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19RU-002 Leases and joint operations

19RU-002 Leases and joint operations

The IFRS Interpretations Committee has issued its final agenda decision on how the lead operator in a joint operation accounts for lease arrangements. KPMG’s Insights includes updated guidance on accounting for leases in joint arrangements.

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Agenda decision finalised

In March 2019, the IFRS Interpretations Committee (IFRS IC) issued its final agenda decision on how the lead operator in a joint operation accounts for lease arrangements. The question has been raised by a number of entities as part of their implementation of IFRS 16 Leases.

The decision outlines situations where the joint operation is not structured through a separate vehicle and the lead operator, as a sole signatory, enters into a lease contract with a third party for an item of property, plant and equipment that will be operated jointly as part of the joint operation’s activities.

The IFRS IC noted that IFRS 11 Joint Arrangements requires the liabilities that a joint operator recognises to include those for which it has primary responsibility. That is, where the lead operator is a sole signatory it would account for the full lease liability on its balance sheet.

In addition, the lead operator would initially account for the entire right-to-use asset. The lead operator would then need to assess contractual arrangements with the other joint operation investors to determine whether a sub-lease is present.

KPMG has updated its guidance on this issue in Insights. Refer to Appendix 1 for three practical examples contained in our guidance.

The IFRS IC agenda decisions is reproduced in Appendix 2 of the attached PDF file. 

Both appendices are included in the PDF version.

Impact of IFRS 16 on joint arrangements

IFRS 16 defines a leases as a contract, or part of a contract, that conveys the right to control the use of an identified asset (the underlying asset) for a period of time in exchange for consideration. If a contract contains a lease, then it will generally be on-balance sheet for the lessee.

To determine whether a contract conveys the right to control the use of an identified asset for a period of time, an entity assesses whether, throughout the period of use, the customer has a right to:

  • obtain substantially all the economic benefits from use of the identified asset, and
  • direct the use of the identified asset.

If the customer in the contract is a joint arrangement, then an entity considers whether the joint arrangement has the right to control the use of an identified asset throughout the period of use.

Can a joint arrangement be a lessee?

Yes. A joint arrangement – i.e. a joint venture or joint operation – may be a lessee in a lease, provided that the parties to the joint arrangement collectively have the right to control the use of an identified asset throughout its period of use. In many cases, this control is exercised through the joint control of the arrangement.

It would be inappropriate to conclude that a contract does not contain a lease if each of the parties to the joint arrangement:

  • obtains only a capacity portion that is not physically distinct
  • obtains only a portion of the economic benefits from use of the underlying asset, or
  • does not unilaterally direct the use of the underlying asset.

Which party/parties signed the contract?

For a joint arrangement to be a lessee, it must first be identified as the customer in the lease contract with the asset supplier. This means that the contract with the asset supplier is:

  • entered into by the joint arrangement itself, or
  • signed by one or more parties to the joint arrangement on behalf of the joint arrangement.

When the joint arrangement is considered to be the customer in a lease, the accounting for the lease is as follows:

  • For a joint operation where the lead operator has signed the lease contract with the asset supplier:
    • The lead operator will account for the full lease liability on its balance sheet. In addition, the lead operator would initially account for the entire right-to-use asset.
    • The lead operator would then need to assess contractual arrangements with the other joint operation investors to determine whether a sub-lease is present.
    • If a sub-lease is present then the other joint operation investors will account for their respective share of the right-of-use asset and their share of the lease liability in their respective financial statements
    • If a sub-lease is not present then the other joint operation investors do not account for the lease on balance sheet.
  • For a joint operation where all investors have signed the lease contract with the asset supplier each party to the joint operation accounts for its share of the right-of-use asset and its share of the lease liability in its own financial statements.
  • For a joint venture, the right-of-use asset and lease liability are recognised in the financial statements of the joint venture, but not in the financial statements of the partners to the joint venture.

Therefore identifying the customer is critical to determining the accounting for each of the investors in a joint arrangement.

The key consideration for determining if a sub-lease is present is the assessment of who controls the use of the underlying asset:

  • If the lead operator solely controls the use of the underlying asset then a sub-lease would not be present. The other joint operation investors would account for the reimbursement right under the joint operation contract arrangement between all investors. That is, most likely as an executory contract over time, based on usage.
  • If there is collective control over the underlying asset by all joint operation investors then a sub-lease would be present. The lead operator would be the lessor in the sub-lease and the other investors would be lessees. As a lessee the other joint operation investors will account for their respective share of the right-of-use asset and their share of the lease liability.

Refer to Appendix 1 (included in PDF version) for and extract from KPMG’s Insights in relation to the above.

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