Practice Activity 15.2 Identification of the lease element in a contract between a shipping company

Caale is a ship owned by Caale Shipping Company Limited. Caale Shipping Company Limited enters into a contract with Mr. Okeke for the use of Caale to convey agricultural produce from Sapele to Kebbi for four years. The contract terms are as follows:

i. During the four-year period, Caale will be operated and maintained by the Caale Shipping Company Limited.

ii.Caale will be used by Mr. Okeke to convey agricultural produce. Mr. Okeke decides the nature of agricultural produce, timing of transportation, and the ports through which Saale will sail.

iii.Mr. Okeke is prohibited from sailing Caale into waters notorious for piracy.

iv. Mr. Okeke is prohibited from conveying any other kind of cargo other than the agricultural produce. In addition, Mr. Okeke cannot hire another operator for Caale. This is because Caale Shipping Company Limited is responsible for the operation, maintenance of Caale, and safe passage of the agricultural produce that is transported using Caale.

Required: Ascertain with reasons whether a lease element is present or not in the contract between Caale Shipping Company Limited and Mr. Okeke.

See a suggested solution to practice activity 15.2 here.

Suggested solution to practice activity 15.2

The contract between Caale Shipping Company Limited and Mr. Okeke contains a lease element. There is a lease element in the contract to use Saale for transporting agricultural produce from Sapele to Kebbi for four years.

The lease element exists in the contract because:

i. The contract gives Mr. Okeke the right to direct the use of an identifiable asset (Caale) throughout the four-year period as evidenced by the right of Mr. Okeke to direct how and for what purpose the ship (Caale) is used throughout the four-year period. This is because of the following reasons:

1. Mr. Okeke has the right to direct how and for what purpose the ship is used because it is within the scope of his right of use defined in the contract.

2. He can change how and for what purpose the asset is used throughout the four-year period.

3. The decision-making right of Mr. Okeke is relevant because the rights affect the economic benefits to be derived from the use of Caale.