Identifying the customer in a contract for the use of assets
IFRS 16 Leases introduces new guidance on identifying the customer in contracts involving joint arrangements.
We look at the practical application of this guidance within the context of joint arrangements in the oil and gas industry.
Joint arrangements are commonplace in the oil and gas industry, contracting regularly with suppliers for the use of assets with varying size, cost and strategic importance. Applying IFRS 16 to these contracts could be a key challenge as it will require the joint arrangement to identify whether it is the customer. This is critical to the lease accounting treatment for each of the parties to the joint arrangement.
For example, if the joint arrangement is the customer, then all parties to the arrangement will reflect their share of the lease in their financial statements – either by recognising the parties’ share in the assets and liabilities of a joint operation; or by equity accounting for a joint venture.
When joint arrangements are incorporated – e.g. as a joint venture – they are able to contract in their own name. In this case, identifying them as the customer is relatively straightforward.
However, joint arrangements in the oil and gas industry are more likely to be structured as unincorporated joint operations. In these cases, they lack the legal capacity to contract in their own name and will be dependent on the party nominated as the operator to contract for the use of assets on their behalf.
For example, if the operator is the customer, then the operator will account for the whole of the lease liability and the other parties will account for their share of any sub-lease from the operator.
Assessing whether the operator is contracting on behalf of the joint arrangement or on its own behalf as principal will be based on the substance of the joint arrangement. This will require careful assessment of the relevant contractual arrangements and supporting evidence.
The substance of the arrangement may also be influenced by the nature of the asset itself. When the asset is specialised, expensive and of strategic importance, the contractual arrangements are typically structured in such a way that all parties to the arrangement have collective control over the asset – i.e. the joint arrangement is the customer.
Conversely, the operator is more likely to be the customer when contracting for the use of non-specialised assets that are of less strategic importance. This is also the case when the operator can subsequently grant control of the asset to the joint arrangement or to multiple joint arrangements – i.e. it has the ultimate discretion to deploy the asset throughout the contract period.