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Leases — Education session

Date recorded:

Definition of a lease

The Technical Manager introduced the paper dealing with the definition of a lease. Whilst many constituents had commended the Boards for providing greater clarity around what constituted a lease. At the same time, though, many constituents became increasingly worried about where to draw the borderline between a lease and a service. That distinction mattered as, under the proposals, leases would be recorded on balance whereas services would not. Specifically, concerns were raised and guidance requested as regards whether or not substitution rights were substantive and how to determine whether a contract conveyed the right to control the use of an identified asset. In summary, the Staff recommended:

  • retaining the definition of a lease, but adding clarifications;
  • clarifying whether fulfilment of the contract depends on the use of an identified asset;
  • clarifying the right to control the use of an identified asset by focussing on the ability to affect the potential cash flows to be derived from using the asset;
  • adding guidance regarding which decisions most significantly affect the potential cash flows to be derived from use and removing guidance in the 2013 ED regarding assets that are incidental to the delivery of services;
  • retaining the majority of the application guidance in the 2013 ED;
  • clarifying that restrictions on the use of an asset were generally considered ‘protective rights’; and
  • not including a definition of a service in the final lease standard.

One Board member requested clarification in relation to whether a restriction on the right of use will be considered protective or something beyond that. The Technical Manager confirmed that this was the intention, as discussed in the paper. In general, those protective rights were designed to protect the supplier’s interest to limit the scope of the use of the asset, but not necessarily to restrict the right of use of the asset. In response to a question from another IASB member, the staff clarified that there could be other cases where those restrictions would turn the contract into a service (for example, a capacity contract, as is specifically discussed in Agenda Paper 3A).

In relation to whether a contract depended on an identified asset if the supplier did not benefit from substituting an alternative asset, one Board member asked how easily this could be identified. He also asked if the staff had considered the notion of ‘significant economic incentive’, which was more widely recognised. The Technical Manager confirmed that this was the concept they had used in developing this clarification, particularly when considering the feedback received on the 2013 ED. The staff believed that in most cases, it would be clear how to identify whether or not the supplier would benefit from substituting the asset. The Board member further asked how this could be identified in the case of substituting one photocopier for another. The Technical Manager replied that it would be necessary to consider the cost of moving the photocopier, what other alternative uses the photocopier might have. The staff had also clarified in the paper that if the customer could obtain the information, then he would be allowed to assume that the right was not substantive. The Technical Manager further clarified that although this could be looked at as two-step process, i.e. assessing 1) whether there is an identified asset, and 2) whether there is a right of use of the asset, she believed that looking at both concepts together was a better notion when analysing who exercised control over the asset.

One Board member requested clarification regarding example 4A. In that example, the customer determined the location of the rig, and the staff had concluded that the customer would make decisions that most significantly affected the economic benefit of the asset. He asked whether economic benefits were based on cash flows. The staff clarified that economic benefits would be the cash flows that could be derived directly or indirectly from the use of the asset, and that this concept would be included in the application guidance. Also with regard to example 4A, another Board member wondered whether the focus should be on the fact that the asset was specialised, in terms of location or operation. He could not understand the difference between examples 4 and 4A. He also disagreed with using examples with industries that were highly specialised. The staff clarified that they were not trying to put more emphasis in one factor over another. The objective was that the focus should be on ‘how’ and ‘what purpose’ decisions affected the cash flows. The Technical Manager also clarified that paragraph 51 of agenda paper 3A included some indicators that, in general, would significantly affect the cash flows derived from the use of the asset. She recognised that it would not be the best way to address this issue by including these examples in the final standard. The Technical Manager also clarified that the difference between example 4 and 4A was that, in the first case, the rig was used for exploitation purposes (the entity already knew there was oil), and moving the rig would be costly, whilst in example 4A, the rig was used for exploration purposes (the entity did not yet know whether there was oil), and it was part of the process to move the rig and make decisions about the location of the rig. The operation of the rigs was very different in both cases. Another Board member expressed concern that the conclusion should not be based on tiny differences and it should be more obvious whether there was a lease or a service. It would be necessary to focus on a more holistic approach rather than identifying tiny differences.

In relation to example 2, one Board member asked about the weight given to decisions made in the contract to make a conclusion before the operations starts. The staff clarified that specifying the output of an asset does not necessarily give the customer control of the asset; the customer had to have current ability to make decisions. It was necessary for the customer to have the ability to make decisions throughout the period in order to have control. The Board member further indicated that she believed that the decisions made in general looked as if other operational decisions were left to the operator. The project manager clarified if that all decisions were being made in the contract and the customer had not ability to change anything, then it would be a service.

 

Separating lease and non-lease components

The Technical Principal introduced the paper covering two topics. The Boards will be asked to

  1. consider the lowest appropriate unit of account for application of the final leases standard and
  2. consider when lease components should be separated from non-lease components and how to allocate the consideration in the contract between the separate components

On the first issue, Staff is not proposing any changes to the 2013 ED. On the second issue, though, Staff is proposing a change from the 2013 ED for lessees, such that when separating lease and non-lease components in the absence of observable information, the lessee would be allowed to use estimates.

With regard to a reassessment of the lease term, one Board member questioned the reason as to why the staff considered that the allocation would be reassessed, too, as the price would not change. The project manager indicated that, in general, this would be the case. From a practical point of view, it would not be necessary to reassess the allocation. However, in a reassessment scenario the liability would be remeasured, so it could be necessary to reconsider the allocation.

One board member questioned why the Staff was proposing introducing guidance when this was an area where there were no practical issues. The project manager responded that, currently, there was no guidance in IFRSs or U.S. GAAP. Hence, the Staffs felt that it would be beneficial to have some guidance.

 

Initial direct cost

The Technical Associate briefly introduced the paper addressing which initial direct cost should be considered. She reported that only a few constituents had commented on the issue. The Staff proposed two views: Approach 1 would use an incremental cost notion similar to that contained in the upcoming standard on revenue recognition and Approach 2 would retain the notion currently contained in IAS 17 and be potentially a bit wider than Approach 1.

No significant comments made.

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