contain a lease. [IFRIC 4.7].

  However, an arrangement may still contain a lease if a specific asset is not explicitly

  identified but it would not be economically feasible or practical for the supplier to

  provide the use of alternative items. For example, the supplier may only own one

  suitable asset. [IFRIC 4.8].

  Some arrangements may allow the supplier to replace the specified asset with a similar

  asset if the original asset is unavailable, e.g. because it is unexpectedly inoperable. The

  Interpretations Committee takes the view that, as such a requirement is in effect a

  warranty obligation it does not preclude lease treatment. [IFRIC 4.7].

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  To take a relatively simple example, an arrangement in which an entity (the purchaser)

  outsources its product delivery department to another organisation (the supplier) will not

  contain a lease if the supplier is obliged to make available a certain number of delivery

  vehicles of a certain standard specification and the supplier is a delivery organisation with

  many suitable vehicles available. However, if the supplier has to supply and maintain a

  specified number of specialist vehicles in the purchaser’s branding, then this arrangement

  is more likely to contain a lease. The latter arrangement may be commercially more akin

  to outsourcing the purchaser’s acquisitions of delivery vehicles rather than its delivery

  functions. Similar issues would have to be taken into account if data processing functions

  are outsourced as these may require substantial investment by the supplier in computer

  hardware dedicated to the use of a single customer.

  Where arrangements are likely to contain leases (delivery vehicles in the purchaser’s

  branding, dedicated hardware), the purchaser cannot be unaware that there are specific

  assets underlying the service. There would have been negotiations between supplier and

  purchaser that would probably be reflected in the contract documentation. By contrast, if

  the purchaser does not know what assets are used to provide the service (beyond the fact

  that they are trucks and computers, of course), and in the circumstances it is reasonable

  not to know, it is plausible that there is no underlying lease in the arrangement. This

  remains true even if the supplier has dedicated specific assets to the service being provided

  and expects their cost to be recouped during the course of the contractual relationship.

  2.1.2

  Parts of assets and the unit of account

  IFRIC 4 notes that some arrangements transfer the right to use an asset that is a

  component of a larger asset but the issue of whether and when such rights should be

  accounted for as leases is not dealt with in the Interpretation. The Interpretation states

  merely that ‘arrangements in which the underlying asset would represent a unit of

  account’ in either IAS 16 – Property, Plant and Equipment – or IAS 38 – Intangible Assets

  – are within the scope of the Interpretation. [IFRIC 4.3]. ‘Unit of account’ presumably means

  an asset whose cost, replacement, impairment and depreciation are separately accounted

  for under one of these standards (see Chapters 17 and 18). However, the opposite is not

  necessarily the case. It does not mean that a component of one of these assets cannot be

  the underlying asset. Generally, in the case of physical assets a portion of a larger asset

  that is not physically distinct is not considered to be a specified asset. Many intangible

  assets are capable of being subdivided with the part subject to the lease itself meeting the

  definition of an intangible asset, as discussed further at 3.1.2 below.

  There are many arrangements in practice that demonstrate the issue of the unit of account.

  For example, a plant may contain more than one production unit or line that might be

  regarded as a single ‘component’ (because each makes the same product) or alternatively

  each of its units or lines might be regarded as separate ‘components’. Depending on other

  aspects of the arrangement, a particular production line may be the asset that is the subject

  of a lease, if the supplier cannot transfer production to a different line to supply the goods.

  Leases (IAS 17) 1609

  Similar examples from the telecommunications industry include fibre optic cable,

  satellite and wireless tower arrangements. Fibre agreements vary from those that allow

  use of the whole or portions of a cable, to those that specify the wavelength or spectrum

  within a fibre. Many arrangements are essentially for transmission capacity within the

  vendor’s fibre cable or network. As a result, arrangements have to be examined

  carefully to determine if they do specify an asset.

  2.1.3

  The arrangement conveys a right to use the item

  In order to contain a lease, the arrangement must convey a right to use the asset.

  [IFRIC 4.6]. An arrangement does not convey the right to use an asset unless the purchaser

  has the right to control the use of the underlying item, which depends on any one of the

  following conditions being met: [IFRIC 4.9]

  (a) the purchaser has the ability or right to operate the asset or direct others to operate

  the asset in a manner it determines while obtaining or controlling more than an

  insignificant amount of the output or other utility of the asset;

  (b) the purchaser has the ability or right to control physical access to the underlying

  asset while obtaining or controlling more than an insignificant amount of the

  output or other utility of the asset; or

  (c) facts and circumstances indicate:

  (i) it is remote that one or more parties other than the purchaser will take

  more than an insignificant amount of the output or other utility that will be

  produced or generated by the asset during the term of the arrangement;

  and

  (ii) the price that the purchaser will pay for the output is neither contractually

  fixed per unit of output; nor equal to the current market price per unit of

  output as of the time of delivery of the output.

  Therefore, control of the asset may be obtained in circumstances in which an entity

  obtains ‘more than an insignificant amount of the output’ but only if it has the ability

  or right to operate (or direct others to operate) the asset in a manner that it

  determines or if it has the ability or right to control physical access to the asset ((a)

  and (b) above).

  When the arrangement involves a single purchaser taking substantially all of the output

  from a specific asset other than at market price per unit of output and the price varies

  other than in response to market price changes, the variability (‘off-market’ nature) is

  regarded by IFRIC 4 as indicating that payment is being made for the right to use the

  asset rather than for the actual use of or output from the asset. In these circumstances

  the arrangement would also convey the right to use the asset, even though the purchaser

  would have neither the ability nor right to operate the asset, or direct others to operate

  the asset in a manner it determines, nor have the ability or right to control physical

  access to the underlyi
ng asset.

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  The effects of this are demonstrated by the following examples.

  Example 23.1 contains two scenarios that illustrate arrangements that contain a lease.

  Scenario (a) is based on an illustrative example in IFRIC 4. [IFRIC 4.IE1-2].

  Example 23.1: Arrangements that contain a lease

  (a) Take-or-pay contract that depends on a specific asset (a gas supply facility)

  A production company (the purchaser) enters into an arrangement with a third party (the supplier) to

  supply a minimum quantity of gas needed in its production process for a specified period of time. The

  supplier designs and builds a facility near to the purchaser’s plant to produce the gas and maintains

  ownership and control over all significant aspects of operating the facility. The agreement provides for

  the following:

  • The facility is explicitly identified in the arrangement, and the supplier has the contractual right to supply gas

  from other sources, although supplying gas from other sources is not economically feasible or practicable.

  • The supplier has the right to provide gas to other customers and to remove and replace the facility’s

  equipment and modify or expand the facility to enable the supplier to do so. However, at inception of

  the arrangement, the facility is designed to meet only the purchaser’s needs and the supplier has no plans

  to modify or expand the facility.

  • The supplier is responsible for repairs, maintenance and capital expenditures.

  • The supplier must stand ready to deliver a minimum quantity of gas each month.

  • On a monthly basis, the purchaser will pay a fixed capacity charge and a variable charge based on actual

  production taken. The purchaser must pay the fixed capacity charge irrespective of whether it takes any

  of the facility’s production. The variable charge includes the facility’s actual energy costs, which

  comprise approximately 90 per cent of the facility’s total variable costs. The supplier is subject to

  increased costs resulting from the facility’s inefficient operations.

  • If the facility does not produce the stated minimum quantity, the supplier must return all or a portion of

  the fixed capacity charge.

  The arrangement contains a lease within the scope of IAS 17. An asset (the facility) is explicitly identified in