BLM10012 - Lease accounting: accounting standards: accounting definition of a lease
This manual is being updated to reflect FRS 102 (2024 amendments). For guidance on the tax treatment of accounts prepared under IFRS 16 or the revised FRS 102, please refer to pages within the BLM50000 chapter.
In some circumstances, it will be necessary to determine whether an agreement falls to be treated as a lease for accounting purposes. In particular, while some parts of tax legislation contain their own definition of leasing, other parts define leasing with reference to accounting standards.
The accounting definition of a lease varies depending on the accounting framework applied.
UK GAAP (pre 2024 amendments) & FRS 105
Prior to the 2024 Amendments FRS 102 (Appendix I Glossary) defined a lease as:
“An agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.”
FRS 105 continues to use this definition following the UK GAAP 2024 periodic review amendments.
UK GAAP 2024 Periodic Review Amendments & IFRS 16
FRS 102 (2024 amendments) and IFRS 16 take an alternative approach by defining whether a contract is, or contains, a lease.
FRS 102 (2024 amendments): Appendix I Glossary and IFRS 16 Defined Terms both define a lease as “A contract, 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.”
FRS 102 (2024 amendments) 20.15 and IFRS 16.9 state that “…A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.”
An identified asset may be specified explicitly in a contract or implicitly at the time it is made available for use by the customer but (even if specified in the contract) there is no identified asset if the supplier has a substantive right to substitute the asset throughout the period of use (FRS 102 (2024 amendments) 20.19 & 20; IFRS 16.B13 & B14).
FRS 102 (2024 amendments) 20.16 further states that "A contract conveys the right to control the use of an identified asset when, throughout the period of use, the customer has both the right to direct the use of the identified asset, and the right to obtain substantially all the economic benefits from that use. If the customer has the right to control the use of the identified asset for only a portion of the term of the contract, the contract contains a lease for that portion of the term.” Equivalent wording is also found at IFRS 16.B9.
Whilst the requirements in FRS 102 (2024 amendments) and IFRS differ from FRS 102 (pre 2024 amendments), conclusions about whether a lease exists are not expected to change in many cases. In cases of doubt or difficulty and where the recognition of a lease is relevant to the tax position of the lessee or lessor you should seek advice from an Advisory Accountant before reaching a conclusion.
Transactions treated as leases and leases treated as if they are not leases
In certain instances, transactions that do not legally contain a lease may be accounted for as a lease and vice versa, as set out below.
FRS 102 (Pre 2024 amendments) and FRS 105
FRS 102 (Pre 2024 amendments) requires that “Transactions and other events and conditions should be accounted for and presented in accordance with their substance and not merely their legal form” (para 2.8). Section 2.1A says that if there are inconsistencies between the concepts and the principles (that are set out in Section 2) and specific requirements of another Section of FRS 102, then the “specific requirements of the other Section within the FRS take precedence over this section.”
A similar statement exists at FRS 105 Section 2.2.
FRS 102 Sections 20.3 and 20.3A, and FRS 105 Sections 15.3 and 15.4, confirm that determining whether an arrangement is, or contains, a lease is based on the substance of the arrangement, and provide examples of such situations and factors to consider when making the assessment.
FRS 102 (Post 2024 amendments) and IFRS
As stated above, FRS 102 (2024 amendments) and IFRS 16 require assessment of whether a contract is or contains a lease.
IFRS 16 includes application guidance to assist with the lease assessment for more complicated scenarios. IFRS 16 Illustrative Examples 1 – 10 also illustrate how an entity might apply some of the requirements of IFRS 16 to particular aspects of a lease (or other contracts).
Under both UK GAAP and IFRS there are pronouncements that apply to Private Finance Initiatives and similar transactions. In UK GAAP these pronouncements are found in FRS 102 (both pre and post 2024) Section 34.12-16A. In IFRS they are found in IFRIC 12. Where these pronouncements apply the transactions may be accounted for, wholly or in part, under the relevant non-leasing standard.