CPA Canada’s IFRS Discussion Group recently discussed the following fact pattern:
- A landowner (“Landowner”) with a plot of agricultural land enters into an agreement for a specified period of time with Entity X (“Customer”) allowing the Customer to place a specified number of wind turbines and associated infrastructure on the plot of land.
- The Customer will decide where within the plot of land each wind turbine will be placed. Each wind turbine involves a concrete pad of a specified dimension attached to the land and a fenced area of a specified dimension around the wind turbine. The associated infrastructure includes some buildings of a specified dimension that will house equipment associated with the wind turbines as well as some transmission cabling.
- The area of land on which the wind turbines and infrastructure are placed, as well as the fenced area around the wind turbines, is exclusively used by the Customer. Once placed, the Landowner cannot require the Customer to move any of the turbines or infrastructure during the term of the agreement.
- The rest of the plot continues to be available to the Landowner for agricultural purposes. The Customer is permitted to cross that land to access the wind turbines and associated infrastructure.
Under IFRS 16 Leases, a contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration: this requires among other things that the lessee has the right to obtain substantially all of the economic benefits from use of the asset. The group discussed what constitutes the “identified asset” in this particular fact pattern, and whether the lessee has such a right to obtain substantially all of the economic benefits from its use. You might say the asset consists only of the portion of land actually used by the customer, and that the customer obtains substantially all the benefits from that portion because – once the turbines are in place – the customer has exclusive use of it for the period associated with the agreement. Alternatively, you might think the identified asset is the entire plot of land covered by the agreement, and that since much of the plot continues to be available to the landowner for agricultural purposes, the customer does not have the right to obtain substantially all the economic benefits from its use.
The group took the first view, putting weight on the identifiable nature and exclusive use of the land assigned to the customer. Some group members threw in comparable situations where determining the identified asset might be more complex, such as advertising placed on the side of a building and an antenna installed on a cell tower.
The group then considered whether the contract contains both lease and non-lease components, and if so, how the consideration in the contract should be allocated between them. In theory, the non-lease components would consist of the remaining areas shared with the landowner, since the lessee doesn’t have exclusive use of these areas. The customer’s right to cross this shared land to access the turbine could have some value in itself, if for example, the landowner had allocated a greater portion of its land to the agreement than it might have done, because of the ongoing logistics of moving the customer’s equipment between the turbines. In this case the customer would allocate the consideration to each lease component based on the relative stand-alone price of the lease component and the aggregate stand-alone price of the non-lease components. Of course, it’s not too likely that an observable stand-alone selling price for the lease of the exclusively-used portions of land would be readily available.
In any event, you may recall that IFRS 16 contains a practical expedient whereby a lessee may elect, by class of underlying asset, not to separate non-lease components from lease components, and to account for them together as a single lease component. The IASB took this step for cost-benefit reasons, expecting that lessees would likely only adopt the approach when a contract’s non-lease components are relatively small, and so wouldn’t significantly increase the lessee’s recorded lease liabilities. So in the fact pattern above, the most likely scenario would probably be that nothing gets allocated to the non-lease components, either because the lessee makes use of the practical expedient, or because they’re not material anyway – that is, notwithstanding the speculation above, given that the whole point of the exercise is to run wind turbines, it seems the great bulk of the consideration paid would relate directly to that function. Of course, one could again devise scenarios where this wouldn’t be quite as clear (but whatever the scenario, the escape clause of the practical expedient would remain available).
It’s a useful little case study, both as a reminder of the rigour of the thinking that may need to go into identifying the existence of a lease, and as a reminder that you needn’t let it drive you completely mad…
The opinions expressed are solely those of the author