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Dear Chris,
As per IFRS 16 if lessor has the right to substitute the asst then the contract is not a lease.
In below scenario the transaction constitutes to a lease.I am bit confused, please shed some light.
Thanks“While searching for some invoices, the accountant found a contract which Calendar had entered into on 1 January 20X7 with Diary, another entity. The contract allows Calendar to use a specific aircraft owned by Diary for a period of three years. Calendar is required to make annual payments.
On 1 January 20X7, costs were incurred negotiating the contract. The first annual payment was made on 31 December 20X7. Both of these amounts have been expensed to the statement of profit or loss.There are contractual restrictions concerning where the aircraft can fly. Subject to those restrictions, Calendar determines where and when the aircraft will fly, and the cargo and passengers which will be transported.
Diary is permitted to substitute the aircraft at any time during the three-year period for an alternative model and must replace the aircraft if it is not working. Any substitute aircraft must meet strict interior and exterior specifications outlined in the contract. There are significant costs involved in outfitting an aircraft to meet Calendar’s specifications.You need to apply the definition of a lease to the scenario and then reach a conclusion – it is not serious if your conclusion differs. It is serious if you do not know the definition. On balance do you have exclusive use of the asset.
Sounds like a lease to me, but it’s a judgement call.
The way I think of this particular scenario, does the contract give you access to the object or does it give you access to the functionality/service the object provides?
If the contract gives you access to the object, to which you can do whatever you wish (i.e you can use it or leave it in a garage doing nothing, it’s your call) – then it is a lease.
If the contract gives you access to the functionality or service the object provides, then your focus is on the output of the object – not necessarily the object itself. This is not a lease. The means of achieving the output does not matter as much as the output itself, which is all you are concerned about. Because of this, the Lessor is able to substitute the object, it doesn’t affect what you are entitled to, or what you get. This is not a lease.
With the question, Calendar gets the right to a specific aircraft. He can do with it what he wishes, i.e fly it or store it in a garage. He is not getting the right to fly from one place to another (i.e the output of an aircraft).
The substitution of the aircraft mentioned in the question, for me it’s more simply to replace the original aircraft if it’s broken, not a means to provide what is agreed in the contract. The lessor cannot change the aircraft Calendar has, under ordinary circumstances, as he has the right to a specific aircraft.
All of this is insignificant to Stephen’s emphasis that understanding of the definition is more important than ‘correctness’ of the answer
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