• the introduction of new technology that is not substantially developed at inception
of the contract;
• a substantial difference between the customer’s use of the asset, or the
performance of the asset, and the use or performance considered likely at
inception of the contract; and
• a substantial difference between the market price of the asset during the period of
use, and the market price considered likely at inception of the contract. [IFRS 16.B16].
The requirement that a substitution right must benefit the supplier economically in
order to be substantive is a new concept. In many cases, it will be clear that the supplier
will not benefit from the exercise of a substitution right because of the costs associated
with substituting an asset. [IFRS 16.BC113]. If an asset is located at the customer’s premises
or elsewhere, the costs associated with substitution are generally higher than when
located at the supplier’s premises, and therefore, are more likely to exceed the benefits
associated with substituting the asset. [IFRS 16.B17]. However, simply because a supplier
concludes that the cost of substitution is not significant does not automatically mean
that it would economically benefit from the right of substitution.
IFRS 16 further clarifies that a customer should presume that a supplier’s substitution
right is not substantive when the customer cannot readily determine whether the
supplier has a substantive substitution right. [IFRS 16.B19]. This requirement is intended to
clarify that a customer is not expected to exert undue effort to provide evidence that a
substitution right is not substantive. We believe that the Board did not include a similar
provision for suppliers, because they should have sufficient information to make a
determination of whether a substitution right is substantive.
Contract terms that allow or require a supplier to substitute alternative assets only when
the underlying asset is not operating properly (e.g. a normal warranty provision) or when
a technical upgrade becomes available do not create a substantive substitution right.
[IFRS 16.B18].
Example 24.5: Substitution rights
Scenario A:
Assume that an electronic data storage provider (supplier) provides services, through a centralised data centre, that
involve the use of a specified server (Server No. 9). The supplier maintains many identical servers in a single,
accessible location and determines, at inception of the contract, that it is permitted to and can easily substitute another server without the customer’s consent throughout the period of use. Further, the supplier would benefit economically
from substituting an alternative asset, because doing this would allow the supplier to optimise the performance of its
network at only a nominal cost. In addition, the supplier has made clear that it has negotiated this right of substitution as an important right in the arrangement, and the substitution right affected the pricing of the arrangement.
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Analysis: The customer does not have the right to use an identified asset because, at the inception of the
contract, the supplier has the practical ability to substitute the server and would benefit economically from
such a substitution. However, if the customer could not readily determine whether the supplier had a
substantive substitution right (e.g. there is insufficient transparency into the supplier’s operations), the
customer would presume the substitution right is not substantive and conclude that there is an identified asset.
Scenario B:
Assume the same facts as in Scenario A except that Server No. 9 is customised, and the supplier does not
have the practical ability to substitute the customised asset throughout the period of use. Additionally, it is
unclear whether the supplier would benefit economically from sourcing a similar alternative asset.
Analysis: Because the supplier does not have the practical ability to substitute the asset and there is no evidence
of economic benefit to the supplier from substituting the asset, the substitution right is non-substantive, and
Server No. 9 would be an identified asset. In this case, neither of the conditions of a substitution right is met. As
a reminder, both conditions must be met for the supplier to have a substantive substitution right.
3.1.4
Right to obtain substantially all of the economic benefits from use of
the identified asset
To control the use of an identified asset, a customer is required to have the right to
obtain substantially all of the economic benefits from use of the asset throughout the
period of use (for example, by having exclusive use of the asset throughout that period).
A customer can obtain economic benefits from use of an asset directly or indirectly in
many ways, such as by using, holding or sub-leasing the asset. The economic benefits
from use of an asset include its primary output and by-products (including potential cash
flows derived from these items), and other economic benefits from using the asset that
could be realised from a commercial transaction with a third party. [IFRS 16.B21].
The term ‘substantially all’ is not defined in IFRS 16. However, entities might consider
the term similarly to how it is used in IAS 17 in the context of lease classification.
Economic benefits arising from construction or ownership of the identified asset (e.g.
tax benefits related to excess tax depreciation and investment tax credits as discussed
in IFRS 16.BC 118) are not considered economic benefits derived from the use of the
asset. Therefore, they are not considered when assessing whether a customer has the
right to obtain substantially all of the economic benefits.
When assessing the right to obtain substantially all of the economic benefits from use of
an asset, an entity considers the economic benefits that result from use of the asset
within the defined scope of a customer’s right to use the asset. For example:
(a) if a contract limits the use of a motor vehicle to only one particular territory during
the period of use, an entity considers only the economic benefits from use of the
motor vehicle within that territory, and not beyond; or
(b) if a contract specifies that a customer can drive a motor vehicle only up to a
particular number of miles during the period of use, an entity considers only the
economic benefits from use of the motor vehicle for the permitted mileage, and
not beyond. [IFRS 16.B22].
If a contract requires a customer to pay the supplier or another party a portion of the cash
flows derived from use of an asset as consideration, those cash flows paid as consideration
are considered to be part of the economic benefits that the customer obtains from use of
the asset. For example, if the customer is required to pay the supplier a percentage of sales
from use of retail space as consideration for that use, that requirement does not prevent the
Leases (IFRS 16) 1703
customer from having the right to obtain substantially all of the economic benefits from use
of the retail space. This is because the cash flows arising from those sales are considered to
be economic benefits that the customer obtains from use of the retail space, a portion of
which it then pays to the supplier as consideration for the right to use that space. [IFRS 16.B23].
3.1.5
R
ight to direct the use of the identified asset
A customer has the right to direct the use of an identified asset throughout the period
of use when either:
• the customer has the right to direct how and for what purpose the asset is used
throughout the period of use; or
• the relevant decisions about how and for what purpose an asset is used are
predetermined; and
• the customer either 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 supplier having the right to change those operating instructions; or
• the customer designed the asset, or specific aspects of the asset, in a way that
predetermines how and for what purpose the asset will be used throughout
the period of use. [IFRS 16.B24].
Requiring a customer to have the right to direct the use of an identified asset is a change
from IFRIC 4. A contract may have met IFRIC 4’s control criterion if, for example, the
customer obtained substantially all of the output of an underlying asset and met certain
price-per-unit-of-output criteria even though the customer did not have the right to
direct the use of the identified asset as contemplated by IFRS 16. Under IFRS 16, such
arrangements would no longer be considered leases.
3.1.5.A
How and for what purpose the asset is used
A customer has the right to direct how and for what purpose the asset is used if, within the
scope of its right of use defined in the contract, it can change how and for what purpose
the asset is used throughout the period of use. In making this assessment, an entity
considers the decision-making rights that are most relevant to changing how and for what
purpose the asset is used throughout the period of use. Decision-making rights are relevant
when they affect the economic benefits to be derived from use. The decision-making rights
that are most relevant are likely to be different for different contracts, depending on the
nature of the asset and the terms and conditions of the contract. [IFRS 16.B25].
How and for what purpose an asset is used is a single concept (i.e. ‘how’ an asset is used
is not assessed separately from ‘for what purpose’ an asset is used). [IFRS 16.BC120].
The IASB have indicated that decisions about how and for what purpose an asset is used
can be viewed as similar to the decisions made by a board of directors. Decisions made
by a board of directors about the operating and financing activities of an entity are
generally the most relevant decisions rather than the actions of individuals
implementing those decisions. [IFRS 16.BC120].
Examples of decision-making rights that, depending on the circumstances, grant the
right to change how and for what purpose the asset is used, within the defined scope of
the customer’s right of use, include:
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(a) rights to change the type of output that is produced by the asset (for example, to
decide whether to use a shipping container to transport goods or for storage, or to
decide upon the mix of products sold from retail space);
(b) rights to change when the output is produced (for example, to decide when an item
of machinery or a power plant will be used);
(c) rights to change where the output is produced (for example, to decide upon the
destination of a truck or a ship, or to decide where an item of equipment is used); and
(d) rights to change whether the output is produced, and the quantity of that output
(for example, to decide whether to produce energy from a power plant and how
much energy to produce from that power plant). [IFRS 16.B26].
Examples of decision-making rights that do not grant the right to change how and for what
purpose the asset is used include rights that are limited to operating or maintaining the
asset. Such rights can be held by the customer or the supplier. Although rights such as those
to operate or maintain an asset are often essential to the efficient use of an asset, they are
not rights to direct how and for what purpose the asset is used and are often dependent on
the decisions about how and for what purpose the asset is used. However, rights to operate
an asset may grant the customer the right to direct the use of the asset if the relevant
decisions about how and for what purpose the asset is used are predetermined. [IFRS 16.B27].
The customer does not need the right to operate the underlying asset to have the right
to direct its use. That is, the customer may direct the use of an asset that is operated by
the supplier’s personnel. However, as discussed at 3.1.5.B below, the right to operate an
asset will often provide the customer the right to direct the use of the asset if the relevant
decisions about how and for what purpose the asset is used are predetermined.
3.1.5.B
Relevant decisions about how and for what purpose the asset is used are
predetermined
In some cases, it will not be clear whether the customer has the right to direct the use of
the identified asset. This could be the case when the most relevant decisions about how
and for what purpose an asset is used are predetermined by contractual restrictions on
the use of the asset (e.g. the decisions about the use of the asset are agreed to by the design
of the asset or by contractual restrictions on the use of the asset). This may occur when
the customer and the supplier in negotiating the contract predetermined the most relevant
decisions and those decisions cannot be changed. The IASB indicated that it would expect
decisions about how and for what purpose an asset is used to be predetermined in few
cases. [IFRS 16.BC121]. In such cases, a customer has the right to direct the use of an identified
asset throughout the period of use when the customer either:
• has the right to operate the asset, or direct others to operate the asset in a manner
it determines, throughout the period of use without the supplier having the right
to change those operating instructions; or
• designed the asset (or specific aspects of the asset) in a way that predetermines how
and for what purpose the asset will be used throughout the period of use. [IFRS 16.B24].
Significant judgement may be required to assess whether a customer designed the asset
(or specific aspects of the asset) in a way that predetermines how and for what purpose
the asset will be used throughout the period of use.
Leases (IFRS 16) 1705
3.1.5.C
Specifying the output of an asset before the period of use
As noted above, the relevant decisions about how and for what purpose the asset is used
can be predetermined in a number of ways. For example, the relevant decisions can be
predetermined by the design of the asset or by contractual restrictions on the use of the
asset. [IFRS 16.B28].
In assessing whether a customer has the right to direct the use of an asset, an entity
considers only rights to make decisions about the use of the asset during the period of
use, unless how and for what purpose an asset is used is predetermined. See 3.1.5.B
above. Consequently, unless the customer designed the asset (or specific aspects of the
asset) in a way that predetermines how and for what purposes the asset will be used
predetermined before the period of use. For example, if a customer is able only to
specify the output of an asset before the period of use, the customer does not have the
right to direct the use of that asset throughout the period of use. The ability to specify
the output in a contract before the period of use, without any other decision-making
rights relating to the use of the asset, gives a customer the same rights as any customer
that purchases goods or services. [IFRS 16.B29].
3.1.5.D Protective
rights
A contract may include terms and conditions designed to protect the supplier’s interest
in the asset or other assets, to protect its personnel, or to ensure the supplier’s
compliance with laws or regulations. These are examples of protective rights. For
example, a contract may (i) specify the maximum amount of use of an asset or limit
where or when the customer can use the asset, (ii) require a customer to follow
particular operating practices, or (iii) require a customer to inform the supplier of
changes in how an asset will be used. Protective rights typically define the scope of the
customer’s right of use but do not, in isolation, prevent the customer from having the
right to direct the use of an asset. [IFRS 16.B30].
Example 24.6: Right to direct the use of an asset
Customer X enters into a contract with Supplier Y to use a vehicle for a three year period. The vehicle is
identified in the contract. Supplier Y cannot substitute another vehicle unless the specified vehicle is not
operational (e.g. it breaks down).
Under the contract:
• Customer X operates the vehicle (i.e. drives the vehicle) or directs others to operate the vehicle (e.g. hires
a driver);
• Customer X decides how to use the vehicle (within contractual limitations, discussed below). For example,
throughout the period of use, Customer X decides where the vehicle goes as well as when or whether it is
used and what it is used for. Customer X can also change these decisions throughout the period of use; and
• Supplier Y prohibits certain uses of the vehicle (e.g. moving it overseas) and modifications to the vehicle
to protect its interest in the asset.
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 336
