Strategic Business Reporting (International) · Leases

IFRS 16 Scope, Definition and Identifying a Lease

Updated 11 October 2026 · Fact-checked

A contract is, or contains, a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. You test for an identified asset, then the right to obtain substantially all economic benefits and the right to direct use. Then you separate non-lease components.

Understand IFRS 16 Scope, Definition and Identifying a Lease

IFRS 16 applies to all leases, with a few exclusions. The first question in any exam scenario is not 'how do I account for this?' It is 'is there a lease at all?' Many contracts are labelled as services, but they may contain a lease. Others are labelled as leases, but they are services.

The definition has two core parts. First, there must be an identified asset. This is usually named in the contract, or implied when the asset is made available to the customer. Second, the customer must have the right to control the use of that asset throughout the period of use.

The asset is not identified if the supplier has a substantive substitution right. This means the supplier can practically swap the asset and would benefit economically from doing so. A right to substitute only when the asset is faulty or needs repair is not substantive. A capacity portion of an asset is identified only if it is physically distinct, such as a floor of a building. A share of capacity that is not physically distinct, such as a percentage of a pipeline's capacity, is not.

Control needs two rights. The customer must have the right to obtain substantially all of the economic benefits from using the asset. The customer must also have the right to direct how and for what purpose the asset is used. If those decisions are predetermined, the customer directs use if it operates the asset, or if it designed the asset in a way that predetermines how it will be used.

Once you find a lease, you split the contract into lease and non-lease components, for example a lease of a machine plus maintenance. Consideration is allocated on relative standalone prices. A lessee may elect, by class of underlying asset, not to separate and to account for the whole as one lease component. Lessees may also elect the exemptions for short-term leases and low-value assets.

Key rules to remember

Definition of a lease: Lease = contract conveying the right to control the use of an identified asset for a period of time in exchange for consideration; Both an identified asset and control of its use are required. A period of time can be expressed as an amount of use, such as units produced.
Right to control use: two tests: (1) Right to obtain substantially all economic benefits AND (2) right to direct the use of the asset; Both tests must be met throughout the period of use. If either fails, there is no lease.
Substitution right is substantive only if: Supplier has the practical ability to substitute AND would benefit economically from substituting; Assess at inception. If the customer cannot readily tell, assume the right is not substantive.
Allocation to components: Allocated price = Contract price × (Standalone price of component ÷ Total of standalone prices); Lessee uses this for each lease and non-lease component, unless it elects not to separate.
Optional exemptions (lessee): Short-term lease: term of 12 months or less with no purchase option. Low-value asset: low value when new, assessed per asset; Lessee recognises payments as an expense, normally straight-line. These are elections, not requirements.
Scope exclusions: Not in IFRS 16: leases to explore for minerals, oil and gas; biological assets (IAS 41); service concession arrangements (IFRIC 12); licences of IP granted by a lessor (IFRS 15); rights held under licensing agreements for films, patents and copyrights (IAS 38); A lessee may, but need not, apply IFRS 16 to intangible assets other than the licences of IP scoped out.

How to solve IFRS 16 Scope, Definition and Identifying a Lease questions

Use this order for any question asking whether a contract contains a lease. Always tie each conclusion to facts in the scenario.

1Check scope. Is the item excluded, for example a mineral exploration lease, a biological asset or a service concession?
2Identify the asset. Is it specified or implied? Is it a physically distinct portion?
3Test substitution. Can the supplier substitute, in practice, and would it gain from doing so? If yes, there is no identified asset.
4Test economic benefits. Does the customer take substantially all the output or benefits throughout the period?
5Test direction. Who decides how and for what purpose the asset is used? If those decisions are predetermined, who operates it or designed it?
6Conclude clearly: lease or service. State the reason in one sentence.
7If there is a lease, identify non-lease components and allocate the price on standalone prices, or apply the practical expedient not to separate.
8Then consider the lessee exemptions for short-term and low-value leases, and link to the accounting.

Quickest way: Three-question lease test

When to use it: Use when you have limited time and the scenario contains a contract that looks like a service or hire arrangement.

Ask: is there an identified asset? If the supplier can substitute it substantively, stop. No lease.
Ask: does the customer get substantially all the benefits? If not, stop. No lease.
Ask: does the customer decide how and why the asset is used? If yes, it is a lease. Then say what is non-lease and how to split it.

Common mistakes in IFRS 16 Scope, Definition and Identifying a Lease

Relying on the contract's title, such as 'service agreement' or 'hire agreement'.
Students treat legal form as decisive.
Fix: Apply the definition. Substance decides, not the label.
Treating any substitution right as ending the lease.
Students see the word 'substitution' and stop.
Fix: Only a substantive right defeats an identified asset. Substitution only for repair, or where the supplier gains nothing, is not substantive.
Ignoring who directs the use and looking only at who owns or operates the asset.
Ownership feels like control.
Fix: Ask who decides how and for what purpose the asset is used during the period. The supplier may own and operate it while the customer still has the decision rights.
Saying a capacity share of an asset is always a lease.
Students forget the physically distinct requirement.
Fix: A share of capacity is an identified asset only if physically distinct, like a floor. A proportion of a pipeline is not, unless it represents substantially all capacity.
Treating the short-term and low-value exemptions as compulsory.
Students read them as rules rather than elections.
Fix: Say the lessee 'may elect'. The short-term election is by class of asset, and the low-value election is lease by lease.
Allocating the whole payment to the lease when a service is bundled in.
Students overlook non-lease components such as maintenance.
Fix: Separate components and allocate on relative standalone prices, unless the lessee elects not to separate.

Worked examples

Example 1

Rana Ltd contracts with a shipping firm for the use of a specific vessel, identified by its registration number, for 3 years. The shipping firm may substitute the vessel only if it breaks down. Rana decides the cargo, the route and the timetable, and it is the only user. Does the contract contain a lease?

Show the solution

Identified asset: a specific vessel is named. The supplier's substitution right applies only on breakdown, so it is not substantive. The asset is identified.
Economic benefits: Rana is the only user, so it obtains substantially all the economic benefits from use over 3 years.
Direction of use: Rana decides the cargo, route and timetable. It directs how and for what purpose the vessel is used.
All conditions are met, so control is passed for the period in exchange for consideration.

Answer: The contract contains a lease. Rana is the lessee and recognises a right-of-use asset and lease liability, unless it elects an exemption.

Example 2

Mehta plc signs a 5-year contract for the use of a data centre room and related support. The fixed annual charge is $120,000. Standalone prices are: room rental $90,000 and support services $30,000. The room is a specified, physically distinct room and Mehta controls its use. Mehta has not elected the practical expedient. How should the $120,000 be allocated?

Show the solution

The specified room is an identified asset, physically distinct. Mehta controls its use, so the room is a lease component.
Support services are a non-lease component.
Total standalone prices = $90,000 + $30,000 = $120,000, equal to the contract price, so no scaling is needed.
Lease component = $120,000 × 90,000 ÷ 120,000 = $90,000 a year.
Non-lease component = $120,000 × 30,000 ÷ 120,000 = $30,000 a year.

Answer: $90,000 a year is allocated to the lease and included in the lease liability measurement. $30,000 a year is accounted for as a service expense. If Mehta had elected not to separate, the whole $120,000 would be treated as a lease.

Exam tips

Start every 'is it a lease?' answer by quoting the definition, then apply it to facts. Markers award marks for application, not recall.
Look for scenario clues: named asset, supplier substitution clauses, who sets the use, minimum purchase or take-or-pay terms.
State the conclusion early and justify it. Use professional scepticism where a contract title does not match the economics.
Mention the exemptions and the practical expedient only when the facts fit. Do not list every scope exclusion.
If the contract is a lease, link briefly to the accounting consequence, then point to the measurement topic.

Practice questions from Leases

IFRS 16 Scope, Definition and Identifying a Lease in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

IFRS 16 Scope, Definition and Identifying a Lease: frequently asked questions

What is an identified asset under IFRS 16?

It is a specific asset, named explicitly or implied when made available to the customer. It is not identified if the supplier has a substantive right to substitute it. A physically distinct portion of a larger asset can also be identified.

How do I tell a lease from a service contract?

Ask whether the customer controls the use of a specific asset. In a lease, the customer obtains substantially all the benefits and directs how the asset is used. In a service contract, the supplier decides how it delivers the service.

Do I always have to separate lease and non-lease components?

A lessee must separate them and allocate on relative standalone prices, unless it elects, by class of underlying asset, to treat them as a single lease component. Lessors allocate under IFRS 15.

Which leases are outside IFRS 16?

Leases to explore for minerals, oil and gas, biological assets, service concession arrangements, and licences of intellectual property granted by a lessor are scoped out. Rights under licensing agreements, such as films and patents, fall under IAS 38.