17.3 Impact of IFRS 16
IFRS 16 is the new leases standard that is effective for annual reporting periods commencing
on or after 1 January 2019. IFRS 16 significantly changes the accounting for leases by lessees,
and could have far-reaching implications for the finances and operations of mining
companies and oil and gas companies. For example, determining which agreements are in
the scope of IFRS 16, applying the definition of a lease, and allocating contract consideration
to the lease and non-lease components of contracts will require judgement.
IFRS 16 requires lessees to recognise most leases on their balance sheets as lease
liabilities with corresponding right-of-use assets. Lessees will apply a single model for
most leases. Generally, the profit or loss recognition pattern will change as interest and
depreciation expenses are recognised separately in the statement of profit or loss
(similar to today’s finance lease accounting). However, lessees can make accounting
policy elections to apply accounting similar to operating lease accounting under IAS 17
to short-term leases and leases of low-value assets.
Lessor accounting is substantially unchanged from current accounting. As with IAS 17,
IFRS 16 requires lessors to classify their leases into two types: finance leases and
operating leases. Lease classification determines how and when a lessor recognises lease
revenue and what assets a lessor records.
For mining and oil and gas lessees, recognising lease-related assets and liabilities on their
balance sheets could have significant financial reporting and business implications.
IFRS 16 could influence leasing decisions and strategies (e.g. a customer may consider
shorter lease terms to minimise lease liabilities) and debt covenants and borrowing
capacity may be affected.
Implementing the standard could also require an entity to develop new processes and
controls to track and account for leases, including: (1) identifying a lease; (2) initially and
subsequently measuring lease-related assets and liabilities; (3) identifying and allocating
consideration to lease and non-lease components; and (4) collecting and aggregating the
information necessary for disclosure.
In addition, because the accounting for operating leases under IAS 17 and service
contracts is similar, entities may not have always focused on determining whether an
arrangement is a lease or a service contract. Some entities may need to revisit
assessments made under IAS 17 and IFRIC 4 because, under IFRS 16, most leases are
recognised on lessees’ balance sheets, and the effects of treating an arrangement as a
service instead of an arrangement containing a lease may be material. If an entity is able
to demonstrate that their IFRIC 4 assessments had been properly completed, lessees are
permitted to make an election not to reassess whether existing contracts contain a lease
as defined under IFRS 16. If an entity elects this practical expedient, contracts that do
not contain a lease under IAS 17 and IFRIC 4 (e.g. service arrangements) are not
reassessed either.
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While the requirements of the IFRS 16 model are discussed in detail in Chapter 24,
some of the key aspects of IFRS 16 that are particularly relevant to mining companies
and oil and gas companies include:
• scope and exclusions (see 17.3.1 below and Chapter 24 at 2.2);
• definition of a lease (see 17.3.2 below and Chapter 24 at 3.1);
• substitution rights (see 17.3.3 below and Chapter 24 at 3.1.3);
• arrangements entered into by joint arrangements (see 17.3.4 below and Chapter 24
at 3.1.1);
• identifying and separating lease and non-lease components and allocating contract
consideration (see 17.3.5 below and Chapter 24 at 3.2);
• identifying lease payments (see 17.3.6 below and Chapter 24 at 4.5.1);
• allocating contract consideration (see 17.3.7 below and Chapter 24 at 3.2.3.B); and
• interaction of leases and asset retirement obligations (see 17.3.8 below).
17.3.1
Scope and scope exclusions
17.3.1.A Mineral
rights
Consistent with IAS 17, leases to explore for or use minerals, oil, natural gas and similar
non-regenerative resources are excluded from the scope of IFRS 16 [IFRS 16.3] (amongst
other types of arrangements – see Chapter 24 at 2.2 for the full list of scope exclusions).
IFRS 16 does not specify whether the scope exclusion for leases to explore for or use
minerals, oil, natural gas and similar non-regenerative resources applies broadly to other
leases that relate to, or are part of, the process of exploring for, or using, those resources.
For example, in some jurisdictions, the minerals are owned by the government, but the
land within which the minerals are located is privately owned. In these jurisdictions, a
mining and metals entity needs to enter into a mineral lease with the government as well
as a surface lease (i.e. the right to use the land) with the private landowner. IFRS 16’s
Basis for Conclusions states that IFRS 6 specifies the accounting for rights to explore
for, and evaluate, mineral resources. [IFRS 16.BC68(a)].
Today, mining companies and oil and gas companies generally apply a similar IAS 17
scope exclusion to surface leases that are directly related to mineral rights. However,
they do not interpret the exclusion to extend to leases of equipment used in E&E and
other mining activities.
The new US GAAP leases standard (ASC 842 – Leases), includes more specific guidance
on how this scope exclusion should be applied. It states that leases of minerals, oil,
natural gas and similar non-regenerative resources, including the intangible rights to
explore for those resources and the rights to use the land in which those natural
resources are contained (unless those rights of use include more than the right to
explore for natural resources) are outside the scope of ASC 842. However, equipment
used to explore for the natural resources is within the scope of ASC 842.2.
Given lease accounting will not have to be applied to leases which fall within this scope
exclusion, entities will need to continue to apply judgement to determine how broadly
to interpret and apply this scope exclusion under IFRS 16.
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IFRS 16 is not specific as to whether the scope exclusion only applies to mineral rights in
the E&E phase or whether it also applies to other rights (e.g. exploitation and/or extraction
rights that arise in connection with development and production phases). The wording of
the exclusion specifies that it applies to ‘leases to explore for or use minerals’ (emphasis
added), which suggests that it applies more broadly (i.e. to the E&E, development and
production phases). However, the reference to IFRS 6 in the Basis for Conclusions of
IFRS 16 [IFRS 16.BC68(a)] may infer that the exclusion is limited to rights in the E&E phase.
Today, mining companies and oil and gas companies generally apply the IAS 17 scope
exclusion to the mineral rights in the E&E, development and production phases. We would
expect that given the wording in the main body of the standard, the scope exclusion would
continue to apply to mineral rights in all pha
ses. We would also expect that consistent with
ASC 842, in the event that rights extend include more than the right to explore for or use
natural resources, the scope exclusion would not apply. For example, in the event that
there is also a corporate head office building on part of the land, an apportionment would
be applied, and the scope exclusion would not apply to the portion of the land upon which
the head office is built. Furthermore, we would not expect the scope exclusion to extend
to equipment used to explore, develop or produce mineral rights.
17.3.1.B
Land easements or rights of way
Land easements or rights of way are rights to use, access or cross another entity’s land
for a specified purpose. For example, a land easement might be obtained for the right
to construct and operate a pipeline or other assets (e.g. railway line) over, under or
through an existing area of land or body of water while allowing the landowner
continued use of the land for other purposes (e.g. farming), as long as the landowner
does not interfere with the rights conveyed in the land easement.
When determining whether a contract for a land easement or right of way is a lease,
mining companies and oil and gas companies will need to assess whether there is an
identified asset and whether the customer obtains substantially all of the economic
benefits of, the identified asset and has the right to direct the use of that asset(s)
throughout the period of use.
This will require careful consideration of the rights and obligations in each arrangement
and conclusions may vary given the nature of these contracts can also vary by jurisdictions.
The issue of accounting for land easements is discussed in Chapter 24 at 3.1.2.
17.3.2
Definition of a lease
A lease is a contract (i.e. an agreement between two or more parties that creates
enforceable rights and obligations), or part of a contract, that conveys the right to use
an asset (the underlying asset) for a period of time in exchange for consideration. To be
a lease, a contract must convey the right to control the use of an identified asset.
A wide variety of arrangements exist in the mining sector and oil and gas sector that may
provide a right to control the use of an identified asset(s). Some examples include:
mining or oil field services contracts (e.g. equipment used to deliver a service, including
drilling contracts); shipping, freight and other transportation arrangements, including
railway infrastructure and harbour loading services contracts; refining, processing and
tolling arrangements; and storage arrangements (including certain capacity portions of
such arrangements). Also, while not specific to the mining sector or oil and gas sector,
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there are many other arrangements commonly entered into by mining companies and
oil and gas companies that will also need to be considered. Such arrangements include
outsourcing arrangements, such as IT; and utility supply arrangements, such as those for
the purchase of gas, electricity, water or telecommunications.
All of these arrangements will need to be assessed to determine whether they represent,
or contain, a lease.
17.3.3 Substitution
rights
IFRS 16 states that even if an asset is specified in an arrangement, a customer does not
have the right to use an identified asset if, at inception of the contract, a supplier has the
substantive right to substitute the asset throughout the period of use. A substitution right
is substantive if the supplier has both the practical ability to substitute alternative assets
throughout the period of use and the supplier would benefit economically from
exercising its right to substitute the asset. If the customer cannot readily determine
whether the supplier has a substantive substitution right, the customer presumes that
any substitution right is not substantive.
Entities will need to carefully evaluate whether a supplier’s substitution right is
substantive based on facts and circumstances at inception of the contract. 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]. For example, an
asset is highly customised and/or significant costs have been incurred to ensure the asset
meets the specifications required by the contract such that the supplier would not
benefit economically from exercising its substitution right. In addition, the supplier’s
substitution rights may not be substantive if alternative assets are not readily available
to the supplier or they could not be sourced by the supplier within a reasonable period
of time and hence there is no practical ability to substitute them.
While IFRIC 4 had a similar concept of substitution rights, the requirement that a substitution
right must benefit the supplier economically in order to be substantive, is a new concept.
See Chapter 24 at 3.1.3 for further discussion.
17.3.4
Arrangements entered into by joint arrangements
Mining companies and oil and gas companies often enter into joint arrangements and
these are effected by a joint operating agreement (JOAs) with other entities. A contract
for the use of an asset by a joint arrangement might be entered into in a number of
different ways, including:
• Directly by the joint arrangement, if the joint arrangement has its own legal identity.
• By each of the parties to the joint arrangement (i.e. the lead operator and the other
parties, commonly referred to as the non-operators) individually signing the same
arrangement.
• By one or more of the parties to the joint arrangement on behalf of the joint
arrangement.
• By the lead operator of the joint arrangement in its own name, i.e. as principal. This
may occur where the lead operator leases equipment which it then uses in fulfilling
its obligations as manager of the joint arrangement and/or across a range of unrelated
activities, including other joint arrangements with different joint operating parties.
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IFRS 16 states that where a contract has been entered into by a joint arrangement, or on
behalf of the joint arrangement, the joint arrangement is considered to be the customer
in the contract. [IFRS 16.B11)]. Accordingly, in determining whether such a contract
contains a lease, an assessment needs to be made as to which party (i.e. the supplier and
either the joint arrangement or the lead operator) has the right to control the use of an
identified asset throughout the period of use.
There has been, and continues to be, considerable debate as to how the term ‘on behalf
of the joint arrangement’ should be interpreted and applied in practice. This issue was
submitted to the Interpretations Committee and they considered this at their September
2018 meeting. Specifically, they discussed a fact pattern whereby one of the joint
operators, being the lead operator, in an unincorporated joint arrangement (i.e. a joint
operation), as the sole signatory, enters into a lease arrangement with a third-party
lessor in relation to an item of property, plant and equipment that will be operated
jointly as part of the JOA. In addition, the lead operator has the right to recover a share
of the lease costs from the other joint operators (the non-operators) in accordance with
the JOA. The submitter asked if the lead operator should recognise, in full, the lease
liability for the lease arrangement for which the lead operator alone has the primary
obligation to make payment to the lessor.
See Chapter 24 at 3.1.1 for more information on this issue and the outcome of the
Interpretations Committee’s September meeting.
Evaluating the requirements of IFRS 11 and IFRS 16 for arrangements entered into by
joint arrangements may involve significant judgement. As entities continue to evaluate
the impact of such requirements, interpretations may evolve. Mining companies and oil
and gas companies may also need to exercise judgement in determining how to disclose
information about leases that will be meaningful to financial statement users,
particularly when they are lead operators of some leased assets and non-operators of
other assets for which they may recognise their share of a sublease and/or recognise
joint interest payables for activities the lead operator performs using leased assets.
17.3.5
Identifying and separating lease and non-lease components
Many contracts may contain a lease(s) coupled with an agreement to purchase or sell
other goods or services (non-lease components). Examples of contracts in the mining
sector and oil and gas sector that may contain a lease and significant non-lease
components for services provided by the supplier include but are not limited to:
• transportation and storage contracts, which generally require the supplier to
operate the facilities, and/or provide staff/crew;
• outsourced mining services contracts or oilfield services arrangements including
closure arrangements; and
• exploration drilling contracts, which typically include operation services.
For these contracts, the non-lease components are identified and accounted for
separately from the lease component(s), in accordance with other standards. For
example, the non-lease components may be accounted for as executory arrangements
by lessees (customers) or as contracts subject to IFRS 15 by lessors (suppliers).
See Chapter 24 at 3.2.2 for further information.
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International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 669
