Dedicated warehouse-use contracts: identifying an embedded lease

When a logistics company contracts for dedicated warehouse space as a customer, the arrangement is a lease requiring right-of-use asset and lease liability recognition if it conveys the right to control use of an identified physical space, rather than merely purchasing a fulfillment or storage service from the warehouse operator. Missing an embedded lease keeps a real long-term financial obligation off the balance sheet, understating both assets and liabilities and misrepresenting leverage.

Is the warehouse space physically distinct and explicitly or implicitly specified in the contract, or does the operator retain a practical and economically beneficial ability to substitute the space? Does the customer direct how and for what purpose the space is used and obtain substantially all the economic benefit from that use, or does the operator retain substantive decision-making rights over the goods stored or the space itself? If an embedded lease is identified, is the lease term (including reasonably certain renewal periods) and discount rate determined consistently with the entity's other property leases?

1) Determine whether the space is physically distinct and explicitly or implicitly specified in the contract. 2) If a space is identified, assess whether the operator has the practical ability to substitute the space and would benefit economically from doing so (both conditions must hold for substitution rights to be substantive and preclude lease treatment). 3) Assess whether the customer directs how and for what purpose the space is used and obtains substantially all the economic benefit from its use. 4) If both the identified-asset and control criteria are met, recognize a right-of-use asset and lease liability (as lessee/customer); otherwise account for the arrangement as a service under IFRS 15. 5) Where the arrangement contains both a lease of space and non-lease services, separate and allocate consideration between the components unless a practical expedient not to separate is elected. 6) Reassess the classification if contract terms are renegotiated in a way that changes substitution rights or control.

Measure the lease liability at the present value of fixed and in-substance fixed payments over the lease term (including renewal periods reasonably certain to be exercised), using the rate implicit in the contract if readily determinable, otherwise the customer's incremental borrowing rate reflecting the term and economic environment of the space. Measure the right-of-use asset at the lease liability plus any initial direct costs and prepayments, less incentives received.

Disclose: (1) the judgment applied in classifying dedicated warehouse arrangements as leases versus service contracts, including the substitution-rights analysis; (2) the resulting right-of-use assets and lease liabilities within the standard IFRS 16 lessee disclosures (maturity analysis, depreciation, interest expense); (3) the allocation methodology where lease and non-lease components are separated; (4) any short-term or low-value exemptions applied to smaller dedicated-space arrangements.

• Expensing all dedicated warehouse fees as a service cost without assessing the substitution rights and control indicators
• overlooking that substitution rights are only relevant if the supplier both can and would benefit economically from substituting (a right that exists only on paper, or that the supplier would never exercise due to cost, does not preclude lease treatment)
• failing to separate lease and non-lease service components when both exist in a single contract
• using the wrong discount rate (e.g. the entity'
• s general corporate borrowing rate instead of one reflecting the specific term and economic environment of the space).