When analysing the provision of this reporting standard at the core, one thing is obvious, i,e, a lease is really about one thing—control. Does the lessee actually control a specific asset, or can the supplier come in and swap it out whenever they please? To answer this in according to Ind AS 116 and IFRS 16, if the supplier has a real and practical right to replace the asset, then it is not a lease. Simple, right? Actually not in real sense. Because just saying something in a contract does not automatically make it true in the real world. And just because a supplier can replace an asset doesn’t mean they ever will. That’s where things get tricky.
Take an example where you lease a car, but the rental company keeps the right to swap it for another car at any time, does that mean they actually will? May be not, unless you have got something fancy, and they suddenly realize they can make more money renting it to someone else. The same logic applies to business leases. A supplier might technically have the right to replace an asset, but if doing so is a headache, expensive, or just impractical, it’s nothing more than legal jargon.
Let us take the example of a manufacturing firm that leased a precision CNC machine—a behemoth of a thing, custom-programmed to produce aerospace components with microscopic tolerances. The supplier had a neatly worded contract stating they could replace the machine with another “equivalent” unit if necessary. But question may arise in this context: How many suppliers keep an extra multi-million-dollar precision machine just sitting in the backroom, waiting to be swapped? they do not. Even if they did, the new machine would require weeks of reprogramming, recalibration, and operator retraining a logistical nightmare. So, while the contract suggested flexibility, reality said otherwise. That CNC machine was, for all intents and purposes, an identified asset. Lease is recognized.
Now, let’s think other way round. What if substitution is actually possible? Picture a national logistics company leasing GPS-enabled delivery trucks from a fleet provider. If one truck breaks down, another can be deployed within hours, with minimal disruption. The supplier benefits financially by optimizing vehicle utilization, and the lessee never has control over a specific truck—just access to a working fleet. In this case, substitution is both practical and economically beneficial, meaning there’s no lease to recognize.
But here’s where things get more complex: what if substitution could happen but there’s no proof that it ever does? I once came across a contract for a company using high-security data servers in a third-party facility. The supplier retained the right to replace the servers whenever they wanted, but did they ever? No one could say. There were no records of past substitutions, no transparency around the process, and no reason to believe the supplier would willingly swap an expensive, fully operational server for fun. In cases like this, the accounting standards say: “If you can’t verify it, assume it doesn’t happen.” And that means lease recognition.
So, if we look at the outcomes of the above, a contractual right to substitute means nothing unless it is actually enforceable and beneficial. If a supplier would lose money or face operational chaos by exercising it, they would not. If the lessee cannot even tell whether it happens, the default assumption is that it doesn’t. And if common sense implies that replacing a one-of-a-kind, highly specialized asset that is nearly impossible, because the numbers on the balance sheet should reflect reality, not legal fiction.
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