At the inception of a contract, an entity shall assess whether the contract is, or contain lease element.
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 along with other conditions to be satisfied.
For checking that the contract contains a lease element or not, a contract has to fulfill all the conditions:-
1. Asset derived from the contract should be an identified asset
2. The customer has the right to control the use of an asset throughout the period
3. The customer has the right to direct how and for what purpose the asset is used throughout the period of use.
4. The customer has the right to operate the asset throughout the period of use, without the supplier having the right to change those operating instructions.
5. If the customer has not right to operate the asset without the supplier instruction then the customer has the right to design the asset in a way that predetermines how and for what purpose the asset will be used throughout the period of use.
If any on the above condition is not fulfilled then the contract does not contain lease element. It simply implies that there is no question of applicability of IND AS 116.
Identified asset
As per para B13 of IND AS 116 an asset arises out of the contract can be either explicitly specified in the contract or implicitly specified at the time available for use by the customer.
As per para 20 of IND AS 116 which provides guidance regarding identified asset in case of portion of assets states as follows:
A capacity portion of an asset is an identified asset if it is physically distinct (for example, a floor of a building). A capacity or other portion of an asset that is not physically distinct (for example, a capacity portion of a fibre optic cable) is not an identified asset, unless it represents substantially all of the capacity of the asset and thereby provides the customer with the right to obtain substantially all of the economic benefits from use of the asset.
Right to control the use of an identified asset
As per para B9 of IND AS 116, there are two conditions which should be satisfied to determine whether the customer has the control the use of identified asset:-
1. Right to obtain substantially all of the economic benefits from use of the identified asset throughout the period of use and,
2. Right to direct the use of identified asset.
Right to direct the use
A customer has the right to direct the use of an identified asset in either of the following situations:
1. If the customer has the right to direct how and for what purpose the asset is used throughout the period of use; or
2. If the relevant decisions about how and for what purpose the asset is used are predetermined and:
a. the customer has the right to operate the asset (or to direct others to operate the asset in a manner that it determines) throughout the period of use, without the lessor having the right to change those operating instructions; or
b. the customer designed the asset in a way that predetermines how and for what purpose the asset will be used throughout the period of use
But as per para B14 even if an asset is specified, a customer does not have the right to use an identified asset if the supplier has the substantive right to substitute the asset throughout the period of use. A supplier’s right to substitute an asset is substantive only if both of the following conditions exist:
1. the supplier has the practical ability to substitute alternative assets throughout the period of use (for example, the customer cannot prevent the supplier from substituting the asset and alternative assets are readily available to the supplier or could be sourced by the supplier within a reasonable period of time); and
2. the supplier would benefit economically from the exercise of its right to substitute the asset (i.e., the economic benefits associated with substituting the asset are expected to exceed the costs associated with substituting the asset).
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