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HMRC internal manual

Business Leasing Manual

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HM Revenue & Customs
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Lease accounting: accounting standards: IFRIC 4, determining whether an arrangement contains a lease

To state the obvious, most transactions that are accounted for as leases are leases as they are generally defined for accounting purposes.

However, for commercial reasons arrangements have been developed that do not take the legal form of a lease but which convey rights to use assets in return for a payment or series of payments. IFRS (IFRIC 4) recognises this and requires such transactions to be accounted for as leases.

IFRIC 4 is only applicable to entities applying IFRS and is effective for periods beginning on or after 1 January 2006. It does not apply to entities applying UK GAAP, however the principles of FRS 5 would generally apply to transactions of this kind.

IFRIC 4 applies where ‘a transaction or a series of related transactions that does not take the legal form of a lease conveys the right to use an asset … in return for a payment or series of payments’. The use of the word ‘conveys’ distinguishes this from the GAAP definitions of a lease which simply refer to ‘the right to use’.

IFRIC 4 goes on to say that

“the right to use the asset is conveyed if any one of the following conditions is met:

  1. The purchaser has the ability or right to operate the asset or direct others to operate the asset in a manner it determines while obtaining or controlling more than an insignificant amount of the output or other utility of the asset.
  2. The purchaser has the ability or right to control physical access to the underlying asset while obtaining or controlling more than an insignificant amount of the output or other utility of the asset.
  3. Facts and circumstances indicate that it is remote that one or more parties other than the purchaser will take more than an insignificant amount of the output or other utility that will be produced or generated by the asset during the term of the arrangement, and the price that the purchaser will pay for the output is neither contractually fixed per unit of output nor equal to the current market price per unit of output as of the time of delivery of the output.”

The essence of these conditions is that the ‘lessee’ has the right to obtain or have some control over the output from the asset, rather than the right to use the asset (as required for a lease as defined for GAAP). Where these conditions are satisfied the arrangement is accounted for in accordance with IAS 17. Some examples are mentioned at BLM10030.