An Insight into the Ind AS 116
The Ministry of Corporate Affairs (MCA) introduced the Ind AS 116 and other certain amendments to the Indian Accounting Standards on 30th March 2019. The new sets of corporate guidelines were incorporated and came into force from 1st April 2019 for the coming financial year.
The new accounting standard relates to the new leases accounting principles in the place of the existing guidelines.
By the end of this article, the readers will have the knowledge and understanding to evaluate the following fronts:-
– Impact of changes due to Ind AS 116, significant to the functioning of certain companies;
– Helping and testifying the effect of certain changes and begin to consider them in the new financial year;
– Positive impacts of such changes to enable the companies to operate more effectively and efficiently by highlighting the new processes and system and take guidance whenever needed.
It should be noted that the Ind AS reporters are to highlight and disclose the information regarding the assessment of Ind AS 116 and certain other amendments in the period prior to the adoption. The entities are entitled to provide the information regarding the impact of such changes in the financial statements of the year ending on 31st March 2019 and onwards.
Applicability of IND AS 116
– As per the AS 8 “Accounting Policies, Changes in Accounting Estimates and Errors”, paragraph 30 and 31 states that the companies are required to provide detailed disclosure of the expected impact of the new accounting standards that have not been adopted in the present period.
– Following the application of Ind AS 116, the AS 8 clarifies that the entities are to assess the possible impacts of Ind AS 116 and other amendments in the status of the financial statements. This should provide estimable information regarding the implications of AS 116 in the functioning of the company in the period of initial application.
– In order to comply with the requirements of the AS 8, the companies are adhered to disclose the following information:-
1) The title of the new Ind AS;
2) the nature of the upcoming change or the changes in the accounting policy;
3) the date by which the application of the Ind AS is required;
4) The set date at which the company goes forward with the application of the Ind AS;
5) A discussion of the impact of changes on the company’s financial statements or a statement viewing the fact that there are no estimable changes or any information regarding them.
For our readers’ convenience, we have listed below the two major components of the Ind AS 116, the lessor and the lessee.
Who is a ‘lessor’?
In simple words, a lessor is a person/owner who grants the use of a particular asset under an agreement to be used by the other party. The following are the characteristics of a lessor:-
– A lessor is the owner of an asset that is leased or rented, to another party in exchange of some monetary consideration;
– The lessor goes into a binding contract with the other party for the use of a particular asset for a certified period of time. The agreement, is known as the lease agreement that states the terms and conditions of the formed contract.
Who is a lessee?
As mentioned above, the lessee is the person who gets into the contract with the lessor as ‘another party’. The lessee rents the property or the assets from the lessor. Listed below are the characteristics of a ‘lessee’.
– Lessee is the ‘tenant’ who takes hold of the lessor’s property for a certain period.
– The lessee, in return, pays a considerable sum of money to the lessor for the use of his/her property or asset.
Overview of the IND AS 116
Ind AS 116 will replace the current guidance of Ind AS 17. The readers should know that Ind AS 17 relates to the ‘Leases’ contract. As per Ind AS 116, “a ‘lease’ is a contract, or a part of the contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration”.
Below are the amendments associated with the activities of the lessees under the lease contract as per the Ind AS 116.
– The lessees will have to recognize the lease liability depicting the future lease contracts and the ‘right to use asset’ for almost all the lease contracts. This is contrary to the Ind AS 17 where the lessees were to have a distinctive line between the operating lease (off-balance sheet) and the finance lease (on-balance sheet)
– Under the new Ind AS, the lessees have the provision for making optional exemptions for certain short term leases and the low-value asset leases.
– Ind AS 116 requires the lessees to make certain amendments in the formulation of the statement of profit and loss. The lessee needs to present the interest expense on the lease liability and depreciation on the right-to-use asset.
– Looking at the cash flow statement, cash payments of the lease liability and its associated interests are presented under the head of financing activities.
– All those items that are not included in the lease liability such as leases of low-level assets are classified under the operating activities of the company.
Below listed are the amendments to the functioning of lessors under the new IND AS.
– As per the new Ind AS, the accounting of lessors will not change.
– The lessors will continue to distinguish between the finance and the operating lease, depending on whether substantially all of the risks and rewards are incidental to the ownership of the underlying asset have been transferred.
All the users of financial information should know that the IND AS 116 adds new, enhanced, and significant disclosure requirements both for the lessor and the lessee.
Nature of Change
To provide further aid to our readers’ financial suspicions regarding Ind AS 116, we have summed up the above points to understand the nature of change in the operating capacity of a company engaged in leasing activities.
– Ind AS 116 will primarily affect the accounting of the lessee of the lease agreements. This new AS removes the distinction between finance and the operating concepts under the leasing activities. Side by side, it requires the recognition of an asset and a financial liability to pay rentals for virtually all lease contracts.
– The statement of profit and loss will also be affected because the total expenditure was higher in the earlier years of a lease as compared to the later years. Viewing the impacts of AS 116, key metrics like EBITDA will alter.
– Operating cash flows will be higher as the payment of lease liability and the related interests will be shown under the financing activities.
– However, accounting by lessors will not see any gradual change. There may be certain modifications relating to the guidance under the new definition/meaning of a lease under the AS.
What can be the best thing than to get holds on suitable examples to understand a particular case or a scenario? We have listed below two examples that will help the readers, further evaluate the impact of IND AS 116 in the construction of their new financial cycle.
There is a group supervised by the company’s top authorities to review all the lease agreements in the light of the new lease accounting rules of IND AS 116.
The group’s primary objective is to apply the transition approach and not restate the comparative information in the financial statements for the year ending on 31st March 2019 to show the impact of the new AS.
It should be highlighted that the new standard tends to affect the accounting of the group’s operating lease agreements.
Supposedly, on the reporting date, the group has the non-cancellable operating lease commitment of a certain amount. Out of this, a specified sum relates to short-term leases and to low-value leases. Both of these components are shown as a straight-line expense under profit and loss.
For the remaining commitments, the group expects to recognize the lease liabilities after making adjustments for prepayments and accrued lease payments as recognized on 31st March 2019. It should be observed that the amount of the overall net assets and the net current assets will be lower due to the presentation of a portion of a liability as a current liability.
Considering the adoption of the new AS, the group expects to see a decline in the net profit after tax. The modified EBITDA used to measure the segment results is expected to increase as the operating lease payments were included in EBITDA. However, the amortization of right-to-use assets and related interests is excluded.
Operating cash flows will increase and the financing cash flows will decrease. This will be classified as cash flows from financing activities.
The group’s presence as a lessor is not material. Hence, it is not disclosed since it is not expected to create any impact on the financial statements.
Under this scenario, the preparations for the use of new AS are substantially complete. Here the group intends to use the exemptions provided by the new AS for short-term leases and the leases for low-value assets.
Going by the underlying situation, the estimated impacts of IND AS 116 on the group’s financial statements are listed below:
– Balance Sheet: The group expects to see an increase in total assets, split between the right-to-use assets and deferred tax assets. Financial activities are expected to increase while the net equity will decrease.
– Statement of Profit and Loss: The group estimates to witness the increase in the depreciation from the right-to-use assets and increased finance costs due to the interest levied on lease liabilities.
– Statements of Cash Flows: The group estimates to see the increase in the operating cash flows and the decrease in financing cash flows as repayment of the lease liabilities and the related interest will be classified under the cash flows from financing activities.
We sincerely hope that the readers are able to view the significant impacts of the changes brought by the new IND AS 116. Viewing the current times, applying such changes without rendering to malpractices will only help the companies’ operating grounds to see fruitful financial results in the new leasing contracts.
The information contained herein is of a general nature and is not intended to address the circumstances of any person or entity. Although we endeavor to provide accurate and timely information, there is no guarantee that such information is accurate as of the date it received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the situation.