Ind AS 116 - A Comprehensive Guide to Lease Accounting in India

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Explore everything you need to know about Ind AS 116 – India's standard for lease accounting. Understand its objectives, scope, recognition, measurement, presentation, and disclosure requirements for both lessees and lessors, along with practical examples, impact analysis, and transition options.

Introduction to Lease Accounting under Ind AS 116

Indian Accounting Standard (Ind AS) 116, ‘Leases’, marks a transformative shift in how companies account for leases. Effective from April 1, 2019, Ind AS 116 replaces Ind AS 17, introducing a unified approach to lease accounting and bringing increased transparency and comparability to financial statements. This standard aligns with IFRS 16 and radically changes the landscape for lessees while retaining key principles for lessors.

Objectives of Ind AS 116

Ind AS 116 aims to ensure that lessees and lessors provide relevant information in a manner that faithfully represents lease transactions. Its core objectives are:

• To recognize all major leases “on the balance sheet” of lessees.

• To provide users of financial statements with the tools to assess the effect leases have on the financial position, performance, and cash flows of an entity.

Scope and Applicability

Ind AS 116 applies to all lease contracts except for a few specific exclusions:

• Leases related to minerals, oil, natural gas, and similar non-regenerative resources.
• Leases of biological assets (within Ind AS 41, Agriculture).
• Service concession arrangements (within Ind AS 115).
• Licenses of intellectual property under Ind AS 115.
• Rights under licensing agreements for intangible assets like films, patents, or copyrights (handled by Ind AS 38).

The standard permits optional exemptions for:

• Short-term leases (less than 12 months)
• Leases of low-value assets (e.g., small IT equipment).

 

Key Definitions

• Lease: A contract that conveys the right to control the use of an identified asset for a period in exchange for consideration.

• Right-of-Use (ROU) Asset: An asset representing a lessee’s right to use an underlying leased asset.

• Lease Liability: The present value of future lease payments, representing the lessee’s obligation to make those payments.

Lessee Accounting under Ind AS 116

1. Recognition

2. At commencement of a lease, a lessee must:

• Recognize a ROU asset.
• Recognize a corresponding lease liability.

3. Measurement

Initial Measurement:

• Lease liability: Present value of unpaid lease payments, discounted using the interest rate implicit in the lease or the lessee’s incremental borrowing rate.

• ROU asset: Initially measured at cost, comprising the initial measurement of the lease liability, lease payments made at or before commencement, less lease incentives, direct costs, and estimated restoration costs.

Subsequent Measurement:

• Lease liability: Increased by interest, reduced by lease payments, and remeasured for reassessments.

• ROU asset: Depreciated on a straight-line basis unless another systematic basis is representative. Impairment principles also apply.

Exemptions

Lessees may elect not to apply Ind AS 116 for:

• Leases of 12 months or less (short-term).
• Leases where the underlying asset is of low value.
• Payments for these are recognized generally on a straight-line basis or another systematic pattern.

Lessors’ Accounting 

Ind AS 116 largely retains the accounting approach for lessors as in Ind AS 17:

• Leases are classified as either finance leases (transfers substantially all risks and rewards of ownership) or operating leases.
• Recognition and measurement principles for lessors remain unchanged, except for enhanced disclosure requirements.

     

Presentation in Financial Statements

Lessees:

• Balance Sheet: Both ROU assets and lease liabilities are now included.
• Profit & Loss: Depreciation on ROU asset and interest on lease liability are recorded.
• Cash Flow Statement: Principal payments are financing activities; interest can be financing or operating as per policy. Operating lease payments previously classified as operating cash flows are now split.

Lessors:

• Finance leases: Recognizes a receivable at an amount equal to the net investment in the lease.
• Operating leases: Continues to recognize the underlying asset, recognizing lease income on a straight-line basis or another systematic basis.

Disclosure Requirements

Ind AS 116 mandates significantly more comprehensive disclosures for both lessees and lessors to ensure transparency:

• Lessees must provide quantitative and qualitative disclosures, including maturity analyses, variable lease payment information, and terms of significant leasing arrangements.

• Lessors disclose selling profit or loss, interest income, income from variable payments, and provide maturity analyses of lease receivables.

Practical Examples

Example: Retail Store Lease

Under the old standard (Ind AS 17), a company leasing a shop space would typically recognize only the rent expense.

With Ind AS 116, the company recognizes a ROU asset equal to the present value of lease payments and a lease liability. Over the lease term, depreciation and finance costs are recognized in P&L. This often leads to higher expense in the early years and decreases over the lease period.

Transition to Ind AS 116

Entities transitioning to Ind AS 116 could choose between:

• Full Retrospective Approach: Restate all prior periods as if the standard had always applied.

• Modified Retrospective Approach: No restatement; adjust opening equity for cumulative effect, with detailed disclosures explaining the impact.

Practical expedients are available, such as not reassessing whether contracts are, or contain, leases at the date of initial application.

Impact of Ind AS 116

For Lessees:

• Balance Sheet: Increased assets (ROU) and liabilities (lease obligations), altering financial ratios like debt-equity.

• Profitability Metrics: EBIT and EBITDA often improve as operating lease expense is replaced by depreciation and interest, but PBT may be affected due to front-loaded expense recognition.

• Cash Flows: Operating cash flows improve as a portion of lease payments now show as financing outflows.

• Debt Covenants: Adjustments may impact compliance with covenants tied to financial ratios.

For Lessors:

Marginal impact since classification between operating and finance leases continues; however, definitions and disclosures see changes. Risk and reward transfer evaluation is key.

Differences Between Standard Ind AS 116 and Ind AS 17

Industry Implications and Challenges

1. Real Estate/Banks: Companies with significant operating leases see balance sheets grow materially.
2. IT/Telecom: Equipment and service arrangement assessments become critical.
3. Manufacturing/Auto: Sale-leaseback transactions require special attention under new guidance.
4. Startups/SMEs: Smaller entities without complex lease structures benefit from low-value and short-term exemptions.

Practical challenges include:

• Complexity in lease data collection and system upgrades.
• Changes in business metrics and internal controls.
• Re-evaluation of existing contracts for embedded leases or remeasurement triggers.

Frequently Asked Questions

Q1: Are all leases on the balance sheet under Ind AS 116?

Most leases are; only exemptions apply for short-term and low-value leases.

Q2: What are low-value assets?

Generally, assets like laptops or office furniture qualify, but there’s no explicit threshold; assessment is based on the nature of the asset.

Q3: What transition options are available?

Entities can use either full retrospective or modified retrospective, with certain practical expedients for ease of adoption.

Practical Tips for Implementation

• Start early with a company-wide lease inventory.
• Leverage technology for lease management and accounting.
• Engage with lessors to understand and document contract terms thoroughly.
• Communicate upcoming changes to stakeholders, especially those monitoring financial covenants.

In conclusion, Ind AS 116 is a game-changer for lease accounting in India, enhancing transparency and comparability. It requires companies—especially lessees—to reassess not just their accounting practices, but also their business decisions and contractual frameworks. While transition challenges exist, the end-goal is a truer reflection of an entity’s financial obligations and economic reality.