Ind AS 116 : A Major Shift for Accounting by Lessees

Ind AS 116 is effective from 1st April 2019 for all companies preparing their financials in compliance with Indian Accounting Standards by replacing Ind AS 17.  New standard requires Lessees to follow single accounting model for all leases.  For lessors, there is little change to the existing accounting under Ind AS 17. Lessors will continue to distinguish between finance leases (recognise a lease receivable) and operating leases (continue to recognise the underlying asset). The article primarily focus on the major changes in lease accounting by lessees.

Objective and Scope:

The objective is to ensure that lessees and lessors provide relevant information in a manner that faithfully represents those transactions. This information gives a basis for users of financial statements to assess the effect that leases have on the financial position, financial performance and cash flows of an entity.

This standard applies to all leases, including leases of right-of-use assets in a sublease, except for:

  • Leases to explore for or use minerals, oil, natural gas, and similar non-regenerative resources;
  • Leases of biological assets within the scope of Ind AS 41, Agriculture, held by a lessee
  • Service concession arrangements within the scope of Appendix D, Service Concession Arrangements, of Ind AS 115, Revenue from Contracts with Customer
  • Licenses of intellectual property granted by a lessor within the scope of Ind AS 115, Revenue from Contracts with Customers
  • Rights held by a lessee under licensing agreements within the scope of Ind AS 38, Intangible Assets, for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights

Ind AS 116 exemptions

Ind AS 116 provides recognition exemptions to lessees for the following and specifies alternative requirements for the same:

  • Short term leases – A lease which has a lease term of not more than 12 months on the date of commencement is regarded as a short term lease. The accounting policy election is to be made class-wise.

 

  • Leases for which underlying asset is of low value. This accounting policy election is to be made lease by lease basis.

Identifying a lease

At the inception of a contract, an entity shall assess whether the contract is, or contains a lease. A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

To assess whether a contract conveys the right to control the use of an identified asset for the period, the lessee should have both of the following:

  • The right to obtain substantially all the economic benefits from the use of an identified asset, for example, benefit by using, holding or sub-leasing the asset, and
  • The right to direct the use of identified asset i.e. right to direct how and for what purpose the asset is used or right to operate the asset.

Initial recognition & Measurement

Earlier Ind AS 17 requires both lessees and lessors to record a lease as either a finance lease or an operating lease. Operating leases for lessees under Ind AS 17 were considered ‘off balance sheet’ given Ind AS 17 did not require future lease payments to be recorded as a liability. Ind AS 116 eliminates the current dual accounting model for lessees, which distinguishes between on-balance sheet finance leases and off-balance sheet operating leases. Instead, there is a single, on-balance sheet accounting model that is similar to current finance lease accounting.

Lessees are required to initially recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. The lease liability is measured at the present value of the lease payments to be made over the lease term

The right-to-use asset is initially measured at the amount of the lease liability and adjusted for lease prepayments, lease incentives received, the lessee’s initial direct costs and an estimate of the restoration, removal and dismantling cost

Subsequent Measurement

Lessees accrete lease liability to reflect interest and reduce the liability to reflect lease payments made. The related right-to-use asset is depreciated in accordance with Ind AS 16 Property, Plant and Equipment

For lessees that depreciate the right-to-use asset on a straight-line basis, the total of interest expense on lease liability and depreciation generally results in higher total periodic expense in the initial periods of a lease

Presentation

Right-to-use assets are either presented separately from other assets on the balance sheet or disclosed separately in the notes. Depreciation expense and interest expense cannot be combined in the statement of profit and loss

Balance Sheet Impact

Ind AS 17

Ind AS 116

Lease Assets (Right to Use Asset)

Increase

Lease Liabilities

Increase

Off Balance sheet rights/obligations

Yes

Reduce

 For companies with material off balance sheet leases, there will be a change to key financial metrics derived from the company’s reported assets and liabilities (for example, asset turnover ratio, leverage ratio).

Income statement Impact

Ind AS 17

Ind AS 116

Revenue

Yes

No Change

Operating costs (excluding depreciation and amortization)

Yes

Reduction

EBITDA

Yes

Increase

Depreciation and amortization

Increase

Finance cost

Increase

Profit before tax

Yes

No Major Change

Ind AS 116 replaces the straight-line operating lease expense for those leases applying Ind AS 17 with a depreciation charge for the lease asset (included within operating costs) and an interest expense on the lease liability (included within finance costs).

This change aligns the lease expense treatment for all leases. Although the depreciation charge is typically even, the interest expense reduces over the life of the lease as lease payments are made. This results in a reducing total expense as an individual lease matures.

EBITDA will be notably higher in Ind AS 116 compared to Ind AS 17 for companies with material off balance sheet leases.

Major differences (AS 19 v. Ind AS 17 v Ind AS 116) 

Sl. No Particular AS-19 IND-AS 17 IND AS 116
1 Scope & coverageLand .  The scope excludes lease agreement to use land.·   No specific provisions relating to sub-lease. .  The scope covers Land.·   No specific provisions relating to sub-lease. .  The scope covers Land.·   The standard covers specific provisions relating to the right to use assets in a sub-lease as well.
2 Definition of lease A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time. No specific guidance to determine such arrangement given. Same as AS-19 but specific guidance in determining whether an arrangement contains lease is given in Appendix C of the standard. A lease is the contract that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Specific guidance relating to assessment of contract is provided in the standard.
3 Operating Lease rentals and inflation The standard is silent on its treatment Straight line method should not be used when the rentals are increased based on inflations The standard is silent of its treatment
4 Lease Incentives No specific discussion of lease incentives. The lessor and lessee shall recognise the aggregate cost of incentives as a reduction of rental income over the lease term. The incentives are recorded as deduction from rentals.
5 Classification of Lease in hands of lessee Leases were recorded as per their classification into Operating and Finance Lease Leases were recorded as per their classification into Operating and Finance Lease Lessee will follow Single Lease Accounting. There is no classification as operating or finance Lease for lessee.
6 Lease modification No treatment mentioned in the standard. No treatment mentioned in the standard. Specifically deal with lease modification and its accounting.
7 Disclosures Requirements of lessee NA NA Additional disclosure requirements

 

Implementation Steps

Key challenges:

  • Initial analysis of all contracts in order to establish how much and what type of data will have to be processed.
  • Making new estimates depending on the nature and term of a lease, which could affect the reliability of financial forecasts.
  • Initial recognition and classification: recognition of the lease liability and a right-of-use asset at the commencement date using the present value of the lease payments that are not paid at that date.
  • Subsequent measurement and re-measurement: calculation of increase of carrying amount by interest component, increase / decrease by re-measurement component, etc.
  • Identification of lease modifications: depending on the criteria met, accounting of lease modification as a separate lease, derecognition and recognition of a new lease or change in the carrying amount of an existing lease contract.
  • Disclosures preparation
  • Selection of Transition Approach:
    • Full Retrospective Approach: retrospectively to each prior reporting period presented applying Ind AS 8 i.e. 1 April 2018.
    • Modified Retrospective Approach: retrospectively with the cumulative effect of initially applying the standard on application date i.e. 1 April 2019.

Conclusion

Ind AS 116 is expected to reduce the need for analyst and those using financial statements to make adjustments by providing a richer set of information than was available when companies applied Ind AS 17, providing further insight into a company’s operations and funding. Ind AS 116 is a significant change from current Ind AS, in particular for lessees. A detailed assessment of impact on financials is required.

Link to Useful Resources:

  1. Ind AS 116 : MCA Notification dated 30.03.2019
  2. IFRS – 16 Effect Analysis by IASB
  3. YouTube Video explaining Ind AS 116 Implementation challenges

About Chintan Patel FCA, CPA(USA), Cert.IFRS(ICAI), CISA (USA), DISA, DIRM

CA Chintan Patel is a partner of Naresh J. Patel & Co. Chartered Accountants (www.nareshco.com). Key Professional Contributions: Immediate Past Chairman of Ahmedabad Branch of WIRC of ICAI, Co-author of book on Ind AS & ICDS published by Taxmann, Trainer/Faculty at more than 300 seminars/conferences. He has over 15 years of post qualification experience working with SMCs, MNCs on International GAAP, Companies Act, 2013, GST and other advisory.
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