Ensuring your lease population is complete

Background

For year ends 31 December 2019 and onwards, the long awaited new accounting standard regarding leases (NZ IFRS 16 Leases) comes into effect.

A key (and often overlooked) aspect of the adoption of NZ IFRS 16 is confirming that an entity’s lease population is ultimately “complete” – i.e. all agreements that are “leases” for accounting purposes (i) have been identified as such, and (ii) will therefore be accounted for as such.

This Cheat Sheet has been produced as a high-level overview of why lease population completeness is important, and the steps an entity can take to confirm the completeness of their lease population upon adopting NZ IFRS 16.

Need assistance with your adoption of NZ IFRS 16?

BDO IFRS Advisory is a dedicated service line available to assist entities in adopting NZ IFRS 16. Further details are provided on the following page for your information.

What is covered in the Cheat Sheet

In order to navigate through this area of NZ IFRS 16, this Cheat Sheet is broken down into the following sections:

1. Is the definition of a “lease” different now under NZ IFRS 16
2. Have all an entity’s “leases” been correctly identified previously
3. Who will be concerned about lease population completeness
4. What types of arrangements might definition of a “lease”
5. Approaches to investigating lease population completeness

1. Is the definition of a “lease” different now under NZ IFRS 16

The definition of a “lease” under NZ IFRS 16 is a rough composite of the definition and other principals that existed previously under the old standard (NZ IAS 17 Leases) and accounting interpretation (NZ IFRIC 4 Determining whether an Arrangement contains a Lease).

Put simply, a “lease” is an arrangement where (i) there is an asset, (ii) the entity gets substantially all benefit from the use of that asset, and (iii) the entity can direct the use of that asset.

The commentary to NZ IFRS 16 notes that there should only be a limited number of specific instances where whether an arrangement meets (or does not met) the definition of “lease” will change when NZ IFRS 16 is adopted[1]:

• Some very specific arrangements (i.e. certain “take-or-pay” arrangements) will no longer be defined as “leases”.
• No arrangements will suddenly be (re)defined as “leases”.

So for most entities, the lease population under NZ IFRS 16 will simply include the entity’s arrangements that were previously classified as Operating leases and Finance leases… subject to considering 2. below.

2. Have all an entity’s “leases” been correctly identified previously

An incorrect assumption to 1. above is that (except for certain “take-or-pay” arrangements) the lease population upon adopting NZ IFRS 16 is simply limited to previous Operating leases and Finance leases that have been accounted for.

Doing so makes the assumption that previously an entity has assessed all of its arrangements, and then correctly determined whether the accounting definition of a “lease” was (or was not) met.

Simply because an arrangement may be written up and headed as a “Lease”, does not mean that it automatically meets the definition of a “lease” for accounting purposes (and vice versa).

However, not correctly making this determination may not previously have had a material impact to the financial statements. This is because the accounting treatment of an arrangement as a (operating) lease or not (i.e. as a service contract), was exactly the same – i.e. payments recognised in profit or loss as operating expenses.

However the accounting for leases under NZ IFRS 16 is significantly different, and as such the determination of whether the definition of a lease has been met has renewed focus an impetus.

3. Who will be concerned about lease population completeness

All entities have a requirement to ensure accounting standards are applied accurately.

For those entities adopting NZ IFRS 16, the completeness of their lease population is integral to this, and will therefore need to be considered on the facts or circumstances specific to each entity.

For those entities subject to external audit and/or regulator oversight, an entity’s approach to assessing lease population completeness, and the outcomes of its investigations, will (more likely than not) need to be documented and supported such that it can be assessed and reviewed.

In our experience, this is the key (first) step in adopting NZ IFRS 16 many entities commonly overlook.

4. What service-type arrangements met the definition of a “lease”

Often, whether or not arrangements are leases for accounting purposes boils down to very, entity-specific facts and circumstances.

Ultimately, entities need to refer back to the guidance in NZ IFRS 16 relating to the definition of a lease, and in particular the flow diagram in paragraph B31 (reproduced below).

In summary, service-type arrangements where further analysis may need to be undertaken are typically those where a service (e.g. transport) is provided to an entity via the full (or substantially all) of the practicable service potential of an identifiable item or piece of equipment (e.g. a shipping container/rail carriage/truck/train/ship etc.).

To date, we have seen the following service-type arrangements coming under additional scrutiny upon adopting NZ IFRS 16:

Shipping and logistics	Arrangements where delivery services are provided by:   Substantially all of the supplier’s equipment. Equipment is specified and at the exclusive use of the entity, with the nature and timing of delivery services at the entity’s direction (rather than a pre-determined delivery schedule). Where the equipment being used was previously designed specifically by the entity.
Technology services	Arrangements where entities are able to pro-actively direct how and when underlying IT infrastructure used to deliver technology services.
Power supply	Arrangements with similar features to those above for Shipping and logistics.
Use of space or capacity	Arrangements for the use of ‘space’ or substantially all of the ‘capacity’ of an item,that cannot be substantively substituted, for which an entity is able to direct the use and operate the ‘space’ or ‘capacity’.

5. Approaches to determining lease population completeness

Any approach to determining lease population completeness needs to be undertaken with an entity’s specific facts and circumstances in mind. Also, it is recommended that the approach be discussed and agreed with an entity’s auditor (where applicable) prior to commencement – i.e. to ensure expectations regarding work to be undertaken and documented are aligned upfront.

Below is a (non-exhaustive) list of potential investigations an entity could execute in determining its lease population completeness:

Investigation approach	Description
Anecdotal commentary	Reviewing the nature of an entity’s operations and in-place (service) arrangements against the elements embedded in the definition of a “lease” (i.e. per the above flow diagram).
Reviewing transactions within “at risk” expense codes	Reviewing the nature of transactions recorded in general ledge expense codes including (but not limited to): Transport; Delivery; IT Services; Electricity etc.
Reviewing supplier and creditor lists, and register of contracts	Reviewing system generated supplier and creditor lists, and the entity’s register of contracts, and for each: Noting whether they relate to (i) the supply of goods, (ii) previous Operating or Financing leases, or (iii) other services. For (iii), other services, proving a detailed description of the nature of the services provided and why these are (not) considered leases per the definition.
Reviewing Automatic Payments and Direct Credit Payments	Reviewing the Automatic Payments and Direct Credit Payments set up in an entity’s bank account(s), and for each undertaking the same investigation as for supplier and creditor lists above.

Remember, for those entities subject to external audit and/or regulator oversight how these are documented and supported will need to be considered when an entity is compiling its NZ IFRS 16 adoption information.

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