1. The Core Definition Criteria
Under both IFRS 16 and ASC 842, 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. To establish whether a contract contains a lease, an entity must verify two simultaneous conditions:
  • The contract must involve the use of an identified asset that is explicitly specified or implicitly specified at the point it is made available for customer use.
  • The customer must obtain the right to direct the use of the asset and obtain substantially all of the economic benefits from its use throughout the period.

2. Substantive Substitution Rights
A contract does not contain an identified asset—and is therefore a service contract rather than a lease—if the supplier holds a substantive substitution right throughout the period of use. A substitution right is substantive only if:
  • The supplier has the practical ability to substitute alternative assets throughout the period of use.
  • The supplier would benefit economically from exercising its right to substitute the asset.

If the supplier can only replace the asset when it requires repair or an upgrade, the substitution right is not substantive, and the asset remains identified.
                  ┌───────────────────────────────┐
                  │ Does a Substantive Right Exist?│
                  └───────────────┬───────────────┘
                                  │
         ┌────────────────────────┴────────────────────────┐
         ▼                                                 ▼
 ┌───────────────┐                                 ┌───────────────┐
 │      YES      │                                 │      NO       │
 └───────┬───────┘                                 └───────┬───────┘
         │                                                 │
  Supplier can swap                                 Asset is fixed or
  asset freely for profit.                           swapped only for repairs.
         ▼                                                 ▼
 ┌───────────────────────┐                         ┌───────────────────────┐
 │   Service Contract    │                         │    Lease Exists       │
 │  (Expense as Incurred)│                         │ (Apply Capitalization)│
 └───────────────────────┘                         └───────────────────────┘

 
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