IFRS 16 Lessor accounting: Variable payments based on consumption

[Roger84]

Dear community,

Can you confirm my assumption that the underlying lease from a lessors perspective is absolutely simple or do I miss some parts?

Accounting for the below example:
Asset = Hydro Power plant remains as is and is accounted for as a "normal" assets with its respective depreciation
Lease payments = Through profit and loss in the period in which they have occurred based on the generated and billed electricity

IFRS basis:
IFRS 16.BC168–BC169 Variable lease payments that depend on sales or usage of the underlying asset are
excluded from the lease liability. Instead, these payments are recognised in profit
or loss in the period in which they occur.

Case:
Lessor enters into a 25-year lease of a hydro power plant. The lease payments are
based on usage.
Forecasts show that lease payments for the ‘expected case’ are x million per
annum, and are capped at a maximum production rate of y
To determine the payments to include in the lease asset, the lessor considers the
following.
– The lease payments are based on usage.
– The contract does not require minimum lease payments to equal the
‘expected case’ lease payments.
– Similarly, the contract does not require minimum lease payments to equal the
low case lease payments and as well not to exceed the maximum amount the leasee would purchase and pay for

Thanks in advance for your support

[exIFRS]

Hey Roger84,

Just a couple of clarification questions if I can.

I assume we are talking about LESSEE accounting? The person paying to the lease the asset?

You might need to be a bit clearer on the terms (or maybe they are clear to others and it is just me). Are you saying that the whole lease payment is variable in your opinion. Or are you saying there is a minimum lease payment, and you are asking about an additional variable component?

It is true that a truly variable lease payment is simply expensed as incurred.

But if you are saying there is no unavoidable lease payments then this sounds like a really bad deal for the lessor, they have effectively committed to the possibility of no income for 25 years, why would they do that?

[pub_acco]

If you are a lessee and what you provided is exactly the full terms and conditions, then the contract is perhaps a pure variable lease. I’ve seen in practice though some contracts that first looked variable but later turned out to include some in-substance fixed payments. But at the same time I’ve also seen some pure variable ESCO arrangements like your power plant. In the end, you will need a thorough analysis and examination on the contract.

[JRSB]

Presumably there is a base charge regardless of usage

[Marek Muc]

to add to preceding questions: how the lessee is able to direct the use of the Hydro Power plant?

I'm also wondering whether the variability in lease payments is genuine, i.e. whether the output of Hydro Power plant is highly dependent on the weather conditions? e.g. rainfall? Remember that IFRS 16 has separate provisions for 'in-substance' fixed payments

[Roger84]

Dear exIFRS, pub_acco, JRSB and Marek

Thanks for your response.

It is in fact lessor accounting which is of interest to me. You have a company which produces electricity which is sold to the grid. There is no minimum lease payment. 100% variable depending on the production of the hydro power plant. If there is a regular maintenance it will mean that there will be zero revenue. Then you have the natural impact on the production output of the plant which indeed is impacted by many factors (rainfall etc.).

Everything to a certain maximum limit is sold a rate x. After that the grid still accepts further electricity but the price will go down to 10% of price x. The grid has to take all the electricity if the lessor doesn't find an alternative off-taker. I believe there is as well a contractual restriction for the lessor that up to a certain production level he has to provide the output to the grid.

[exIFRS]

A lease is 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. The leasee must have the right to control the use of an identified asset which means having the right to direct the use of the asset.

Are you sure that this is a lease? What it sounds like you have is a sales contract? The fact the “lessor” can sell to others is a pretty clear indication that control has not been transferred. The fact that possibly a minimum has to be sold to the grid first doesn’t seem substantive in terms of control. Who decides when the plant shut down for maintenance? Who decides when production starts and stops?

[Roger84]

Indeed I tend to the solution that this is a sales contract and hence doesn't contain a lease as per the elements of this specific contract. I am therefore looking now at IFRS 15 which is more appropriate.

If someone thinks differently please let me/us know.

Kind regards and thanks for your thoughts.