Does this contract contain a lease?
How to decide whether a client's contract contains a lease under IFRS 16, including when a supplier can substitute the asset, and how to record it.
By Achekam · · 4 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
Not every lease calls itself one. A distribution client "hires" dedicated trucks from a fleet company under a transport services agreement. A retailer pays a monthly "storage fee" for a particular cold room in a warehouse. A clinic's managed print service includes printers installed on its premises. Each of these contracts may contain a lease, and under IFRS 16 that matters, because a lease puts an asset and a liability on the client's balance sheet.
Right to control the use of an identified asset
ACCA explains that under IFRS 16 a contract is, or contains, a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. ACCA adds that this requires both the right to obtain substantially all the economic benefits from using the asset and the right to direct its use.
Three questions settle most cases:
- Is there an identified asset?
- Does the client obtain substantially all the economic benefits from using it during the period?
- Does the client direct how and for what purpose it is used?
If all three answers are yes, the contract contains a lease. If any answer is no, it is a service contract.
Identified asset, and the supplier's right to substitute
An asset is usually identified by being named in the contract, such as a truck by its registration or a numbered cold room, or implicitly, because only one asset could possibly serve the contract.
ACCA explains that an asset is not "identified" for IFRS 16 purposes if the supplier has the right to substitute an alternative asset throughout the period of use. A right or obligation to substitute the asset for repairs, however, does not stop it being identified.
Read the substitution clause with care:
- A fleet company that can genuinely swap any truck for another from its pool, at any time and for its own operational reasons, has a substitution right. No identified asset, so no lease.
- A fleet company that replaces a truck only when it breaks down is substituting for repairs. The truck is still identified.
- A warehouse that can move the client's goods to whichever cold room it chooses has a substitution right. One that assigns a specific room and moves the client only for maintenance does not.
Benefits and direction of use
Even with an identified asset, the client needs the right to substantially all the economic benefits from its use and the right to direct that use. Where the client's goods share a truck with other customers' goods, the client does not obtain substantially all the benefits. Where the fleet company decides the routes, the timing and which customer the truck serves, the client does not direct its use.
The dedicated truck, painted in the client's colours, driven where and when the client says and used for nothing else, is the textbook hidden lease.
Record the answer to each question separately on the file, with the clause of the contract that supports it. A conclusion that a contract "is a service" without that trail is hard to defend when a reviewer reads the same contract and sees a dedicated asset.
Contracts that hide leases
Places worth checking:
| Contract | Possible hidden lease |
|---|---|
| Outsourced transport or logistics | Dedicated vehicles |
| Storage and warehousing | A specific room, area or racking |
| Managed IT or print services | Equipment on the client's premises |
| Telecoms and data services | Dedicated fibre or rack space |
| Power supply agreements | A dedicated generator or solar installation |
Not every one will turn out to be a lease, but each deserves the three questions.
Exemptions, the register and the policy
IFRS 16 introduces a single lessee accounting model and requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. A contract that contains a lease may therefore still stay off the balance sheet if its term is short or the asset is of low value; see short-term and low-value leases.
Where a lease is recognised, staff can keep the client's lease register in Achekam (Financials Studio, Leases) under IFRS 16 or IFRS for SMEs Section 20. An AI draft of a lease read from the contract is not used until a person confirms it, and every number the AI reads must appear in the contract text. For a hidden lease, the confirmation step is where the preparer's judgement comes in. The AI reads the numbers in the document; deciding that a "services agreement" contains a lease at all, and which part of the payment relates to it, is the person's decision. More on running the register is in the IFRS 16 lease register.
The Studio's standard policy wording is based on IFRS for SMEs and labelled for review before issue, and staff can write their own policies. A full IFRS client with leases needs IFRS 16 wording, including how it identifies leases embedded in service contracts. Notes take their figures from the mapped trial balance; lease details the trial balance cannot hold are left as "[to be completed]".
ACCA's technical article on IFRS 16 explains how to identify a lease and how a lessee recognises a right-of-use asset and lease liability, with worked examples.
Where to start
Ask the client for a list of every contract with a regular monthly payment that is not for staff, rent, utilities or stock. Read each one with the three questions in hand. Most will be services; the few that are not are the ones that would otherwise have been missed.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
