Practical approaches to lease term under IFRS 16

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Marek Muc
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Practical approaches to lease term under IFRS 16

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This agenda decision of the IFRS Interpretations Committee emphasises that ‘the broader economics of the contract, and not only contractual termination payments’, should be considered when determining the enforceable period of the lease under IFRS 16. It will often be hard to determine non-arbitrary enforceable period for certain cancellable/renewable leases (i.e. when there's a relatively short notice period - shorter than 12 months).

It would be interesting to hear what approaches you have seen in practice. For example, what is the enforceable period for a cancellable/renewable lease for a headquarter building or point of sales?

Approaches that I've heard of:
- for property leases, where other significant assets are located in leased property, lease term was tied to remaining useful life of those owned assets
- for a headquarter building, lease term equals the time horizon for which strategic planning is done by lessee (5 years in my example)
- point of sales were divided into groups (strategic location/ not so strategic location etc.) - and for these groups different, but rather arbitrary lease terms (5-10 years) were assigned

What is your experience?
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JRSB
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Re: Practical approaches to lease term under IFRS 16

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Apparently in Taiwan it is common for a small office to be let on a rolling monthly basis. Of course the intention is to stay more than a month, but given the option of everyone involved to give a month's notice - exemption applied! Not your question but sprung to mind. It would be arbitrary to choose a true period because there are so many uncertainties, including the businesses' prospects (including if they do well, where they would move to a bigger office etc).
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Marek Muc
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Re: Practical approaches to lease term under IFRS 16

Post by Marek Muc »

In Poland it is also quite common to see lease agreementd with 3- or 6-months notice. The agenda decision that I linked to in previous post was so impactful because the IFRS Interpretations Committee said that a short notice period is not enough to conclude that the short-term lease exemption applies. We should look at 'broader economics of the contract' i.e. economic incentives not to terminate such a lease. Basically you need to look at para B37 anyway...
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Re: Practical approaches to lease term under IFRS 16

Post by nauman »

I think it's more a question of substance over form and that's what makes the whole thing a bit subjective. No entity would make investments in furniture, fixtures and fittings with the intention of abandoning the premises within 12 months. We generally look at the underlying useful life of assets of Retail stores and then determine the lease terms. Even the lease terms baked into contracts with exit clauses would substantially cover the useful life of fixtures and fittings of Retail stores.
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Re: Practical approaches to lease term under IFRS 16

Post by marea »

This is an interesting topic.
I was wondering in what circumstances would a real estate lease be treated as short -term. If a company is established in its business and has no intention of relocating, then I suppose that real-estate leases would never or in very limited circumstances be eligible to apply the practical expedient for short-term lease. I was thinking about leased parking lots. If the enforceable period is less then 12months, and the company has no intention to relocate it would be difficult to argue that the company will not extend the lease. I am referring to parking lots in city center that are not always available for lease.
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Re: Practical approaches to lease term under IFRS 16

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I guess the risk with leases is to immediately think of offices (because they are the most commonly occurring) when of course it be a wide range of assets
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Marek Muc
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Re: Practical approaches to lease term under IFRS 16

Post by Marek Muc »

I also think that real estate leases will hardly ever qualify for short-term practical expedient. If you need the parking lots in the city centre and they are in short supply, then yes - you should look beyond the non-cancellable contractual period. You can look at those parking lots in the light of the lease term for the office space that they serve.

JRSB, I agree that the focus is on real estate, but I guess that all the vehicles used in transport and logistics are also in the spotlight.
I feel that real estate is special when it comes to assessing lease term, because the so-called evergreen leases are rare for other assets, and in this kind of leases the need to look beyond contractual terms is crucial
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