♣ Background
We are living in second decade of year 2000. The idea of doing business has totally changed over the years. In the earlier years, most entities were buying assets required for operating a business. Over the years, the availability of assets became easier on lease as well. Now, any class of asset can be acquired on rent whether a smartphone or an air plane.
There are many benefits of getting an assets on lease. The main advantage of getting an asset on lease is that your initial outlay of cash to gain the use of an asset is generally less for leasing than it is for purchasing. Further, getting asset on lease has following other benefits as well, such as –
1. You don’t have to worry about maintenance duties
2. You can retain your mobility
3. If cost of asset is very high, then your entity may not be able to purchase or get credit from a financial institution.
The new lease standard i.e ASC 842 (US GAAP) IFRS 16 (globally) and Ind AS 116 has is driven by a theory, if an entity has right to use an asset taken on lease for specific period of time, then it meets the definition of assets and therefore, Ind AS 116 out principal to recognise underlying asset as balance sheet item and treat the same as Property, Plant and Equipment. Further, present value of all future payments to be accounted as liability.
Read earlier Article… A brief introduction to Ind AS 116
https://taxguru.in/chartered-accountant/ind-116-introduction.html
♣ Ind AS 116 will have a dramatic impact on Balance Sheet and P&L of the entities which can be material.
1. Impact on Balance Sheet :
The asset base of the company in the form of right to use asset will increase and corresponding borrowing in the form of Leasehold obligation will come. This will impact debt equity ratios.
2. Impact on P&L :
EBITDA will become higher as there will not be any rent expense and depreciation and interest cost will come.
Due to decrease in rent expense and increase in interest expense, there will be material impact on interest coverage ratio, Return on assets and performance indicators in terms of EBITDA and EBIT.
3. Impact on Cash flow statement:
The payment of lease rent will be shown under financing activity as repayment of principal and interest. (para 50)
In my next article I will discuss How to identify whether contract is lease and How to execute accounting for Lease ?
Thanks for reading 😀
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