IFRS 16 Non-Lease Components: Definition, Examples, and Practical Expedient

Introduction

IFRS 16 Leases has transformed lease accounting, particularly by introducing the concept of a lease liability and a right-of-use (ROU) asset on the lessee’s statement of financial position. One area that often creates confusion is dealing with non-lease components in a lease contract.

Many lease contracts include not just the right to use an asset but also additional goods or services—such as maintenance, cleaning, or administrative support. These elements must be evaluated carefully to determine whether they constitute lease or non-lease components, or perhaps no component at all. This article unpacks the distinction, explains how to account for them, and explores the practical expedient available under IFRS 16.

What is a Lease Component

A lease component gives the lessee the right to control the use of an identified asset for a period of time in exchange for consideration. This control includes the right to obtain substantially all of the economic benefits from the use of the asset and the right to direct its use.

Examples of lease components include:

• The use of a building, vehicle, or equipment;
• Any rights that guarantee exclusive use during the lease term.

Each lease component must be accounted for separately from non-lease components unless the lessee applies a practical expedient, which we will explore later.

What is a Non-Lease Component

A non-lease component is an activity that transfers a good or service to the lessee, but does not relate to the right to control the use of an identified asset.

Examples of non-lease components include:

• Cleaning or maintenance services for office buildings or equipment (e.g. printers);
• Security services;
• Software subscriptions bundled with hardware;
• Administrative or support services associated with the leased asset.

These components typically reflect ongoing services and do not convey a right to use a specific asset. As a result, they fall outside the scope of the lease liability and ROU asset.

Why the Distinction Matters

Under IFRS 16, only lease components are included in the measurement of the lease liability and ROU asset. Non-lease components are accounted for separately under other applicable standards (e.g. IFRS 15 for services) and are typically expensed as incurred.

This distinction is important because it affects:

• The initial measurement of the lease liability;
• The depreciation and interest expense recognised over the lease term;
• Disclosures in the financial statements.

Misclassifying a non-lease component as a lease can overstate both assets and liabilities.

The Practical Expedient: A Simplified Approach

To ease the burden of separating components, paragraph 15 of IFRS 16 allows lessees to apply a practical expedient. Under this expedient, a lessee may elect, by class of underlying asset, not to separate non-lease components from lease components, and instead account for the entire contract as a lease.

Pros and Cons of the Practical Expedient

Advantages:

• Simplifies accounting, especially where the lease contract is complex or contains minor service elements;
• Avoids the need to estimate stand-alone prices;
• Reduces operational burden in large lease portfolios.

Disadvantages:

• Leads to higher lease liabilities and ROU assets, as the cost of services is capitalised;
• May not reflect the economic substance of the transaction.

This election must be applied consistently for all leases in the same asset class and must be disclosed.

Allocating Consideration to Components

Where the lessee does not apply the practical expedient, paragraph 13 of IFRS 16 requires the total consideration in the contract to be allocated to each component on the basis of relative stand-alone prices.

Per paragraph 14, the stand-alone price is:

The price the lessor, or a similar supplier, would charge the lessee for that component separately. If an observable stand-alone price is not readily available, the lessee shall estimate it, maximising the use of observable information.

This allocation ensures that only the portion of consideration related to the lease component is capitalised.

Costs That Are Not Components

Certain costs in lease contracts do not qualify as either lease or non-lease components. These include amounts paid for administrative tasks that do not transfer a good or service to the lessee—such as:

• Fees for negotiating the lease;
• Charges for invoice processing or contract management.

These items are not allocated a portion of the consideration. Instead, the total consideration (including these amounts) is allocated across the lease and non-lease components proportionately.

Example: Cleaning Services in an Office Lease

Consider a lease agreement for an office building. The contract includes:

• The lease of the building (lease component);
• Daily cleaning and maintenance of the premises (non-lease component);
• A once-off administration fee.

If the lessee does not apply the practical expedient, they must:

1. Allocate the total consideration (including the admin fee) between the building lease and the cleaning services based on their stand-alone prices;
2. Capitalise the lease portion;
3. Expense the cleaning services as incurred;
4. Ignore the administration fee as a component and distribute its consideration proportionally.

If the lessee does apply the practical expedient, they would treat the entire amount as part of the lease and capitalise it, simplifying the process but inflating the lease liability.

What About Lessors?

While this article focuses primarily on lessees, it’s worth noting that lessors are not permitted to apply the practical expedient. Lessors must always separate lease and non-lease components and account for them in accordance with IFRS 15 Revenue from Contracts with Customers (for non-lease components) and IFRS 16 (for lease components).

This ensures that revenue recognition reflects the nature of the services provided and the rights transferred.

Conclusion

Understanding and correctly applying the distinction between lease and non-lease components is essential under IFRS 16. Lessees must assess each contract carefully, decide whether to use the practical expedient, and allocate consideration appropriately. While the practical expedient offers relief, it should be weighed against the potential impact on the balance sheet and financial ratios.

Careful documentation and consistent application of the policy are key to compliance and transparency in financial reporting.

For any clarification, guidance, or feedback on our article, please reach out to us on insight@leash.co.za.