Lease Identification Checklist

When does a contract contain a lease?

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. This single test decides whether an arrangement is on balance sheet as a lease or treated as a service or supply contract. It is the same under IFRS 16 (IFRS 16.9 and B9-B31), ASC 842 (ASC 842-10-15-3 onwards) and FRS 102 Section 20. The differences between IFRS 16 and ASC 842 are downstream, in lease classification and measurement, not in deciding whether a lease exists. FRS 102 Section 20 applies the same control-based model.

Three conditions must all be met. Fail any one and the contract does not contain a lease.

1. Is there an identified asset?

An asset is identified if it is explicitly specified in the contract (for example by serial number or address) or implicitly specified because it is the only asset that can fulfil the contract (IFRS 16.B13; ASC 842-10-15-9). A physically distinct portion of a larger asset, such as one floor of a building or a specified fibre strand, can itself be an identified asset. A capacity portion that is not physically distinct (for example, 40% of a pipeline) is not an identified asset unless it represents substantially all of the asset's capacity (IFRS 16.B20).

There is no identified asset if the supplier has a substantive right to substitute the asset. A substitution right is substantive only if both of these are true (IFRS 16.B14; ASC 842-10-15-10):

• the supplier has the practical ability to substitute alternative assets throughout the period of use, and
• the supplier would benefit economically from exercising the substitution right.

Rights to substitute only for repair or maintenance, or only on or after a particular date or event, are not substantive. If the customer cannot readily determine whether the right is substantive, it presumes it is not. This is the single most contested point in lease identification and the one auditors challenge most often, so document the facts for each limb.

2. Does the customer obtain substantially all of the economic benefits?

The customer must have the right to obtain substantially all of the economic benefits from using the asset throughout the period of use (IFRS 16.B21-B23; ASC 842-10-15-17). Economic benefits include the asset's primary output, by-products, and benefits from commercial use. Benefits the customer must pass on to a third party, such as a share of output paid to the supplier, are still economic benefits the customer obtains from use. The assessment is made within the defined scope of the contract, for example a particular geographic area or time period.

3. Does the customer have the right to direct the use?

The customer directs the use if it has the right to direct how and for what purpose the asset is used throughout the period of use (IFRS 16.B24-B26; ASC 842-10-15-20). These are decisions such as what output the asset produces, when it is used, where it is used, and whether it is used.

If those decisions are predetermined, the customer still directs the use if either (IFRS 16.B27; ASC 842-10-15-25):

• the customer operates the asset, or directs others to operate it, throughout the period of use, and the supplier cannot change those operating instructions, or
• the customer designed the asset, or specific aspects of it, in a way that predetermines how and for what purpose it will be used.

Protective rights that a supplier retains (for example, to protect its asset or comply with law) do not, on their own, prevent the customer from directing the use.

If a lease exists

Confirming a lease is only the first step. Separate any non-lease (service) components from the lease component (IFRS 16.12-17; ASC 842-10-15-28), then check the recognition exemptions: short-term leases of 12 months or less, and, under IFRS 16 and FRS 102 only, low-value assets (IFRS 16.5-8). ASC 842 has no low-value asset exemption. If no exemption applies, measure the lease liability at the present value of the lease payments and recognise a right-of-use asset. Use the lease calculator to model the numbers, the lease liability guide for the measurement detail, and the lease judgement checklist to document your conclusion.

Common situations

• Office or retail space: usually a lease. The space is a physically distinct identified asset and the tenant directs how it is used.
• Server or rack space in a data centre: often a lease if specific, physically distinct equipment is identified and you control its use; often not a lease if the provider can move your workload across shared hardware (substantive substitution).
• Cloud and SaaS contracts: generally not a lease. The customer does not control an identified asset; the provider runs and substitutes infrastructure freely.
• Vehicle with a driver supplied by the owner: assess who directs use. If the supplier decides routes and operation, it is typically a service, not a lease.
• Power purchase agreements and pipelines: turn on whether a specific plant or capacity is identified and who directs how it operates. These are classic judgement cases.