Ind AS 116 Leases came into effect from 01 April 2019. It does not mean that there was no standard on leases before 01 April 2019. IndAs 116 Leases replaced, the existing Ind As 17 – Leases with effect from 01 April 2019. For the entities which are not covered under IndAS, AS 19 Leases will be applicable. The essence of bringing Ind As 116 into effect from 01 April 2019 is to align the Indian Accounting Standards with the Global standards on leases namely IFRS 16 which came into effect from 01 January 2019. The Lessor accounting of leases in their books of accounts did not undergo any material change under IndAS 116 or even under IndAS 17. Hence this article will discuss primarily on the lessee’s point of view. Lessor – One who lets out the asset on lease. Lessee – one who uses the assets under lease transaction.

The Background of IndAS 116: “One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet” 

Sir David Tweedie, Former Chairman of the IASB

Sir David Tweedie, Former Chairman of the IASB, revealed during a speech to the Empire Club of  Canada on April 25, 2008. The airline companies, in general enter into contract with the airplane manufacturers for operating lease of airplanes. The accounting for operating lease contract will not be directly visible in the financial statements of a Company. The core liability is only given as a Note to Financial Statements. It became difficult for the investors and other users of the financial statement to identify the actual liability of the airline companies. Not only in case of the Airline companies, financial statements of any Company that has higher Operating lease liability will not show a clear picture of their actual liabilities. This lead to the birth of necessity to bring in a new standard for accounting of leases i.e. IFRS 16. In turn Ind AS 116 came into effect.

Applicability of IndAS 116: It is applicable to companies which gets covered under Ind AS.IndAS in general is applicable to

a) All Listed Companies (Including Bank, NBFC and Insurance Companies)

b)     Companies with Net worth greater than 250 Crore (Including Bank, NBFC and Insurance Companies).

c)      Companies which voluntarily adopted IndAS.

d)     Subsidiaries, Holding Companies, Associated companies, and Joint Ventures of the Company, which follow IndAS. Irrespective of individual qualification of such companies.

Lease transactions for all assets are covered under Ind AS 116, except:
   ·Leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources·        Leases of biological assets·        Service concession arrangements·        Licenses of intellectual property granted by lessor·        Rights held by a lessee under certain licensing agreements (e.g. films)
   ·The value of such assets (per unit value of assets) are considered to be low (not defined in the Standard) or the term of the lease is less than 12 months.
The effect of IndAS 116 will be seen in the listed companies first, as they have to publish their first quarter results for the period 01 April 2019 to 30 June 2019 by 14 August to the SEBI. Anyhow the disclosure requirement will be reflected only in the March 2020 financials.
 IndAS 116 Vs IndAS 17:

Point to be Noted:

Lessee should satisfy the following conditions for Ind AS 116 to be applicable:
Lessee should receive substantial economic benefits from the Leased assets to get covered in this standard and also should have the control over the right to use the asset which is taken on lease to get covered under Ind AS 116. If the lessee does not have control over the right to use the asset, Ind AS 116 will not applicable.  Example: Lessee enters into lease transaction of a Plant and Machinery, if the lessor imposes any conditions and restricts the use of the leased asset by the lessee, the contract will not be a Lease Contract.
If the lessor has substantive substitution right over the asset leased, such leased assets will not get covered under IndAS116. Eg: A company enters into a contract with a Warehousing Company for occupying space in one of their Warehouses. The company will use this space to deploy its finished goods and other equipment. As per the contract, the Warehousing Company will provide a particular area of space and the space must be located within the hall number 1 of the Warehouse. However, the Warehousing Company has a right to change the allocated location at any time during the contract. The Warehouse has several unoccupied spaces that will meet the company’s requirements. The Company needs to incur minimal costs for changing the allocated space. The Warehousing Company will economically benefit by changing the space allocated to a customer.
The Ind AS 116 will have positive impact on the EBITDA and total assets of the Company and will have an adverse impact on the Net Assets and Interest Coverage Ratios.

Lessee’s Accounting:
The Lessee should consider the following items while accounting for leases under IndAS16:
Under this IndAS, the lessee should record liability under the lease agreement and also record the corresponding assets leased by them.
To record the lease liability, the lessee should identify the following terms:
a)      Lease termb)     Lease Payment andc)      Discount rate
1.      Lease Term:     The lease term in the lease contract should satisfy the following conditions:
a)      The lease term should be for a Non-Cancellable period.b)     The lease agreement should have optional period where lessee can extend lease/excise right to renew.c)      The lease agreement should have optional period where lessee will not execute the right to terminate.
2.      Lease Payment:
The lease should be accounted only if the lease payments are fixed. If the lease payments are variable the lease should not be accounted for under this standard. But if the variable lease payments are linked to the indices, then it should be recorded as leases under this standard.
3.      Discount Rate:
As per the standard the lessee should either consider the Implicit Rate (IRR) in the lease or the Incremental borrowing rate (rate at which the lessee will obtain loan to purchase the leased asset) as the discount rate.
To record the leased Asset, the lessee should identify the Right to use Asset:
Right to use Asset = Lease Liability + Initial Cost + Prepaid Lease Payment + Cost to dismantle (at Present value) – Lease incentive (Present Value)  Transition Provision:
The Company has the option to adopt Ind AS in the following manner:
a)      Fully Retrospectiveb)     Modified Retrospective – Option Ic)      Modified Retrospective – Option II

A.    Fully Retrospective
The transition impact based on the full retrospective transition approach will be as follows:
• The lease liability is recognized on the lease commencement date using the interest rate implicit in the lease. If that rate cannot be readily determined, the incremental borrowing rate is used for discounting
• Comparative periods are restated as if Ind AS 116 is applied from the commencement of the lease, as such entities will present a third balance sheet as at the beginning of the preceding period in addition to the minimum comparative financial statements
• The provisions of Ind AS 8 “Accounting policies, changes in accounting estimates and errors” are applied. Accordingly, a third statement of financial position as at the beginning of the preceding period is presented, in addition to the minimum comparative financial statements
Impact Points:
1.      The active contract should be restated retrospectively from the date of commencement of the contract.
2.      The impact of such restatement will have impact on the opening reserves of the third balance sheet (i.e. at the beginning of the preceding period in addition to the minimum comparative financial statements)
3.      Only if the Company opts fully retrospective third Balance sheet becomes applicable.

B.     Modified Retrospective:
The transition impact based on the modified retrospective transition approach will be as follows:
• For the FY 2019-2020, the effective date of initial application will be 1 April 2019.
• The lease liability is recognized at the date of initial application. The lease liability is measured at the present value of the remaining lease payments discounted using lease incremental borrowing rate at the date of initial application.
Option I
• Under the option given in para C8(b)(i), the right-of-use asset is recognized at the date of initial application. The ROU asset is measured as if the Standard had been applied since the commencement date, but discounted using incremental borrowing rate at the date of initial application. Difference between ROU asset and lease liability is recognized in the opening retained earnings on initial application
Impact Points:
1.      The active contracts will be recognized on 1 April, 2019 only. The value of the right to use assets will be calculated retrospectively from the date of commencement of the contract, using the discount rate at the date of initial application. (i.e. 01 April 2019).
2.      The value of lease liability will be recognized at present value of remaining lease payments discounted at incremental borrowing rate at the date of initial application.
3.      The impact of such restatement will have impact on the opening reserves of the current year balance sheet (i.e. FY 2019-20)
Option II
• Under the option given in para C8(b)(ii), the right-of-use asset is recognized at the date of initial application. The ROU asset is measured at an amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments relating to that lease recognized in the balance sheet immediately before the date of initial application
Impact Points:
1.      The active contracts will be recognized on 1 April, 2019, where the value of the right to use assets will be equal to lease liability plus prepaid lease rental less accrued lease payment relating to that lease recognized in the balance sheet immediately before the date of initial application. There will be no impact on the opening reserve.
2.      The value of lease liability will be recognized at present value of remaining lease payments discounted at incremental borrowing rate at the date of initial application.
3.    The impact will be on the profit or loss account, having final impact on the closing reserves.

Transition Impact in the Financials

Point to be Noted: If the lease contracts were present valued already as a requirement of any other Ind AS during implementation of Ind AS for the first time in a Company, No adjustment will be required while implementing Ind AS 116.
If the remaining lease term of the active contract as on April 01, 2019 is less than a year, then Ind AS 116 need not be applied. As the impact will be anyhow on the Profit or Loss of FY 2019-20.
Disclosures:
The following are the disclosures to be made in the financials prepared on March 31, 2020 with respect to Ind AS 116
1.      Disclosure on Interest Expense2.      Depreciation of Right to Use of the Asset3.      Expense relating to lease of assets which are of lesser cost and hence Ind AS 116 is not applied.4.      Expense relation to lease of assets with shorter duration and hence Ind AS 116 is not applied.5.      Commitments as disclosed under Ind AS 17 should be reconciled with lease liability recorded under Ind AS 116.
Presentation:
In Balance Sheet:
a)      Leased Assets to be shown separately as Right to use of Asset.b)     Lease Liability should be shown separately in financials. There is no specific guidance given in Ind AS 116, but IFRS 16 states that lease liability should be grouped under Borrowings.
In Profit or Loss:
a)      Interest expense on the financial liability under finance costb)     Depreciation of Right to use of Asset under the Depreciation and Amortization
In Cash flow the impact will be on the Operating cash flow and Cash flow from financing activities.
Deferred Tax:
Under Income Tax Act, the lessee is not allowed to capitalize the lease payment made to the Lessor, even though it is considered as finance lease under erstwhile Ind AS 17. In Income tax act, the Lessor claims the depreciation benefit unlike the Ind AS. Hence deferred tax treatment arises on the Finance lease. Under Ind AS 116, single lease accounting model is followed, where all the leases are capitalized in the lessees’ books and hence this will give raise to deferred tax accounting. Initially there might be recording of deferred tax liability as the lease payments under Income tax Act may be higher than the depreciation and interest on lease payments.

Special Thanks to CA Karthikeyan M, for reviewing my article and for suggesting valuable inputs.