Time charters: lease or service

How do voyage, time and bareboat charters differ?

Under a voyage charter, the owner operates the vessel and carries a specified cargo on a specified route, so it is a service; see voyage revenue recognition. Under a time charter, the owner provides the vessel with crew, maintenance and insurance, and the charterer decides the voyages and pays bunkers and port costs. See bunker fuel. Under a bareboat charter, the charterer takes the vessel without crew and runs it as if it owned it, often for many years.

Why does a time charter contain a lease?

IFRS 16 asks whether the contract conveys the right to control the use of an identified asset for a period. The vessel is identified by name, and the owner rarely has a substantive right to substitute another. During the charter, the charterer obtains substantially all the economic benefits from the vessel's use and decides how and for what purpose it is used: which cargoes it carries, between which ports and when. That the owner's crew operates the ship does not prevent the charterer from directing its use; one of IFRS 16's own illustrative examples, a time charter of a ship, reaches this conclusion. So a time charter contains a lease of the vessel. Vessels placed in a pool raise a similar question about whether the pool leases them; see shipping pools. See identifying a lease.

Time charters: splitting the hire

An owner charters a vessel out for 5 years at US$ 20,000 a day. Comparable bareboat charters, for the vessel alone, are about 14,000 a day, and ship managers charge about 7,000 a day for crewing, maintaining and insuring a similar vessel. The owner allocates the hire on relative stand-alone selling prices.

Both parts are recognised evenly over the charter: the lease income on a straight-line basis as an operating lease, and the service revenue over time as the crew and management are provided. The owner presents lease income separately from revenue from contracts with customers, or discloses the split, and its vessel stays in property, plant and equipment. A charter covering most of the vessel's economic life, or with a purchase obligation, could be a finance lease, in which case the owner derecognises the vessel and recognises a lease receivable. See lessor accounting.

How does the charterer account for a time charter?

For a time charter longer than twelve months, the charterer recognises a right-of-use asset and a lease liability. It must separate the lease component from the crewing service, measuring the liability on the lease part only, unless it elects, by class of asset, to treat the whole hire as a lease, which increases the liability. Charters of twelve months or less can use the short-term lease exemption, and many spot-market time charters do. Liner companies that charter in much of their fleet carry large right-of-use assets as a result. See lessee accounting.

How are off-hire and variable hire treated?

When a vessel cannot perform, because of a breakdown or a dry-dock, it goes off hire and the charterer stops paying. The owner simply earns no hire for those days; the expected off-hire is reflected as the lease and service are provided, not estimated upfront. Some charters set hire by reference to a published freight index, or add a profit share above a base rate. These amounts are variable; whether index-linked hire is included in the lease liability depends on whether the index is treated as reflecting market rental rates, and practice varies, while profit shares are recognised when earned.

How are bareboat charters accounted for?

A bareboat charter is a lease only, because the charterer provides the crew and runs the vessel. Long bareboat charters with purchase options or obligations, common in Japanese and Chinese leasing structures, are often finance leases for the owner, or, when the vessel was sold to the lessor by the charterer, may not qualify as a sale at all. See vessel sale and leaseback, and for the principles, IFRS 16 sale and leaseback.

How does US GAAP differ?

ASC 842 reaches the same conclusion that time charters usually contain a lease, but lessors may elect a practical expedient to combine the lease and non-lease components when the timing and pattern of transfer are the same and the lease is an operating lease. Many US GAAP owners use it and present all time charter hire as lease revenue, so their revenue lines are not directly comparable with IFRS owners that split the hire. See shipping accounting.

This guide is general information. It is not tax or legal advice for your situation.