Current International Financial Reporting Standards (“IFRS”) require operating leases to be expensed as incurred on a straight-line basis.  Entities are not permitted to recognise liabilities upon entering into operating leases, unless the contract is “onerous”.  

When assessing a lease as a lessee there is always a present obligation to make future lease payments which is expected to result in an outflow of future economic benefits in the form of lease payments for the duration of the lease.  This is a liability according to the definition in IFRS, yet none is recognised. 

This is expected to change with the new leases standard, released at the beginning of the year.

The new leases standard takes the view that all leases create assets and liabilities.  In fact, not only does a lessee have to recognise a liability upon entering into a lease, it has an asset too.  It has a right to use the asset that is the subject of the lease for the duration of the lease term that must now be recognised.  These assets and liabilities are brought onto the statement of financial position once the lease is entered into.  The liability is measured at present value of the future lease payments, and the asset is capitalised at the same amount, adjusted for any additional costs, incentives received, or payments to the lessor.  

The new standard will most likely exempt the need to capitalise the following leases:

• Leases that have a lease term of 12 months or less; and
• Leases of small assets such as laptops and office furniture.

These will be expensed as incurred.  The standard’s objective is to capture those significant lease liabilities that are currently missing from the statement of financial position, such as property leases and “yellow assets” (large items of plant and machinery) used on construction sites.

But what is a lease?

• Do you have exclusive use of the boat for the year?
• Are you entitled to substantially all the economic benefits from the use of the boat for the year?
• Can you decide how to use the boat, where to go and when?  Or is it the captain that makes these decisions?

If you do not have the above rights, you have not leased a boat, but have instead received a travel service.   

If after the assessment you conclude that you do have the relevant rights and that the arrangement is a lease, you are not out of the water yet, as there is a further requirement to assess whether the arrangement contains a service component (i.e. captaincy services).  Fortunately the standard contains an exemption allowing you to not separate out the service component from the lease component of the contract, but instead to combine all the components in the contract and account for them as one single lease.   This exemption is available by class of underlying asset to the lease and there are no further requirements that must be met to use this exemption.

What about lessors?

Adopting the new standard