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Chapter 1: Objective and Scope
Objective and Scope
The objective of IFRS 16 is to set out the principles for the recognition, measurement, presentation and disclosure of leases.
A lease is defined as a “contract, or a part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration”.
When applying IFRS 16, an entity is required to consider:
- all relevant facts and circumstances; and
- the terms and conditions of contracts.
Scope
The standard excludes from its scope:
- leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources;
- leases of biological assets within the scope of IAS 41, ‘Agriculture’, held by lessees;
- service concession arrangements within the scope of IFRIC 12, ‘Service concession arrangements’;
- licenses of intellectual property granted by a lessor within the scope of IFRS 15, ‘Revenue from contracts with customers’; and
- rights held by lessees under licensing agreements within the scope of IAS 38, ‘Intangible assets’, For example items such as motion picture films, video recordings, plays, manuscripts, patents and copyrights.
Exemption from applying IFRS 16 to leases for exploration of, or use of, minerals, oils, natural gas and similar non-regenerative resources
The Standard provides no guidance on how broadly the exception should be applied.
In many cases, the land which is subject to the right to explore and extract non-regenerative resources is owned by the party granting the exploration rights and a single contract transfers the right to use the land and the exploration and extraction rights. In these cases, the whole contract is a single unit of account to which the exception applies.
In other cases, the lease of the land subject to exploration rights may be from a lessor unrelated to the party granting the exploration and extraction rights. While it is clear that the exception applies to the exploration and extraction rights, it is necessary to consider whether the scope exception extends to the lease of the related land. In the absence of specific guidance in IFRS 16, it is reasonable to apply the exception to both:
- the rights to explore for, and extract, the natural resources; and
- the right to use the land in which those natural resources are contained (unless the right to use the land embodies rights other than the rights to explore for, and extract, natural resources).
Application of IFRS 16 to leases of intangible assets
Leases of ‘other’ intangible assets in the context of IFRS 16 might include, for example, exclusive licenses for brands or trademarks held by a lessee. Such leases were previously considered to fall within the scope of IAS 17. The Board decided to permit, but not require, entities to account for these leases in accordance with IFRS 16. Although there is no conceptual basis for excluding them from the scope of IFRS 16, the Board considered that a more comprehensive review of the accounting for intangible assets is required before requiring leases of intangible assets to be accounted for under the new Standard.
Could an arrangement to use a company car which is in the scope of IAS 19 also be in the scope of IFRS 16?
A contract is, or contains, a lease if it conveys the right to control the use of the identified asset for a period of time in exchange for consideration. The term ‘consideration’ should be interpreted broadly as including the possibility of receiving payments. Aside from those payments that meet the definition of lease payments and must be included in the measurement of the lease liability in accordance with IFRS 16, it also covers, for example, variable payments that do not depend on an index or a rate. So, even if all of the payments are variable payments that do not depend on an index or a rate, the contract still meets the definition of a lease, provided that the other conditions are met.
A lessee can choose to apply IFRS 16 to leases of intangible assets other than those mentioned above within the scope of IAS 38. If a lessee does not apply IFRS 16 to leases of intangible assets, it applies IAS 38. A lessor has no choice and has to apply IFRS 16 to leases of intangible assets other than those mentioned above within the scope of IFRS 15.
NOTE: Note that the application of IFRS 16 is not restricted to contracts, or portions of contracts, that are specifically described or labelled as lease.
Practical expedient – application to a portfolio of leases
Although IFRS 16 specifies the accounting for an individual lease, as a practical expedient the Standard can be applied to a portfolio of leases with similar characteristics provided that it is reasonably expected that the effects on the financial statements of applying a portfolio approach will not differ materially from applying IFRS 16 to the individual leases within that portfolio. When accounting for a portfolio, estimates and assumptions that reflect the size and composition of the portfolio should be used.
Applying IFRS 16 to a single contract to lease a number of identical assets
A common example of when this practical expedient applies is when an entity enters into a single contract to lease a number of identical assets. Take, for example, a contract to lease 20 printers (assumed for the purposes of this example to be high-volume commercial printers that do not qualify as low-value assets). As discussed, if the printers can be operated on a stand-alone basis, the right to use each printer is required to be accounted for as a separate lease component. The practical expedient helps to reduce that complexity by permitting the entity to account for the leases as one portfolio, rather than recognizing and accounting for 20 leases separately. In this situation, the practical expedient enables the lessee to use a single discount rate to the portfolio as a whole.
Example: Portfolio application
A lessee in the pharmaceutical manufacturing and distribution industry (Lessee) has the following leases:
(a) leases of real estate (both office buildings and warehouses).
(b) leases of manufacturing equipment.
(c) leases of company cars, both for sales personnel and senior management and of varying quality, specification and value.
(d) leases of trucks and vans used for delivery purposes, of varying size and value.
(e) leases of IT equipment for use by individual employees (such as laptop computers, desktop computers, hand held computer devices, desktop printers and mobile phones).
(f) leases of servers, including many individual modules that increase the storage capacity of those servers. The modules have been added to the mainframe servers over time as Lessee has needed to increase the storage capacity of the servers.
(g) leases of office equipment:
- (i) office furniture (such as chairs, desks and office partitions);
- (ii) water dispensers; and
- (iii) high-capacity multifunction photocopier devices.
Leases of low-value assets
Lessee determines that the following leases qualify as leases of low-value assets on the basis that the underlying assets, when new, are individually of low value:
(a) leases of IT equipment for use by individual employees; and
(b) leases of office furniture and water dispensers.
Lessee elects to apply the requirements in IFRS 16 in accounting for all of those leases.
Although each module within the servers, if considered individually, might be an asset of low value, the leases of modules within the servers do not qualify as leases of low-value assets. This is because each module is highly interrelated with other parts of the servers. Lessee would not lease the modules without also leasing the servers.
Portfolio application
As a result, Lessee applies the recognition and measurement requirements in IFRS 16 to its leases of real estate, manufacturing equipment, company cars, trucks and vans, servers and high-capacity multifunction photocopier devices. In doing so, Lessee groups its company cars, trucks and vans into portfolios.
Lessee’s company cars are leased under a series of master lease agreements. Lessee uses eight different types of company car, which vary by price and are assigned to staff on the basis of seniority and territory. Lessee has a master lease agreement for each different type of company car. The individual leases within each master lease agreement are all similar (including similar start and end dates), but the terms and conditions generally vary from one master lease agreement to another. Because the individual leases within each master lease agreement are similar to each other, Lessee reasonably expects that applying the requirements of IFRS 16 to each master lease agreement would not result in a materially different effect than applying the requirements of IFRS 16 to each individual lease within the master lease agreement. Consequently, Lessee concludes that it can apply the requirements of IFRS 16 to each master lease agreement as a portfolio. In addition, Lessee concludes that two of the eight master lease agreements are similar and cover substantially similar types of company cars in similar territories. Lessee reasonably expects that the effect of applying IFRS 16 to the combined portfolio of leases within the two master lease agreements would not differ materially from applying IFRS 16 to each lease within that combined portfolio. Lessee, therefore, concludes that it can further combine those two master lease agreements into a single lease portfolio.
Lessee’s trucks and vans are leased under individual lease agreements. There are 6,500 leases in total. All of the truck leases have similar terms, as do all of the van leases. The truck leases are generally for four years and involve similar models of truck. The van leases are generally for five years and involve similar models of van. Lessee reasonably expects that applying the requirements of IFRS 16 to portfolios of truck leases and van leases, grouped by type of underlying asset, territory and the quarter of the year within which the lease was entered into, would not result in a materially different effect from applying those requirements to each individual truck or van lease. Consequently, Lessee applies the requirements of IFRS 16 to different portfolios of truck and van leases, rather than to 6,500 individual leases.
Portfolio application by lessors – example
Entity A, a lessor, enters into car finance leases with the general public. The lease portfolio covers leases of various makes of car entered into at various dates. The individual leases within this portfolio have similar terms and conditions, including:
- the same contractual period of five years;
- an early termination option available to a lessee at the end of year three; and
- a similar pricing mechanism that is set such that Entity A does not take the risk associated with future changes in car prices, and might be thought to economically discourage early termination by a lessee. However, there is a reliable history of leases being terminated early and it is reasonable to expect that some of the current lessees will terminate early.
Entity A elects to apply the lease accounting requirements to portfolios of leases as permitted by IFRS 16. To comply with these requirements, Entity A identifies portfolios of leases with similar characteristics, such that it reasonably expects applying the requirements of IFRS 16 to those portfolios will not result in a materially different effect than applying the requirements of IFRS 16 to each individual lease. These characteristics might include, for example, customers’ characteristics, makes of cars and the origination date of the lease.
In determining whether any individual lessee is reasonably certain not to exercise the termination option, Entity A considers the historic behavioral evidence for a portfolio of leases with similar characteristics, as well as any changes in general economic conditions, or factors specific to the cars, that might be expected to alter such behavior. The assessment of whether any individual lessee is reasonably certain to exercise the termination option, or not, is then applied to all the leases in the portfolio. In other words, either all of the lessees in the portfolio are considered to be reasonably certain to exercise the termination option, or all of the lessees are not.
Short-term leases
Short-term leases are leases with a lease term of 12 months or less. The lease term also includes periods covered by an option to extend, or an option to terminate, if the lessee is reasonably certain to exercise the extension option, or not to exercise the termination option. A lease that contains a purchase option is not a short-term lease.
Q&A: Can perpetual lease contracts that contain termination options qualify as short-term leases?
Example 1
Entity A enters into a lease of small office space. The lease continues in perpetuity, but both the lessor and the lessee have termination options. The termination options are exercisable at any time, with a three-month notice period. The entity exercising the termination option will bear no more than an insignificant penalty. Does the contract qualify as a short-term lease for the lessee?
Analysis
A short-term lease is defined as a lease that, at the commencement date, has a lease term of 12 months or less. The lease term is defined as the non-cancellable period of a lease, together with both periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option and periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option. When the lessee and the lessor each have the right to terminate the lease without permission from the other party with no more than an insignificant penalty, the enforceable period of the lease ends at the earliest point in time at which both parties can leave the contract and its contractual obligations. The enforceability of a lease contract does not require assessment of what is reasonably certain. In this example, both the lessee and the lessor have a termination right, with a three-month notice period, and the entity exercising it will bear no more than an insignificant penalty. Hence, the lease term is only three months, and so the lease qualifies as a short-term lease at the commencement date.
Example 2
The fact pattern is the same as in example 1, except that only the lessee has a termination option. Does the contract qualify as a short-term lease?
Analysis
If only the lessee has a termination option, the lease term depends on whether, or for how long, the lessee is reasonably certain not to exercise the termination option. Depending on this analysis, the lease could qualify as a short-term lease if the lease term is 12 months or less.
So, if, for example, it is reasonably certain that the lessee will not exercise the termination option before the end of month 57 (effective at the end of month 60), the lease term is five years. If the lessee is reasonably certain not to exercise the termination option only within the first nine months, the contract qualifies as a short-term lease.
Example 3
The fact pattern is the same as in example 1, except that only the lessor has a termination right. Furthermore, it is now assumed that the contractual term of the lease is 10 years. Does the contract qualify as a short-term lease?
Analysis
If only the lessor has the right to terminate the lease, the non-cancellable period of the lease includes the period covered by the option to terminate the lease (see IFRS 16). Hence, the lease term is equal to the contractual term of the lease (that is, 10 years). The lease contract does not qualify as a short-term lease.
Example 4
The fact pattern is the same as in Example A, except that the lease is entered into on 1 January 20X8 and can only be terminated effective on 31 December each year. Both parties still have the right to terminate with a three-month notice period (that is, if neither party gives notice to terminate the lease by 30 September 20X8, it cannot be terminated until 31 December 20X9). In the first year, the lease qualifies as a short-term lease, because the lease term is less than 12 months. Neither party gives notice to terminate the lease by 30 September 20X8. On 1 October 20X8, does the lease continue to qualify as a short-term lease?
Analysis
On 1 October 20X8, the lease term has changed and the lessee has to consider it as a new lease. The lease term is now 15 months and therefore does not qualify as a short-term lease.
The exemption for short-term leases must be applied by class of underlying asset.
If a lease for which the short-term lease exemption has been taken is subsequently modified or the lease term is changed, it is accounted for as a new lease.
Leases of low-value assets
A lessee makes the assessment of whether the underlying asset is of low value based on the value of the asset when it is new, regardless of the age of the asset.
The low-value exemption can be applied on a lease-by-lease basis.
The analysis of low-value leases does not require the lessee to determine whether low-value assets in aggregate are material. The exemption is still available, even if the aggregate value of low-value leases is material to the lessee.
An underlying asset only qualifies for the low-value exemption if two additional criteria are met. First, the lessee must be able to benefit from the asset on its own or together with other resources that are readily available. Secondly, the underlying asset must not be dependent on, or highly interrelated with, other assets.
Company cars
It is common in some jurisdictions for an employer to provide the use of a car to an employee as a benefit in kind (often referred to as a company car). There are many variations of such arrangements, including the following.
- The use of the car may require an employee to sacrifice a certain amount of their cash remuneration, or the use of the car may be a ‘free’ addition to an employee’s cash remuneration package.
- The car may be provided for an employee’s personal use or for a mix of business and personal use.
- To the extent that an employee uses the car for business purposes the employer may, or may not, reimburse the employee for such use.
- On termination of employment, the arrangement may:
o requires an employee to return the car to the employer;
o gives an employee the option to purchase the car; or
o obligates an employee to purchase the car.
When the contract between an employer and employee in respect of the car requires regular (e.g., monthly) payments by the employee, or a lump sum payment on termination of employment, these amounts are usually deducted from the monthly or final gross cash remuneration and the employee receives a net cash amount.
IAS 19 states that “employee benefits are all forms of consideration given by an entity in exchange for a service rendered by employees or for the termination of employment”. Additionally, IAS 19 explicitly identifies cars as a short-term employee benefit. Therefore, the provision of a company car appears to be within the scope of IAS 19.
However, the definition of a lease in IFRS 16 is “a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration”. The standard does not provide a definition of consideration, but it is generally accepted that it incorporates non-monetary consideration, which could include employee services. So, the provision of a company car could also be considered to be within the scope of IFRS 16.
As neither Standard explicitly takes precedence in accounting for such arrangements, it is necessary to assess which of IFRS 16 and IAS 19 is more appropriate to account for the arrangement as this will affect the required disclosure and may also lead to a difference in the required accounting.
Where it is the case that provision of a company car is dependent on the individual remaining an employee of the entity, it is reasonable to determine that the primary purpose of transferring the right to use a company car is to remunerate an employee in kind for services rendered by the employee and this will be the case regardless of whether:
- the balance between the cash salary and the car benefit in kind component of an employee’s remuneration is known when such arrangements are entered into; or
- there is any impact on cash salary for an employee that chooses not to receive a car as a benefit in kind.
In this case, an entity that purchases cars outright and provides these to employees as a benefit in kind will depreciate those cars and classify the depreciation as a staff cost. Similarly, if an employer (acting as a principal) contracts with a car supplier to lease the cars (and it is assessed that such contracts are leases under IFRS 16), then the accounting consequences for the employer are as follows:
- The employer recognizes a right-of-use asset and a lease liability in accordance with IFRS 16 in respect of the lease between the car supplier and the employer.
- Since the cars are provided to employees as a benefit in kind for services received, the depreciation of the right-of-use asset is classified as a staff cost.
- The employer recognizes the interest expense on the lease liability as a finance cost.
- If an amount is deducted from the employee as a contribution to the cost of the car provided, either regularly during employment or upon resignation, staff costs will be recognized net of those deductions.
- If the employee purchases the car, any remaining right-of-use asset is derecognised and expensed as a staff cost.
Leases at government-subsidized rates
A lessee may obtain government assistance in the form of a lease from the government at a subsidized rate. The lessor may establish the amount of the grant in various ways (by reference to a reduced asset price or a reduced time value of money). Regardless of how the lessor establishes the amount of the grant, to the extent the lease contains an identifiable government grant, the grant should be accounted for separately applying IAS 20 because, in accordance with IAS 20, “the manner in which a grant is received does not affect the accounting method to be adopted in regard to the grant”.
Lease at a government-subsidized (below-market) rate – example The government leases an item of machinery to Entity A with a fair value of CU 1 million and useful life of 10 years in return for 10 annual payments of CU 102,770, which would imply a rate implicit in the lease of 0.5 per cent (assuming a nil unguaranteed residual value and ignoring the impact of any initial direct costs of the lessor). The market incremental borrowing interest rate for the lease of this equipment with a similar payment profile for Entity A is 5 per cent.
In this scenario, although the rate implicit in the lease may be readily determinable, it is significantly below a market rate such that the arrangement is judged to contain a government grant. Entity A accounts for this grant similar to the grant of a loan at below market rate in accordance with IAS 20. The benefit of the below market rate of interest loan is measured as the difference between:
• the fair value of the ‘loan’ received (in accordance with IFRS 9, the fair value of a loan at a below market rate is measured at the present value of the contractual payments, in this case the lease payments, discounted using the market interest rate of 5 per cent which is CU 793,560); and
• the proceeds received, i.e., the right of use asset under market terms (which in this example may be estimated to be the fair value of the asset of CU 1 million).
At the commencement date of the lease, Entity A recognizes a lease liability of CU 793,560 (i.e., the present value of the lease payments discounted at Entity A’s incremental borrowing rate) and, applying IAS 20, may present the government grant benefit of CU 206,440 related to the right-of-use asset in the statement of financial position as either:
• deferred income, which is recognized in profit or loss on a systematic basis over the useful life of the asset. In this case, the right-of- use asset is initially recognized at CU 1 million separately from the deferred income of CU 206,440; or
• a deduction from the carrying amount of the right-of-use asset, in which case the grant is recognized in profit or loss over the life of the right-of-use asset by way of a reduced depreciation expense. In this case, the right-of-use asset is initially recognized at an amount equal to the lease liability of CU 793,560.
Consistent with measurement on initial recognition, subsequent interest expense on the lease liability is accrued at the rate of 5 per cent.
A lease does not qualify as a lease of a low-value asset if a lessee sub-leases, or expects to sub-lease, the leased asset.
Combining contracts
Two or more contracts that are interdependent should be combined and accounted for as a single contract. This requirement applies when:
- the contracts are entered into at or near the same time; and
- the contracts are with the same counterparty (or related parties of the counterparty); and
- one or more of the following criteria are met:
o the contracts are negotiated as a package with an overall commercial objective that cannot be understood without considering the contracts together; or
o the amount of consideration to be paid in one contract depends on the price or performance of the other contract; or
o the rights to use underlying assets conveyed in the contracts (or some rights to use underlying assets conveyed in each of the contracts) form a single lease component as described in IFRS 16.
Short-term leases – impact of interdependent contracts
The requirements of IFRS 16 are intended to capture circumstances in which an entity enters into a number of contracts in contemplation of one another such that the transactions, in substance, form a single arrangement that achieves an overall commercial objective that cannot be understood without considering the contracts together.
For example, assume that a lessee enters into a one-year lease of an asset with particular characteristics. The lessee also enters into a one-year lease for an asset with those same characteristics starting in one year’s time and a similar forward contract starting in two years’ time and in three years’ time. In this scenario, the conditions in IFRS 16 are met; the lessee has entered into four one-year leases at the same time and with the same counterparty, following sequentially, such that the overall economic effect is a lease for the entire term. Consequently, the contracts would be combined and accounted for as a single lease (which would not qualify for the short-term lease exemption).
Combining contracts with unrelated parties which are negotiated as a package
It is not appropriate to combine contracts with unrelated parties.
For example, Entity L enters into a contract to lease an asset to Retailer K, which Retailer K intends to simultaneously sublease to Customer B for five years. Entity L separately contracts with Customer B to provide maintenance services related to the asset for the five-year term. Entity L, Retailer K and Customer B are not related parties. In legal form, there are three separate contracts:
- the lease contract between Entity L and Retailer K;
- the sublease contract between Retailer K and Customer B; and
- the service contract between Entity L and Customer B.
The three contracts are negotiated as a package with the same commercial objective of allowing Customer B to use the asset and receive maintenance services. In addition, the consideration paid by Customer B in its lease and service contracts depends on the price paid by Retailer K in its lease contract.
Entity L should not combine the contracts to lease the asset to Retailer K and provide maintenance services to End User B. This is because IFRS 16 only applies to contracts with the same counterparty (or related parties to the counterparty). Therefore, the contracts in this example cannot be combined even though
(1) they are entered into simultaneously and are negotiated as a package with a single commercial objective and
(2) the amount of consideration in one contract depends on the price of the other contract.
Leases of inventories
Application of IFRS 16 to leases of inventories
IFRS 16 does not specifically exclude leases of inventories from its scope. However, the Board believes that few such transactions would meet the definition of a lease under IFRS 16 because a lessee is unlikely to be able to hold an asset that it leases (and that is owned by another party) for sale in the ordinary course of business, or for consumption in the process of production for sale in the ordinary course of business.
Leasehold land presented as inventories – scope of IFRS 16
In the absence of an exclusion for leases of inventories from the scope of IFRS 16, a lessee should apply IFRS 16 to such leases. For example, if an entity enters into a lease of land with the intention to develop it into properties for sale, the right-of-use asset recognized for the leasehold land should be accounted for applying IFRS 16 and presented as inventories.
Covid-19-related rent concessions
In May 2020, the Board issued Covid-19-Related Rent Concessions (Amendment to IFRS 16). The amendment provides practical relief to lessees in accounting for rent concessions arising as a result of COVID-19. The amendment makes no changes to lessor accounting.
In March 2021, the Board issued Covid-19-Related Rent Concessions beyond 30 June 2021 (Amendment to IFRS 16). The amendment extends the practical expedient added by the May 2020 amendment to apply to rent concessions for which any reduction in lease payments affected payments due on or before 30 June 2022 (previously this date was 30 June 2021).
Lease incentives
In May 2020, the Board issued Annual Improvements to IFRS Standards 2018-2020. The improvements include an amendment to Illustrative Example 13 of IFRS 16 to remove the illustration of the reimbursement of leasehold improvements.