HOW AND FOR WHAT PURPOSE?

The provisions in Ind AS 116 Leases relevant to analysing whether an arrangement contains a lease are given below:

9. 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.

B9 To assess whether a contract conveys the right to control the use of an identified asset for a period of time, an entity shall assess whether, throughout the period of use, the customer has both of the following:

B24 A customer has the right to direct the use of an identified asset throughout the period of use only if either:

a. the customer has the right to direct how and for what purpose the asset is used throughout the period of use; or

ii) the customer designed the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset will be used throughout the period of use.

B25 A customer has the right to direct how and for what purpose the asset is used if, within the scope of its right of use defined in the contract, it can change how and for what purpose the asset is used throughout the period of use. In making this assessment, an entity considers the decision-making rights that are most relevant to changing how and for what purpose the asset is used throughout the period of use. Decision-making rights are relevant when they affect the economic benefits to be derived from use. The decision-making rights that are most relevant are likely to be different for different contracts, depending on the nature of the asset and the terms and conditions of the contract.
 

B26 Examples of decision-making rights that, depending on the circumstances, grant the right to change how and for what purpose the asset is used, within the defined scope of the customer’s right of use, include:

a. rights to change the type of output that is produced by the asset (for example, to decide whether to use a shipping container to transport goods or for storage, or to decide upon the mix of products sold from retail space);

d. rights to change whether the output is produced, and the quantity of that output (for example, to decide whether to produce energy from a power plant and how much energy to produce from that power plant).

B30 A contract may include terms and conditions designed to protect the supplier’s interest in the asset or other assets, to protect its personnel, or to ensure the supplier’s compliance with laws or regulations. These are examples of protective rights. For example, a contract may (i) specify the maximum amount of use of an asset or limit where or when the customer can use the asset, (ii) require a customer to follow particular operating practices, or (iii) require a customer to inform the supplier of changes in how an asset will be used. Protective rights typically define the scope of the customer’s right of use but do not, in isolation, prevent the customer from having the right to direct the use of an asset.

Example – ‘How and for what purpose’ analysis in a hotel stay

Fact pattern

A customer books a room in a hotel for a one-day stay. As per the terms and conditions of the hotel, the customer cannot use the hotel for any illegal activities or cannot sub-lease the room. The room is a specific identified asset, the substitution rights (if any) are not substantive and the customer obtains significant economic benefits from occupying the room. Whether the arrangement between the hotel and the customer contains a lease?

Analysis

Having determined that the room is a specific identified asset, the substitution rights are not substantive and the customer obtains significant economic benefits from occupying the room; the next step in the lease analysis is whether the customer has the right to direct how and for what purpose the asset is used throughout the period of use, as required by B24.
 
The room can be used only for the purposes of room stay; it cannot be sub-let by the customer. To that extent, the how and for what purpose is predetermined. Additionally, the customer cannot use the room for illegal activities. Those are protective rights that the hotel has and do not impact the assessment of whether an arrangement contains a lease in accordance with B30.

The following how and for what purpose decisions are not predetermined and are controlled by the customer and affect the economic benefits to be derived by the customer from the use of the room during the period of stay:

•        Use of air-conditioner or refrigerator or television or other devices in the room;
•        Use the room to sleep or to make conference calls;
•        Use the room to have lunch or dinner, etc.

Therefore, the customer has the right to direct how and for what purpose the asset is used (to the extent those are not predetermined) throughout the period of use (see B25).

CONCLUSION

The arrangement between the hotel and the customer contains a lease. The customer is a lessee and would be entitled to the exemption with respect to short-term lease or low value lease. Additionally, the lessee will have to comply with certain presentation and disclosure requirements as required by Ind AS 116.
 
The hotel (lessor) is not entitled to exemptions from short-term lease or low value lease. From the perspective of the hotel, the single-day lease would qualify as an operating lease. The lessor will have to comply with certain presentation and disclosure requirements as required by Ind AS 116.

Whilst the above example may not have any significant implications for the hotel or its customer, the example is provided to explain the concept of ‘How and for what purpose’ in evaluating whether a contract includes a lease arrangement.

—  Ramana Maharshi

One who neglects or disregards the existence of earth, air, fire, water and vegetation disregards his own existence which is entwined with them

—  Mahavira