Ind AS 116 Leases: Comprehensive Guide for Financial Reporting

The introduction of Ind AS 116, “Leases,” marks a significant shift in accounting for lease transactions. This standard aims to improve transparency and comparability by establishing a single lessee accounting model. Ind AS 116 mandates the recognition of lease assets and liabilities on the balance sheet, thereby providing a more accurate depiction of an entity’s financial position. This article offers a detailed overview of Ind AS 116, elucidating its objective, scope, recognition, measurement, and disclosure requirements.

 Objective: 

Ind AS 116 aims to establish comprehensive principles governing the recognition, measurement, presentation, and disclosure of leases, ensuring the faithful representation of transactions by both lessees and lessors. The primary goal is to provide financial statement users with a basis for assessing the impact of leases on an entity’s financial position, financial performance, and cash flows. 

Scope: 

• Inclusions: The standard is applicable to all leases, encompassing right-of-use assets in a sublease. 
• Exclusions: However, certain types of leases are excluded: 

• Leases for exploring or using 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 under Appendix D of Ind AS 115 (Revenue from Contracts with Customers). 
• Licenses of intellectual property granted by a lessor within the scope of Ind AS 115. 
• Rights held by a lessee under licensing agreements within the scope of Ind AS 38 (Intangible Assets) for items like motion picture films, video recordings, plays, manuscripts, patents, and copyrights. 

• Intangible Assets: While Ind AS 116 specifies accounting for individual leases, as a practical expedient, entities may apply the standard to a portfolio of leases with similar characteristics, provided the effects on financial statements are not expected to differ materially. 

Examples: 

• Inclusion of Right-of-Use Assets in Sublease: 

• Scenario: A company leases office space from Lessor A and, in turn, subleases a part of that space to another company. 
• Application: Ind AS 116 applies to both the original lease with Lessor A and the sublease. The lessee accounts for the right-of-use asset in both instances. 

• Exclusion of Intellectual Property License: 

• Scenario: A company licenses software from a lessor under an agreement that falls within the scope of Ind AS 115. 
• Application: Since licenses of intellectual property granted by a lessor are excluded from Ind AS 116, the company accounts for this arrangement under the revenue recognition principles of Ind AS 115. 

• Applicability to Intangible Assets: 

• Scenario: A company leases the right to use a patented technology. 
• Application: While the standard generally doesn’t apply to intangible assets (except those specified), the lessee has the option to apply it to such leases. 

• Portfolio Approach Practical Expedient: 

• Scenario: A company has a significant number of leases with similar characteristics, e.g., small office spaces. 
• Application: Instead of applying Ind AS 116 individually to each lease, the company, as a practical expedient, applies it to the entire portfolio if the effects on financial statements are not expected to materially differ.

Recognition Exemption Overview: 

Ind AS 116 provides recognition exemptions for certain leases, allowing lessees to elect not to apply the standard’s recognition, measurement, and presentation requirements to short-term leases and low-value leases. 

Recognition Exemption Categories: 

• Short-Term Leases: 

• Definition: Leases with a lease term of 12 months or less. 
• Election: Lessees can choose not to apply Ind AS 116 requirements to short-term leases. 
• Expense Recognition: Lease payments associated with short-term leases are recognized as an expense either on a straight-line basis over the lease term or using another systematic basis representing the pattern of the lessee’s benefit. 
• Election by Class: The exemption for short-term leases is made by the class of underlying asset to which the right of use relates. 

• Low-Value Leases: 

• Definition: Leases involving underlying assets that are of low value. 
• Election: Lessees can choose not to apply Ind AS 116 requirements to low-value leases. 
• Expense Recognition: Similar to short-term leases, lease payments associated with low-value leases are recognized as an expense on a straight-line basis or another systematic basis. 
• Absolute Basis Assessment: The determination of whether an underlying asset is of low value is performed on an absolute basis, and leases of low-value assets qualify for exemption regardless of their materiality to the lessee. 
• Excluded Circumstances: If a lessee subleases an asset or expects to sublease it, the head lease does not qualify as a low-value lease. 

• Examples of Low-Value Assets: Tablet and personal computers, small office furniture items, telephones. 

Disclosure Requirements: 

If a lessee applies either exemption, disclosure is mandatory, or the financial statements must include information to make the effect of the exemption known to users. 

Examples: 

• Short-Term Lease Example: 

• Scenario: A company leases office equipment for 10 months. 
• Application: The lessee can elect to treat this as a short-term lease, recognizing the lease payments as an expense on a straight-line basis over the 10-month lease term. 

• Low-Value Lease Example: 

• Scenario: A lessee acquires small office furniture. 
• Application: If the furniture is of low value, the lessee can choose not to apply Ind AS 116 and expense the lease payments on a systematic basis. 

• Disclosure Example: 

• Scenario: A lessee decides not to apply Ind AS 116 to low-value leases. 
• Application: The lessee must disclose this fact and provide relevant information in the financial statements to ensure users are informed about the exemption’s impact. 

• Sublease Exclusion Example: 

• Scenario: A lessee subleases a computer it previously leased. 
• Application: In this case, the head lease does not qualify for the low-value lease exemption due to subleasing, and the lessee must apply Ind AS 116.

Separating Components of a Contract: 

When a contract involves both lease and non-lease components, accounting standards require entities to account for each lease component separately from non-lease components. Here are the key points: 

• Allocation of Contract Consideration: 

• The total contract consideration should be allocated to each lease component based on the relative stand-alone price of the lease component. 
• Non-lease components are accounted for separately using other applicable accounting standards. 

Example: If a lease agreement includes both the right to use a property (lease component) and maintenance services (non-lease component), the total contract consideration would be allocated between these components based on their stand-alone prices. 

• Practical Expedient: 

• As a practical expedient, a lessee can choose not to separate non-lease components from lease components. 
• Instead, the lessee can account for the entire contract, including both lease and non-lease components, as a single lease component. 

Example: A lessee might enter into a lease agreement for office space that includes both the right to use the space (lease component) and maintenance services (non-lease component). Choosing the practical expedient simplifies accounting by treating both as a single lease component. 

• Exception for Embedded Derivatives: 

• The practical expedient does not apply to embedded derivatives that meet the criteria outlined in Ind AS 109 (Financial Instruments). 

Example: If the contract includes an embedded derivative, such as an interest rate swap, it needs to be accounted for separately according to the criteria in Ind AS 109. 

Lease Term Determination: 

Determining the lease term is crucial for accounting purposes. The lease term includes: 

• Commencement Date: 

• The lease term starts on the commencement date, which is when the lessor makes the underlying asset(s) available for use by the lessee. 

• Components of Lease Term: 

• Non-cancellable period of the lease. 
• Periods covered by options to extend the lease if the lessee is reasonably certain to exercise. 
• Periods covered by options to terminate the lease if the lessee is reasonably certain not to exercise. 

• Enforceability: 

• A lease is no longer enforceable when both the lessee and lessor have the right to terminate the lease without significant penalty. 

• Revision of Lease Term: 

• The entity revises the lease term if there is a change in the non-cancellable period of a lease. 

Example: If a lessee and lessor agree to extend the lease term, the entity would need to revise the lease term accordingly.  

Recognition and Measurement of Lease in the Books of Lessee: 

• Commencement of Lease: 

• On the lease commencement date, the lessee recognizes the right-of-use asset and measures it at cost. 
• Simultaneously, the lessee recognizes a lease liability, measured at the present value of lease payments not yet paid. 
• The discount rate used for present value calculation is either the interest rate implicit in the lease or the lessee’s incremental borrowing rate. 

Example: A company leases equipment for five years with annual lease payments of $12,000. The lessee, on the commencement date, recognizes the right-of-use asset and the lease liability, using the appropriate discount rate. 

• Cost Calculation: Cost = Lease Liability + Lease payments made – lease incentives received + initial direct costs + estimated dismantling and restoration costs. 
• Lease Payments Calculation: Lease Payments = Fixed payments – lease incentives + variable payments + expected guaranteed residual value + exercise price of a purchase option + penalties for termination. 

• Subsequent Measurement of Right-of-Use Asset: 

• The right-of-use asset is measured using a cost model or revaluation model (if the entity applies the revaluation model as per Ind AS 16). 

Example: If the underlying asset is a building, and the company typically revalues buildings, it may opt for the revaluation model. 

• Cost Model: The lessee measures the right-of-use asset at cost less accumulated depreciation and any accumulated impairment losses. 
• Remeasurement of Right-of-Use Asset: Lessees adjust the carrying amount for remeasurement of the lease liability, unless the carrying amount is already reduced to zero or the change in the lease liability relates to a variable lease payment independent of an index or rate. 

• Subsequent Measurement of Lease Liability: 

• After initial recognition, the lease liability is measured at amortized cost using the effective interest method. 

Example: If there are changes in lease payments due to modifications, reassessment, or revised fixed lease payments, the lease liability is recalculated. 

• Reassessment of Lease Liability: 

• Lessees remeasure the lease liability to reflect changes in lease payments. 
• The amount of remeasurement is recognized as an adjustment to the right-of-use asset. 

Example: If future lease payments increase, the lessee adjusts the liability and the right-of-use asset accordingly. 

• If the carrying amount of the right-of-use asset is reduced to zero, and there’s a further reduction in the lease liability, any remaining amount of the remeasurement is recognized in profit or loss.

Presentation: 

• Balance Sheet Presentation: 

• Right-of-use assets should be presented separately or disclosed in the notes. If not presented separately, they should be included in the appropriate line item as if owned. 

Example: If a company leases a building, the right-of-use asset may be presented in the property, plant, and equipment section or disclosed separately, providing clarity to users. 

• Lease liabilities should be presented separately or disclosed in the notes, identifying the line items that include these liabilities. 

• Investment Property Presentation: 

• Right-of-use assets meeting the definition of investment property are presented within the investment property section. 

Example: If a company leases a property for investment purposes, the right-of-use asset is presented alongside other investment properties. 

• Statement of Profit and Loss: 

• Interest expense on the lease liability is presented separately from the depreciation charge for the right-of-use asset. 

Example: If the annual interest expense is $5,000 and depreciation is $10,000, the statement of profit and loss shows them separately. 

• Interest expense on the lease liability is considered a component of finance costs. 

• Statement of Cash Flows: 

• Cash payments for the principal portion of the lease liability are classified within financing activities. 

• Cash payments for the interest portion of the lease liability are classified within financing activities following Ind AS 7. 
• Short-term lease payments, payments for leases of low-value assets, and variable lease payments not included in the lease liability measurement are classified within operating activities. 

Example: Cash payments for principal and interest on a finance lease are separately classified in the financing activities section.  

Accounting in the Books of Lessor: 

• Lease Classification: 

• Lessors classify leases as either operating or finance leases based on the risks and rewards transferred. 

Example: If the lessor transfers substantial risks and rewards, it’s a finance lease; otherwise, it’s an operating lease. 

• Classification occurs at inception and is reassessed only in the case of lease modification. 

• Substance Over Form: 

• Lease classification depends on the substance of the transaction rather than the form of the contract. 

Example: Even if a lease contract might seem like an operating lease, if it transfers substantial risks and rewards, it is classified as a finance lease. 

• Changes in estimates or circumstances (e.g., changes in the economic life or residual value) don’t trigger a new lease classification.

Finance Lease Receivable Measurement: 

• Initial Measurement: 

• A lessor measures a finance lease receivable initially at the present value of future lease payments plus any unguaranteed residual value. 

Example: If the future lease payments amount to $100,000 and there is an unguaranteed residual value of $10,000, the initial finance lease receivable is $110,000. 

• The lessor discounts these amounts using the rate implicit in the lease. 

• Lease Payments Included: 

• The finance lease receivable includes various lease payments: 

• Fixed payments (including in-substance fixed payments) less lease incentives payable. 
• Variable payments depending on an index or rate. 
• Residual value guarantees provided at the guaranteed amount. 
• Exercise price of purchase options if the lessee is reasonably certain to exercise. 
• Termination penalties payable as per the expected lease term. 

Example: If a lessee pays $1,000 fixed payments, has a variable payment based on an index, and a guaranteed residual value of $5,000, the finance lease receivable includes these components.  

Lease Modification: 

• Separate Lease Modification: 

• A lessee accounts for a lease modification as a separate lease if it adds the right to use more underlying assets, and the consideration increases by an amount equivalent to the stand-alone price for the increased scope. 

Example: If a lease modification adds another piece of equipment, and the payment increases by the stand-alone price for that equipment, it’s treated as a separate lease. 

• Non-separate Lease Modification: 

• For modifications not considered separate leases: 

• The lessee remeasures the lease liability at the effective date using the discount rate determined then. 
• For modifications decreasing the lease scope, the lessee decreases the right-of-use asset, recognizing a gain or loss reflecting the proportionate decrease. 
• For all other modifications, the lessee adjusts the right-of-use asset. 

Example: If a lease is modified, reducing the leased space, the right-of-use asset is adjusted accordingly, and any gain or loss is recognized proportionately.  

Practical Expedient for Covid-19-Related Rent Concessions: 

The Standard introduces a practical expedient for lessees regarding rent concessions directly linked to the Covid-19 pandemic. Lessees may opt not to assess these concessions as lease modifications, applying accounting treatment similar to changes not resulting in lease modifications. 

Conditions for Application: 

• The change in lease payments results in revised consideration for the lease that is substantially the same as or less than the consideration preceding the change. 

Example: If a rent concession results in reduced payments on or before June 30, 2022, with increased payments afterward, it meets this condition. 

• Any reduction in lease payments affects only payments originally due on or before June 30, 2022. 
• There is no substantive change to other terms and conditions of the lease. 

Disclosure Requirements if Applied: 

• If the expedient is applied, the entity must disclose: 

• The decision to apply the expedient to all rent concessions or specific contracts. 
• The amount recognized in profit or loss reflecting changes in lease payments due to rent concessions. 

Effective Date and Retrospective Application: 

• The expedient can be applied for annual reporting periods starting on or after April 1, 2020, and retrospectively beyond June 30, 2021. 
• Cumulative effects are adjusted to the opening balance of retained earnings (or other equity components) in the period of the first application. 
• Disclosure requirements under paragraph 28(f) of Ind AS 8 are not mandatory for the initial application reporting period. 

Consistent Application: 

• Lessees apply the expedient consistently to eligible contracts with similar characteristics and circumstances, regardless of whether it becomes eligible due to Covid-19-Related Rent Concessions or those beyond June 30, 2021.

Presentation in the Context of Lessor’s Balance Sheet: 

• Underlying Assets from Operating Leases: 

• The lessor presents assets subject to operating leases in its balance sheet based on the nature of the underlying asset. 

Sale and Leaseback – Recognition and Measurement: 

• Determining Sale of Asset: 

• If the transfer of an asset in a sale and leaseback transaction meets the criteria of being a sale, both the seller-lessee and the buyer-lessor account for it as both a sale and a lease. 

For Seller-Lessee: 

• Measures the right-of-use asset at a proportion of the previous carrying amount related to the retained right-of-use asset. 
• Recognizes only the gain or loss related to the rights transferred to the buyer-lessor. 

For Buyer-Lessor: 

• Accounts for the purchase of the asset according to applicable standards. 
• Accounts for the lease following lessor accounting requirements under Ind AS 116. 

• Determining Non-Sale (Financing Arrangement): 

• If the transfer does not qualify as a sale, the transaction is treated as a financing arrangement by both the seller-lessee and the buyer-lessor. 

For Seller-Lessee: 

• Continues to recognize the transferred asset. 
• Recognizes a financial liability equal to the transfer proceeds under Ind AS 109. 

For Buyer-Lessor: 

• Does not recognize the transferred asset. 
• Recognizes a financial asset equal to the transfer proceeds under Ind AS 109. 

Examples: 

• Sale and Leaseback as a Sale: If a company sells a property and leases it back, recognizing a gain only on the portion of the rights transferred to the buyer-lessor. 
• Sale and Leaseback as Financing Arrangement: If the sale and leaseback do not qualify as a sale, the seller-lessee continues recognizing the asset and acknowledges a financial liability, while the buyer-lessor does not recognize the asset but establishes a financial asset.

Temporary Exception Arising from Interest Rate Benchmark Reform – Ind AS 116: 

Practical Expedient for Lease Modifications: 

• Objective: Ind AS 116 provides a practical expedient for lease modifications resulting from interest rate benchmark reform. 
• Conditions for Required Modification: A lessee is required to remeasure the lease liability if: 

• The modification is necessary due to interest rate benchmark reform. 
• The new basis for determining lease payments is economically equivalent to the previous basis. 

• Additional Modifications: If there are other modifications made alongside those required by benchmark reform, all modifications must be accounted for together following Ind AS 116. 
• Transition Date Application: These amendments are applicable for annual reporting periods starting on or after April 1, 2021, and entities may choose to restate prior periods without hindsight. If not restated, any difference between previous and current carrying amounts is recognized in the opening retained earnings. 

Definition of Lease – Transition Date Accounting: 

• Options on Initial Application of Ind AS 116: 

• Companies may choose not to reassess previously identified lease contracts under Ind AS 17 and apply transition provisions to those leases. 
• They may choose not to apply Ind AS 116 to contracts not previously identified as leases under Ind AS 17. 

• Disclosure Requirements: 

• If entities choose the above options, disclosure of this fact is mandatory, and the practical expedient applies to all contracts. 

Transition Accounting in the Books of Lessee: 

• Options for Transition: 

• Retrospective Adoption: Lessees may adopt the standard retrospectively. 
• Modified Retrospective Approach: Lessees may follow a modified retrospective approach. 

• Consistent Application: The chosen election must be consistently applied to all leases. 

Examples: 

• Benchmark Reform Modification: If a lessee has a lease with variable payments linked to a benchmark and the benchmark changes due to reform, the lessee applies the practical expedient to adjust the lease liability based on the equivalent economic impact. 
• Transition Options: A company, on adopting Ind AS 116, chooses not to reassess its previously identified leases under Ind AS 17, providing disclosure on this choice. It also opts not to apply Ind AS 116 to contracts not recognized as leases before.

Modified Retrospective Approach in Transition Accounting – Lessee: 

Objective: The modified retrospective approach under Ind AS 116 allows lessees not to restate comparative information. Instead, they recognize the cumulative effect of applying Ind AS 116 as an adjustment to the opening balance of retained earnings or other equity components at the date of initial application. 

Transition for Operating and Finance Leases: 

• Operating Lease: 

• Lease Liability Measurement: Present value of remaining lease payments discounted using the lessee’s incremental borrowing rate at the initial application date. 
• Right-of-Use Asset: Retrospective calculation, using a discount rate based on the incremental borrowing rate at the initial application date, or the amount of lease liability adjusted by any previously recognized prepaid or accrued lease payments. 

• Finance Lease: 

• Lease Liability: Carrying amount of the lease liability immediately before the initial application date. 
• Right-of-Use Asset: Carrying amount of the lease asset immediately before the initial application date. 

Application of Ind AS 116: 

• Apply the provisions of Ind AS 116 to right-of-use assets and lease liabilities from the date of initial application. 

Practical Expedients: 

• The standard provides practical expedients under the modified retrospective approach for leases previously classified as operating leases under Ind AS 17. 

Transition Accounting in the Books of Lessor: 

General Transition Rules: 

• Except for sub-leases and sale-and-leaseback transactions, lessors generally do not make adjustments on transition. 

Sale-and-Leaseback Transactions: 

• Transactions Entered Before Initial Application Date: 

• No reassessment of sale-and-leaseback transactions before the initial application date regarding Ind AS 115 requirements for accounting as a sale. 

• Sale-and-Leaseback Transaction Accounting (Finance Lease): 

• Seller-lessee accounts for the leaseback as a finance lease existing at the initial application date. 
• Continues to amortize any gain on the sale over the lease term. 

• Sale-and-Leaseback Transaction Accounting (Operating Lease): 

• Seller-lessee accounts for the leaseback as an operating lease. 
• Adjusts the leaseback right-of-use asset for deferred gains or losses related to off-market terms recognized in the balance sheet before the initial application date. 

Examples: 

• Lessee Transition: A company, upon adopting Ind AS 116, decides not to restate comparative information but recognizes the cumulative effect of applying the standard as an adjustment to the opening balance of retained earnings. 
• Operating Lease Transition: For an operating lease transition, a lessee chooses to measure the lease liability based on the incremental borrowing rate and retrospectively calculate the right-of-use asset, selecting the method that best suits each lease. 
• Finance Lease Transition: In the case of a finance lease transition, a lessee adopts the carrying amount of the lease liability and right-of-use asset immediately before the initial application date. 
• Sale-and-Leaseback: If a sale-and-leaseback transaction is accounted for as a finance lease, the seller-lessee continues to amortize any gain on the sale over the lease term, adhering to Ind AS 17 requirements. 

Conclusion

Ind AS 116 significantly alters lease accounting, emphasizing transparency and providing a uniform approach to recognizing and measuring leases on the balance sheet. Its comprehensive scope, coupled with detailed disclosure requirements, enhances the ability of financial statement users to understand the economic realities of lease transactions. Entities must carefully assess the impact of Ind AS 116 on their financial reporting processes, ensuring compliance while leveraging the standard’s provisions to reflect their lease transactions faithfully.