AASB 16 Check: What term is used for allocating consideration?

Allocating considerationto lease and non-lease components

It is common for a contract to contain lease and non-lease components. Here we respond to the question we are hearing on what term to use by a lessor when allocating contract consideration to lease and non-lease components under AASB 16 Leases.

Scenario

Company G leases office space to Company H. Under the arrangement, G also provides cleaning services for the entire lease term. Contract term is five years with the lessee having an option to extend for another two years. Annual payments, including cleaning, are $160,000 for the initial five years. For the extension period, annual payments are reduced to $150,000:

if the contract runs for five years, total consideration is $800,000
if the contract runs for seven years, total consideration is $1,100,000.

The stand-alone selling price of the property lease without cleaning services is estimated at $120,000 p.a., and the stand-alone selling price for cleaning is $50,000 p.a.

At commencement date, G concludes that the lease term is seven years, on the basis that it is reasonably certain that H will exercise the extension option.

If the contract was wholly accounted for under AASB 15, the contract term would be five years, because this is the period for which the two parties are contractually committed.

Interpretive response: Company G should allocate the consideration to the lease component (property lease) and non-lease component (cleaning services) based on the lease term as determined under AASB 16 – i.e. seven years.

This means that G allocates the total consideration based on seven years ($1,100,000) to the property lease and cleaning services. The calculations are illustrated below.

Placeholder for Table

In accordance with AASB 16 the total consideration allocated to the property lease is recognised on a straight line basis. Therefore G recognises $110,857 p.a. ($776,000/7) for seven years.

G separately applies the requirements of AASB 15 to the amount of total consideration allocated to the cleaning services – $324,000. In applying AASB 15 to the cleaning services, G needs to determine the amount of consideration relating to years one to five, and that relating to the option to renew for two years at a discount. This can be complex to apply.

In technical speak

At inception of a contract, an entity shall assess whether the contract is, or contains, a lease. 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 [AASB 16.9].

An entity shall determine the lease term as the non-cancellable period of a lease, together with … periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option… [AASB 16:18].

For a contract that contains a lease component and one or more additional lease or non-lease components, a lessor shall allocate the consideration in the contract applying paragraphs 73–90 of AASB 15 [AASB 16:17].

If you would like to discuss the application of the standard for your organisation, please contact us.