New leases standard – defining the scope

As we discussed here, the IASB has issued IFRS 16 Leases, effective for annual reporting periods beginning on or after January 1, 2019.

We’ve already covered the main aspects of lessee accounting in a series of articles. But let’s go back and examine the question of when you even have to worry about the standard. Here’s how it defines its scope:

  • “An entity shall apply this Standard to all leases, including leases of right-of-use assets in a sublease, except for:
  • (a) leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources;
  • (b) leases of biological assets within the scope of IAS 41 Agriculture held by a lessee;
  • (c) service concession arrangements within the scope of IFRIC 12 Service Concession Arrangements;
  • (d) licences of intellectual property granted by a lessor within the scope of IFRS 15 Revenue from Contracts with Customers; and
  • (e) rights held by a lessee under licensing agreements within the scope of IAS 38 Intangible Assets for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights.”

The IASB concluded these areas are all adequately addressed by other standards (albeit that in the first instance, IFRS 6 addresses rights to explore mineral resources mainly by providing an exemption from having to think about it as much). The standard also specifies that a lessee may, but is not required to, apply the standard to leases of intangible assets other than to rights held under licensing agreements. The basis for conclusions notes: “The IASB acknowledged that there is no conceptual basis for excluding leases of intangible assets from the scope of IFRS 16 for lessees. However, the IASB concluded that a separate and comprehensive review of the accounting for intangible assets should be performed before requiring leases of intangible assets to be accounted for applying the requirements of IFRS 16.”

The standard also sets out some broad principles for looking at contracts in the aggregate: “as a practical expedient, an entity may apply this Standard to a portfolio of leases with similar characteristics if the entity reasonably expects that the effects on the financial statements of applying this Standard to the portfolio would not differ materially from applying this Standard to the individual leases within that portfolio. If accounting for a portfolio, an entity shall use estimates and assumptions that reflect the size and composition of the portfolio.” It might seem that this shouldn’t need to be said – that an entity can always apply judgment in how it approaches a standard if it gets to the materially right place. However, since IFRS 15 makes a similar statement about applying a portfolio approach, some respondents to the exposure draft worried about the implications of not having such a statement in IFRS 16 (yet another example, if one were needed, that accountants are hardly the least neurotic people in the world). In a similar vein, an entity combines two or more contracts entered into at or near the same time with the same counterparty (or related parties of it), and accounts for them as a single contract if they’re negotiated as a package with an overall commercial objective; or the amount of consideration to be paid in one contract depends on the price or performance of the other; or the rights to use underlying assets conveyed in the contracts form a single lease component.

It’s also interesting to observe some of the possible scope exemptions rejected by the IASB. Some argued for a distinction between “core” and “non-core” assets: “For example, information about assets and liabilities arising from leases of delivery vans is important to assess the operations of a delivery company, but it may not be important for materiality reasons in assessing the operations of a bank that uses vans to deliver supplies to its retail banking locations.” Some board members apparently favoured such an approach. But the IASB noted that defining these concepts would be extremely difficult, and would likely reduce comparability between financial statements of different entities.

The IASB also considered whether long-term leases of land should be excluded from the scope of IFRS 16, on the basis that a long-term lease of land is sometimes regarded as being economically similar to purchasing it. However, the IASB decided there’s no conceptual basis for differentiating long-term leases of land from other leases and that anyway, for a long-term lease of land, the present value of the lease payments is likely to represent substantially all of its fair value.

Finally, the IASB observed that the term ‘leased inventory’ is sometimes used to describe purchases of non-depreciating spare parts, operating materials, and supplies associated with leasing another underlying asset. The IASB noted though that if an entity has assets that (as per the definition of inventory) are held for sale in the ordinary course of business, or for consumption in the process of production for sale in the ordinary course of business, it’s unlikely that it only obtained those assets by leasing them from another party that actually owns them. So it concluded the term “leased inventory” doesn’t likely refer to a lease in the sense of IFRS 16, and that this kind of activity doesn’t need to be addressed by a scope exemption.

And with those boundaries defined, the IASB concluded that the sky was the new limit for lease accounting!

The opinions expressed are solely those of the author

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