Summary of IND AS 116 from lessee perception

Recently, I have wrote an article on ‘How to Identify that Contract Contains Lease Element as per Ind As 116

Continuing further, after reading the contract, if you came to know that the contract contains the lease, then it is very important to know about the accounting treatment of the same.

As we all know, accounting shall be made in the books of both i.e., lessor and lessee. So, in this article we will discuss the accounting treatment in the books of lessee.

So, before going forward, let’s understand the meaning of some important terms:

Meaning of lease, lessor, lessee and lease term

Lease is a contract in which lessor give the right to lessee to use the asset against consideration for a period of time.

Lessor is the person who provide the right to use the asset.

Lessee is the person who obtain the right to use the asset.

Lease term means the period of time in which a contracted lease is in place. It comprises:

1. Non cancellable period

2. Extended period if lessee, is reasonably certain to exercise that option

3. Termination period, if lessee is not reasonably certain to exercise that option.

Note

For identification of certainty it is relevant to see economic benefit arise from the decision of renewal or cancellation

Lease term may be change in future based upon certain facts and assumptions.

Lets take an example for this, suppose X ltd has taken a building on lease for 10 years and in 10^th year X ltd has two option:-

1. To cancel the lease or,

2. To renew the lease for further 3 years.

And X ltd does not have economic benefit from cancellation of lease.

Therefore, the lease term is 9 years + 1 year + 3 years = 13 years

Recognition exemption

A lessee can elect not to apply IND AS 116 in two cases:-

1. Short term lease

2. Lease for which underlying asset is of low value.

Short term lease refers to those lease whose lease term is 12 month or less than 12 month. But if lease contains purchase option at the end then the lease is not short term.

An underlying asset can be of low value only if:-

1. the lessee can benefit from use of the underlying asset on its own or together with other resources that are readily available to the lessee; and

2. the underlying asset is not highly dependent on, or highly interrelated with, other assets.

Recognition of lease in the books of lessee

On the commencement of lease, lessee book the right to use of asset (ROU Asset) at cost and lease liability at present value of future lease payments. The lease liability is calculated based on the implicit rate of interest in the lease and if such rate is not available then use incremental borrowing rate.

Cost of ROU asset comprises the following:-

Lease liability + Initial direct cost + Installation cost + upfront payment – lease incentive + Present value of Decommissioning removal and other liabilities (DROL).

Future lease payment comprises of the following:-

Fixed payment – lease incentives + Variable payments (whose amount may vary due to Index) + Guaranteed residual value + Purchase option if lessee reasonable to opt + penalties if any.

Lessee book the interest expense in its statement of profit and loss by unwinding the lease liability with the same implicit rate used for discounting.

ROU asset should be depreciated as per IND AS 16. Lessee books the depreciation expense on the ROU asset over its lease term or useful life whichever is lower. But if Lessee has opt purchase option at the end of the lease term then the period of charging depreciation can be more than lease term but not more than the useful life of asset.

Subsequent measurement of ROU asset

ROU asset shall be measured by applying cost model or revaluation model if the ROU asset belong the class of asset on which the revaluation model applies as per IND AS 16.

In cost model, Lessee shall measure cost of ROU asset less accumulated depreciation as per IND AS 16 less accumulated Impairment loss as per IND AS 36.

In revaluation model, lessee shall measure fair value of ROU asset less accumulated depreciation as per IND AS 16 less accumulated impairment loss as per IND AS 36.

If there is any remeasurement in lease liability arising from variable indexed payment, change in residual guaranteed value, renewal option, purchase option, change in lease term then lessee shall adjust the carrying amount of ROU asset unless the carrying amount has reduced to zero.

Subsequent measurement of lease liability

After initial recognition, lessee book the interest expense and measure the lease liability at amortised cost using the effective interest method.

Reassessment of Lease Liability

• Revised discounting rate used in reassessment of lease liability

Lessee shall use revised discounting rate when there is a change in lease liability due to:-

1. Change in lease term

2. Lessee opt purchase option at the end of lease term

• Unchanged discounting rate used in reassessment of lease liability

Lessee shall use same discounting rate when there is a change in lease liability due to:-

1. Change in amount expected of residual guarantee value

2. Change in future lease payment resulting from a change in an index rate.

Let’s take an example to summarize of lease accounting by lessee

X ltd obtained a machine on lease for 3 years. Lease rental is Rs. 1,00,000 p.a. which is payable at the beginning of the year. Installation cost is Rs. 50,000. Lessor gave incentive of Rs. 10,000 to X ltd for taking machine on lease. Assuming Discount rate is 10%. X ltd will have to incur decommissioning expense of Rs. 30,000 at the end of 3^rd year. Pass journal entries for 1^st year.

Solution

Statement showing lease liability

Years	Fixed lease payment	PVF@10%	Present value
1	1,00,000	1.00	1,00,000
2	1,00,000	0.91	90,909
3	1,00,000	0.83	82,645
Lease liability			2,73,554

Statement showing cost of ROU asset

	Lease liability	2,73,554
Add	Installation cost	50,000
Less	Lease Incentive	10,000
Add	Present value of provison for DROL (30000*0.751)	22,539
Cost of ROU Asset		3,36,093

Statement showing liability sheet showing interest expense charged and closing balance of lease liability at the end of each year

Year	Opening lease liability	Payment	Interest	Closing lease liability
1	2,73,554	1,00,000	17,355	1,90,909
2	1,90,909	1,00,000	9,091	1,00,000
3	1,00,000	1,00,000	0	0

Statement showing depreciation charged on ROU asset and closing balance of asset at the end of each year

Year	Opening balance	Depreciation	Closing balance
1	3,36,093	1,12,031	2,24,062
2	2,24,062	1,12,031	1,12,031
3	1,12,031	1,12,031	–

Statement showing interest expense charged and closing balance of provision for DROL at the end of each year

Year	Opening balance	Interest	Payment	Closing balance
1	22,539	2,254	–	24,793
2	24,793	2,479	–	27,272
3	27,272	2,728	30,000	0

Following journal entries are to be passed in year 1

Particulars		Amount in Rs.
ROU Asset	Dr	3,36,093
Lease Incentive	Dr	10,000
Lease Liability	Cr	2,73,554
Provision for DROL	Cr	22,539
Installation Expense	Cr	50,000
(Being asset, lease liability, provision for DROL, incentive and installation expenses booked)
Installation Expense	Dr	50,000
Lease Incentive	Cr	10,000
Cash / Bank Account	Cr	40,000
(Being installation expense paid and lease incentive realized)
Interest Expense	Dr	19,609
Depreciation Expense	Dr	1,12,031
Lease Liability	Cr	17,355
ROU Asset	Cr	1,12,031
Provision for DROL	Cr	2,254
(Being interest and depreciation expense charge)
Lease Liability	Dr	1,00,000
Cash / Bank Account	Cr	1,00,000
(Being lease rental paid)
Statement of profit and loss	Dr	1,31,640
Interest Expense	Cr	19,609
Depreciation Expense	Cr	1,12,031
(Being expense booked in Statement of Profit and loss)

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