IFRS 16 Leases (‘IFRS 16’) requires an entity to assess whether a contract conveys the right to control the use of an identified asset. Where it does, the contract is, or contains, a lease. The IFRS Interpretations Committee (‘IFRIC’) recently published an agenda decision considering whether the customer in a battery offtake arrangement has the right to obtain substantially all of the economic benefits from use of the battery.

This article briefly considers the agenda decision and the broader principle that it reinforces.

The arrangement

The fact pattern considered by the IFRIC involves a battery owner and an electricity retailer. The battery owner is a registered participant in a gross pool electricity market. The two parties enter into an offtake arrangement under which:

• The battery owner retains custody of the battery. However, it must operate the battery in accordance with the electricity retailer’s instructions.
• The retailer’s instructions cover 100% of the battery’s capacity. This includes whether and when to charge and discharge the battery (i.e. buying and selling electricity from and to the market operator).
• The battery is not substitutable.

The settlement arrangement between the parties involves the following elements that are net in cash periodically:

• The electricity retailer pays the owner a fixed amount over the contract period for the right to use the battery
• The battery owner, as a registered participant, buys and sells electricity from and to the market operator at the spot price in line with the retailer’s instructions. It then passes the resulting cash inflows and outflows onto the retailer.

In assessing whether a contract conveys the right to control an identified asset to a customer, IFRS 16 requires an entity to determine whether the customer has both (a) the right to obtain substantially all of the economic benefits from use of the identified asset and (b) the right to direct the use of the identified asset. The submission to the IFRIC assumed that the electricity retailer has the right to direct the battery’s use. The Committee therefore had to consider whether the retailer also has the right to obtain substantially all of the economic benefits from the use of the battery.

Identifying the economic benefits from use

The IFRIC considered paragraph B21 of IFRS 16, which provides that:

‘a customer can obtain economic benefits from use of an asset directly or indirectly in many ways, such as by using, holding or sub-leasing the asset. The economic benefits from use of an asset include its primary output and by-products (including potential cash flows derived from these items), and other economic benefits from using the asset that could be realised from a commercial transaction with a third party.’

Applying this principle requires careful analysis of what economic benefits the asset in question actually provides. The IFRIC observed that the battery does not produce electricity. It stores and releases electricity. The economic benefits from the use of the battery derive from its storage capability and capacity. This must inform the economic benefit assessment.

Framed in this way, the answer in the fact pattern follows quite naturally. The retailer has the exclusive right to use the battery’s full capacity throughout the period of use. It also has the exclusive right to direct the battery owner as to whether, when and by how much the battery is charged and discharged. The IFRIC concluded that the electricity retailer therefore obtains the economic benefits derived from the battery’s storage capacity.

The Committee concluded that the retailer has the right to obtain substantially all of the economic benefits from use of the battery. Combined with the assumed right to direct the use of the asset, the arrangement conveys the right to control the battery’s use and constitutes a lease.

Practical observations

Although the decision addresses a specific fact pattern, the underlying observation may be useful across a wider range of arrangements. The analysis in the agenda decision highlights the key principle that the economic benefits from the use of an asset must be identified by reference to what the asset actually does. This, in turn, requires an analysis of the asset’s function (in this case, to store rather than to produce electricity). The economic benefit question then centres around this.