When is a lease not a lease? When it does not meet the definition of a lease.
Why is this important? Well, if an agreement does not meet the definition of a lease under AASB 16 Leases, then it is not accounted for on-balance sheet. This issue is important for common leases that agencies have with the Department of Housing and Public Works (DHPW) that we discuss later.
Under AASB 16, a lease is defined as an agreement, or part of an agreement, that conveys the right to control the use of an identified asset. The definition does not refer to an agreement labelled as a lease. Agreements not labelled as a lease may meet the definition of a lease under AASB 16; conversely, an agreement labelled as a lease may not meet the accounting definition of a lease.
When discussing leases, it is useful to refer to the quote by Sir David Tweedie, the then Chairman of the International Accounting Standards Board (IASB) on April 25, 2008 when he said, ‘One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet.’
It is often easiest to explain the implications of the definition of a lease with hidden leases, also referred to as embedded leases. To help us with this issue, AASB 16 provides some guidance. As AASB 16 is equivalent to International Financial Reporting Standards (IFRS) 16 Leases, issued by the IASB, the IFRS 16 Illustrative Examples are also useful references1.
One criteria for control of the use of an identified asset is the right to direct the use of that identified asset.
The IFRS 16 Illustrative Examples use agreements for the use of rail cars, and which party directs the use of the rail cars, to illustrate whether there is a lease hidden (or embedded) within the agreement. Under one set of facts, the customer has the right to control the use of identified rail cars, and the definition of a lease is met, even though the agreement is not labelled as a lease. In the other set of facts, the supplier has a ‘substantive substitution right’ to change the individual rail cars available to the customer, and consequently, the customer does not have the right to direct the use of an identified asset, as the asset may change.
Application to local councils
Local councils often outsource rubbish collection to private sector service providers. The question is, if aircraft go on-balance sheet for airlines, should rubbish trucks that rubbish collection service providers use go on council balance sheets? That is, does the local council have a hidden or embedded lease in its service agreements?
When we apply the above reasoning to rubbish collection service agreements, we usually find that the trucks collecting the rubbish are not individually identified in the agreement. For example, the agreements may refer generally to (say) 10 trucks being available, or may only refer to sufficient trucks being made available. Even if the trucks are individually identified, we usually find that the council cannot direct the use of an individually identified truck to be used on a particular route on a particular day.
As the council cannot direct the use of an identified asset (a truck), the definition of a lease is not met, and despite initial appearances, the rubbish trucks would not go on-balance sheet.
Leases that are not leases
A lease agreement may not meet the definition of a lease because there is no right to direct the use of an identified asset. This may arise because the supplier/lessor has a ‘substantive substitution right’, that we discussed above, and consequently the customer does not have the right to direct the use of an identified asset.
For the substitution right to be effective in excluding the agreement from AASB 16, the right must be substantive. The standard provides guidance on what this means. To be substantive, the right must give the supplier the practical ability to substitute an alternative asset throughout the period of use and the supplier would benefit economically from the substitution. For example, the right of the supplier to substitute the asset while it is undertaking repairs and maintenance is not sufficient.
Department of Housing and Public Works (DHPW) leases
Working with Queensland Treasury and DHPW, we have applied the above reasoning to the DHPW arrangements for non-specialised commercial office accommodation under the Queensland Government Accommodation Office’s (QGAO) Office Accommodation Management Framework (the framework).
Based on the objectives of the framework (and its associated documents2) and the fact that DHPW manages office accommodation on a whole-of-government basis, we have reached agreement with Treasury and DHPW that such accommodation is subject to a substantive substitution right.
In effect, DHPW has the power to move public sector agencies amongst DHPW-managed office accommodation when this provides a whole-of-government benefit. Consequently, agencies do not have the right to direct the use of an identified asset, being the identified floor(s) of the current accommodation. Essentially, agencies have a right to occupy certain sized office accommodation, but not on specific floors at a specific location.
Consequently, the office accommodation arrangements do not meet the definition of a lease under AASB 16.
We have reached similar agreement relating to DHPW leases for:
- fleet vehicles provided to agencies through QFleet
- residential accommodation properties under the Government Employee Housing (GEH) program.
While many people can relate to Sir David Tweedie’s aircraft on-balance sheet analogy, the detail is more complicated. You should check your arrangements, whether labelled leases or not, for hidden and embedded leases, and whether other arrangements may be excluded based on substantive substitution rights.
1. Illustrative examples to IFRS standards, as well as implementation guidance and the basis for conclusions, can be obtained by going to the AASB website, locating the table of standards (or interpretations) and clicking on the ‘Extra’ material. The table of standards is here.
2. Department of Housing and Public Works Office Accommodation Management Framework (OAMF) website
- OAMF Framework policy
- OAMF Framework Policy Guideline 2: Space. Policy and guidelines for the use of owned and private sector leased government office accommodation
- OAMF Guideline 4: Occupancy
- OAMF Guideline 2: Space and Guideline 4: Occupancy. Occupancy Agreement for Government Accommodation between Department of Housing and Public Works and Agencies