Summary of Ind AS 116- Leases

Ind AS 116 was notified by Ministry of Corporate Affairs on 30 March 2019 and it is applicable for annual reporting periods beginning on or after 1 April 2019.

The objective of the Ind AS 116 is to ensure that lessees and lessors provide relevant information in a manner that faithfully represents those transactions. Ind AS 116 introduces a single lessee accounting model and requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value.

Under Ind AS 116 lessees have to recognise a lease liability reflecting future lease payments and a ‘right-of-use asset’ for almost all lease contracts. Under Ind AS 116, a contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

Summary of Ind AS 116- Leases is as follows:-

1. Scope

Ind AS 116 is applicable to all leases, including leases of right-of-use assets in a sublease, except for:

(i) leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources;

(ii) leases of biological assets held by a lessee within the scope of Ind AS 41;

(iii) service concession arrangements within the scope of Appendix D]of Ind AS 115;

(iv) licences of intellectual property granted by a lessor within the scope of Ind AS 115; and

(v) rights held by a lessee under licensing agreements within the scope of Ind AS 38, Intangible Assets, for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights.

2. Recognition exemptions

2.1 Short-term leases

A lease that, at the commencement date, has a lease term of 12 months or less. However, a lease that contains an option to purchase the asset is not a short-term lease.

• The election for short-term leases shall be made by class of underlying asset to which the right of use relates and can be made on a lease-by-lease basis.

2.2 Leases for low value assets

An underlying asset can be of low value only if:

(i) 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

(ii) the underlying asset is not highly dependent on, or highly interrelated with, other assets.

• Examples of low-value underlying assets can include tablet and personal computers, small items of office furniture and telephones.
• When new, if the asset is typically not of low value, the lease of such asset does not qualify as a lease of a low-value asset.
• If a lessee subleases an asset, or expects to sublease an asset, the head lease does not qualify as a lease of a low-value asset.
• The assessment of whether an underlying asset is of low value is performed on an absolute basis. Leases of low-value assets qualify for recognition exemption regardless of whether those leases are material to the lessee. The assessment is not affected by the size, nature or circumstances of the lessee.

2.3 Accounting for short term and low value asset leases

If a lessee elects to opt for the recognition exemption for either short-term leases or leases for which the underlying asset is of low value, the lessee shall recognise the lease payments associated with those leases as an expense on either a straight-line basis over the lease term or another systematic basis.

3. Identifying a lease

A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

3.1 Separating components of a contract

For a contract that is, or contains, a lease, an entity shall account for each lease component within the contract as a lease separately from non-lease components of the contract, unless the entity applies the practical expedient (i) specified below.

• The right to use an underlying asset is a separate lease component if both:

(i) 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

(ii) the underlying asset is not highly dependent on, or highly interrelated with, other assets.

• For a contract that contains a lease component and one or more additional lease or non-lease components, a lessee shall allocate the consideration in the contract to each lease component on the basis of the relative stand-alone price.
• The relative stand-alone price shall be determined on the basis of the price the lessor, or a similar supplier, would charge an entity for that component, or a similar component, separately. If an observable stand-alone price is not readily available, the lessee shall estimate the stand-alone price, maximising the use of observable information.

3.2 Right to control

An entity shall assess whether, throughout the period of use, the customer has both of the following:

A. the right to obtain substantially all of the economic benefits from use of the identified asset:

• A customer can obtain economic benefits from use of an asset directly or indirectly in many ways, such as by using, holding or sub-leasing the asset.
• The economic benefits from use of an asset include its primary output and by-products (including potential cash flows), and other economic benefits from using the asset.
• In assessing the right to obtain the economic benefits, an entity shall consider only the defined scope of a customer’s right to use the asset. E.g.: if a contract limits the use of a motor vehicle to only one particular territory during the period of use, an entity shall consider only the economic benefits from use of the motor vehicle within that territory.
• If a contract requires a customer to pay the supplier or another party a portion of the cash flows derived from use of an asset as consideration, those cash flows paid as consideration shall be considered to be part of the economic benefits that the customer obtains from use of the asset.

B. the right to direct the use of the identified asset

A customer has the right to direct the use of an identified asset throughout the period of use only if either:

(i) the customer has the right to direct how and for what purpose the asset is used throughout the period of use

• Within the scope of the entity’s right of use as defined in the contract, it can change how and for what purpose the asset is used throughout the period of use.
• In making the said assessment, an entity needs to consider the decision-making rights that are most relevant to changing how and for what purpose the asset is used throughout the period of use.
• Examples of decision-making rights that grant the right to change how and for what purpose the asset is used:

> change the type of output that is produced by the asset

> change when the output is produced

> change where the output is produced

> change whether the output is produced, and the quantity of that output

OR

(ii) the relevant decisions about how and for what purpose the asset is used are predetermined and:

(a) the customer has the right to operate the asset (or to direct others to operate the asset in a manner that it determines) throughout the period of use, without the supplier having the right to change those operating instructions; or

(b) the customer designed the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset will be used throughout the period of use.

• The decisions about how and for what purpose the asset is used can be predetermined in a number of ways such as by the design of the asset or by contractual restrictions

3.3 Identified asset

• An asset is identified either by being explicitly specified in a contract or by being implicitly specified at the time that the asset is made available for use.
• Even if an asset is specified, a customer does not have the right to use an identified asset if the supplier has the substantive right to substitute the asset throughout the period of use. (If the customer cannot readily determine whether the supplier has a substantive substitution right, the customer shall presume that any substitution right is not substantive.)

Substantive substitution rights

A supplier’s right to substitute an asset is substantive only if both of the following conditions exist:

(i) the supplier has practical ability to substitute alternative assets throughout the period of use (e.g., the customer cannot prevent the supplier from substituting the asset and alternative assets are readily available to the supplier or could be sourced by the supplier within a reasonable period of time); and

(ii) the supplier would benefit economically from the exercise of its right to substitute the asset.

• Evaluation of supplier’s right is based on facts and circumstances at inception of the contract and shall exclude consideration of future events which at inception are not considered likely to occur.
• If the asset is located at the customer’s premises the costs associated with substitution are generally higher and are likely to exceed the benefits associated with substituting the asset.
• The supplier’s right or obligation to substitute the asset for repairs and maintenance or for technical upgrade, does not preclude the customer from having the right to use an identified asset.

3.4 Lease term

An entity shall determine the lease term as the non-cancellable period of a lease, together with both:

(i) periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option; and

(ii) periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option.

• A lease is no longer enforceable when the lessee and the lessor each has the right to terminate the lease without permission from the other party with no more than an insignificant penalty.
• If only a lessee has the right to terminate a lease, that right is considered to be an option to terminate the lease available to the lessee that an entity considers when determining the lease term.
• If only a lessor has the right to terminate a lease, the non-cancellable period of the lease includes the period covered by the option to terminate the lease.
• In assessing the certainty of exercise/ no to exercise of any of the above mentioned option, an entity shall consider all relevant facts and circumstances that create an economic incentive for the lessee to exercise the option.
• Factors that would be considered in this assessment include, but are not limited to:

> Contractual terms and conditions for the optional periods compared with market rates, such as:

– The amount of payments for the lease in any optional period;

– The amount of any variable payments for the lease or other contingent payments such as termination penalties;

– The terms and conditions of any options that are exercisable after periods covered by another option (or other options), e.g. a purchase option that is exercisable at the end of one or more extension periods at a rate that is currently below market rates;

> Significant leasehold improvements or other improvements made to underlying assets that are expected to have a significant residual benefit to the lessee when options become exercisable;

> Costs relating to the termination of the lease (e.g. negotiation, relocation, and search costs, installation and setup costs for new assets, termination penalties or costs to return an underlying asset at the end of the lease term);

> The importance of an underlying asset to the lessee’s operations (e.g. whether the underlying asset is highly specialised, the location of the asset and the availability of suitable alternatives); and

> Conditionality associated with the exercise option (i.e. if an option can be exercised only if one or more conditions are met) and the likelihood that those conditions will be met.

• A lessee shall reassess reasonably certainty of exercise/ not to exercise an option, upon the occurrence of either a significant event or a significant change in circumstances, that is within the control of the lessee and which affects whether the lessee is reasonably certain to exercise/ not to exercise an option.
• Examples of significant events or changes in circumstances include:

> significant leasehold improvements not anticipated at the commencement date

> a significant modification to, or customisation of, the underlying asset that was not anticipated at the commencement date;

> the inception of a sublease of the underlying asset for a period beyond the end of the previously determined lease term; and

> a business decision of the lessee that is directly relevant to exercising, or not exercising, an option.

• A lessee’s past practice with leases, particularly leases of similar assets, should also be considered in determining the likelihood of options being exercised. The reason for exercising such options may not be apparent from any single criterion, but may relate to synergies and a weighting of several reasons that must be considered in aggregate. Therefore two lessees may determine different lease terms on identical lease contracts because the facts and circumstances under which they operate may mean that one lessee concludes it is reasonably certain to exercise one or more options, whereas the other might conclude it is not reasonably certain any of them will be exercised.
• The lessee shall revise the lease term if there is a change in the non-cancellable period of a lease.

IFRIC Update June 2019 Paragraph 18 of IFRS 16 requires an entity to determine the lease term as the non-cancellable period of a lease, together with periods of option to extend/ terminate the lease if it is reasonably certain that the lessee will exercise/ not exercise the option to extend/ terminate the lease. In determining the lease term and assessing the length of the non-cancellable period of a lease, paragraph B34 of IFRS 16 requires an entity to determine the period for which the contract is enforceable. Paragraph B34 specifies that ‘a lease is no longer enforceable when the lessee and the lessor each has the right to terminate the lease without permission from the other party with no more than an insignificant penalty’. The Board’s view is that ‘the lease term should reflect an entity’s reasonable expectation of the period during which the underlying asset will be used because that approach provides the most useful information’. Further, in the Board’s view, an entity is unlikely to add a clause to a lease contract that does not have economic substance. The Committee observed that, in applying paragraph B34 and determining the enforceable period of the lease described in the request, an entity considers: i. the broader economics of the contract, and not only contractual termination payments. For example, if either party has an economic incentive not to terminate the lease such that it would incur a penalty on termination that is more than insignificant, the contract is enforceable beyond the date on which the contract can be terminated; and ii. whether each of the parties has the right to terminate the lease without permission from the other party with no more than an insignificant penalty. Applying paragraph B34, a lease is no longer enforceable only when both parties have such a right. Consequently, if only one party has the right to terminate the lease without permission from the other party with no more than an insignificant penalty, the contract is enforceable beyond the date on which the contract can be terminated by that party. If an entity concludes that the contract is enforceable beyond the notice period of a cancellable lease (or the initial period of a renewable lease), it then applies paragraphs 19 and B37-B40 of IFRS 16 to assess whether the lessee is reasonably certain not to exercise the option to terminate the lease.

4. Lessee

4.1 Initial measurement of the right-of-use asset

• At the commencement date, a lessee shall measure the right-of-use asset at cost.
• The cost of the right-of-use asset shall comprise:

(i) the amount of the initial measurement of the lease liability;

(ii) any lease payments made at or before the commencement date, less any lease incentives received;

(iii) any initial direct costs incurred by the lessee; and

(iv) an estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset, restoring the site on which it is located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs are incurred to produce inventories.

4.2 Initial measurement of the lease liability

• At the commencement date, a lessee shall measure the lease liability at the present value of the lease payments that are not paid at that date.
• The lease payments shall be discounted using the interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate.

• At the commencement date, the lease payments included in the measurement of the lease liability comprise the following payments for the right to use the underlying asset during the lease term that are not paid at the commencement date:

(i) fixed payments (including in-substance fixed payments), less any lease incentives receivable;

(ii) variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date;

(iii) amounts expected to be payable by the lessee under residual value guarantees;

(iv) the exercise price of a purchase option or payments of penalties for terminating the lease if the lessee is reasonably certain to exercise that option.

4.3 Subsequent measurement of the right-of-use asset

• After the commencement date, a lessee shall measure the right-of-use asset applying a cost model. However if the right-of-use assets relate to a class of PPE to which the lessee applies the revaluation model in Ind AS 16, he may elect to apply that revaluation model to all of the right-of-use assets that relate to that class of PPE.
• To apply a cost model, a lessee shall measure the right-of-use asset at cost:

(i) less any accumulated depreciation and any accumulated impairment losses in accordance with Ind AS 16 and Ind AS 36 respectively; and

(ii) adjusted for any re-measurement of the lease liability.

• If the lease transfers ownership of the underlying asset to the lessee by the end of the lease term or if the cost of the right-of-use asset reflects that the lessee will exercise a purchase option, the lessee shall depreciate the right-of-use asset from the commencement date to the end of the useful life of the underlying asset. Otherwise, the lessee shall depreciate the right-of-use asset from the commencement date to the earlier of the end of the useful life of the right-of-use asset or the end of the lease term.

4.4 Subsequent measurement of the lease liability

• After the commencement date, a lessee shall measure the lease liability by:

(i) increasing the carrying amount to reflect interest at the discount rate specified above on the lease liability;

(ii) reducing the carrying amount to reflect the lease payments made; and

(iii) re-measuring the carrying amount to reflect any reassessment or lease modifications or to reflect revised in-substance fixed lease payments.

4.5 Reassessment of the lease liability

• A lessee shall re-measure the lease liability by discounting the revised lease payments using a revised discount rate, if either:

(i) there is a change in the lease term. A lessee shall determine the revised lease payments on the basis of the revised lease term; or

(ii) there is a change in the assessment of an option to purchase the underlying asset. A lessee shall determine the revised lease payments to reflect the change in amounts payable under the purchase option.

A lessee shall determine the revised discount rate as the interest rate implicit in the lease for the remainder of the lease term or the lessee’s incremental borrowing rate at the date of reassessment if the interest rate implicit in the lease cannot be readily determined.

• A lessee shall re-measure the lease liability by discounting the revised lease payments, if either:

(i) there is a change in the amounts expected to be payable under a residual value guarantee. A lessee shall determine the revised lease payments to reflect the change in amounts expected to be payable under the residual value guarantee.

(ii) there is a change in future lease payments resulting from a change in an index or a rate used to determine those payments, including for example a change to reflect changes in market rental rates following a market rent review. The lessee shall re-measure the lease liability to reflect those revised lease payments only when there is a change in the cash flows (i.e. when the adjustment to the lease payments takes effect). A lessee shall determine the revised lease payments for the remainder of the lease term based on the revised contractual payments.

A lessee shall use an unchanged discount rate, unless the change in lease payments results from a change in floating interest rates. In that case, the lessee shall use a revised discount rate that reflects changes in the interest rate.

• A lessee shall recognise the amount of the re-measurement of the lease liability as an adjustment to the right-of-use asset. However, if the carrying amount of the right-of-use asset is reduced to zero and there is a further reduction in the measurement of the lease liability, a lessee shall recognise any remaining amount of the re-measurement in profit or loss.

4.6 Lease modifications

A change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease. (e.g., adding or terminating the right to use one or more underlying assets, or extending or shortening the contractual lease term).

• A lessee shall account for a lease modification as a separate lease if both:

(i) the modification increases the scope of the lease by adding the right to use one or more underlying assets; and

(ii) the consideration for the lease increases by an amount commensurate with the stand-alone price for the increase in scope

• For a lease modification that is not accounted for as a separate lease, at the effective date of the lease modification a lessee shall, allocate the consideration and determine the lease term and re-measure the lease liability of the modified lease by applying the guidance above.

4.7 In-substance fixed lease payments

• Lease payments include any in-substance fixed lease payments.
• In-substance fixed lease payments are payments that may, in form, contain variability but that, in substance, are unavoidable.
• In-substance fixed lease payments exist, for example, if:

(i) payments are structured as variable lease payments, but there is no genuine variability in those payments. Those payments contain variable clauses that do not have real economic substance.

Examples of those types of payments include:

> payments that must be made only if an asset is proven to be capable of operating during the lease, or only if an event occurs that has no genuine possibility of not occurring; or

> payments that are initially structured as variable lease for which the variability will be resolved at some point after the commencement date so that the payments become fixed for the remainder of the lease term. Those payments become in-substance fixed payments when the variability is resolved.

(ii) there is more than one set of payments that a lessee could make, but only one of those sets of payments is realistic. In this case, an entity shall consider the realistic set of payments to be lease payments. However, if there are more than one realistic set of payments that a lessee could make, an entity shall consider the set of payments that aggregates to the lowest amount (on a discounted basis) to be lease payments.

4.8 Costs of the lessee relating to the construction or design of the underlying asset

If a lessee incurs costs relating to the construction or design of an underlying asset, the lessee shall account for those costs applying other applicable Standards, such as Ind AS 16. Costs relating to the construction or design of an underlying asset do not include payments made by the lessee for the right to use the underlying asset. Payments for the right to use an underlying asset are payments for a lease, regardless of the timing of those payments.

5. Lessor

5.1 Classification of leases

• A lessor shall classify a lease as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset and it is classified as an operating lease if it does not transfer substantially all the risks (Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return because of changing economic conditions) and rewards (Rewards may be represented by the expectation of profitable operation over the underlying asset’s economic life and of gain from appreciation in value or realisation of a residual value) incidental to ownership of an underlying asset.
• Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract.
• Lease classification is made at the inception date and is reassessed only if there is a lease modification.
• Examples of situations that would normally (though not always conclusive) lead to a lease being classified as a finance lease are:

> the lease transfers ownership of the underlying asset to the lessee by the end of the lease term;

> the lessee has the option to purchase the underlying asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable;

> the lease term is for the major part of the economic life of the underlying asset;

> at the inception date, the present value of the lease payments amounts to at least substantially all of the fair value of the underlying asset;

> the underlying asset is of such a specialised nature that only the lessee can use it without major modifications;

> if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee;

> gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for example, in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and

> the lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.

• When a lease includes both land and buildings elements, a lessor shall assess the classification of each element as a finance lease or an operating lease separately.
• Whenever necessary in order to classify and account for a lease of land and buildings, a lessor shall allocate lease payments (including any lump-sum upfront payments) between the land and the buildings elements in proportion to their relative fair values at the inception date. If the lease payments cannot be allocated reliably between these two elements, the entire lease is classified as a finance lease, unless it is clear that both elements are operating leases.
• For a lease of land and buildings in which the amount for the land element is immaterial to the lease, a lessor may treat the land and buildings as a single unit for the purpose of lease classification and classify it as a finance lease or an operating lease. In such a case, a lessor shall regard the economic life of the buildings as the economic life of the entire underlying asset.

• Sublease classification

In classifying a sublease, an intermediate lessor shall classify the sublease as a finance lease or an operating lease as follows:

(i) if the head lease is a short-term lease and the entity has opted for recognition exemption, the sublease shall be classified as an operating lease.

(ii) otherwise, the sublease shall be classified by reference to the right-of-use asset arising from the head lease, rather than by reference to the underlying asset.

5.2 Finance leases

At the commencement date, a lessor shall recognise assets held under a finance lease in its balance sheet and present them as a receivable at an amount equal to the net investment in the lease.

The lessor shall use the interest rate implicit in the lease to measure the net investment in the lease. In the case of a sublease, if the interest rate implicit in the sublease cannot be readily determined, an intermediate lessor may use the discount rate used for the head lease to measure the net investment in the sublease.

Initial measurement of the lease payments included in the net investment in the lease – Similar to calculation of lease liability for a lessee.

Manufacturer or dealer lessors

• At the commencement date, a manufacturer or dealer lessor shall recognise the following for each of its finance leases:

(a) revenue being lower of the fair value of the underlying asset or  the present value of the lease payments accruing to the lessor discounted using a market rate of interest;

(b) the cost of sale being the cost, or carrying amount if different, of the underlying asset less the present value of the unguaranteed residual value; and

(c) selling profit or loss in accordance with its policy for outright sales to which Ind AS 115 applies. A manufacturer or dealer lessor shall recognise selling profit or loss on a finance lease at the commencement date, regardless of whether the lessor transfers the underlying asset as described in Ind AS 115.

• A finance lease of an asset by a manufacturer or dealer lessor gives rise to profit or loss equivalent to the profit or loss resulting from an outright sale of the underlying asset, at normal selling prices considering any volume or trade discounts.
• Manufacturer or dealer lessors sometimes quote artificially low rates of interest in order to attract customers. The use of such a rate would result in a lessor recognising an excessive portion of the total income from the transaction at the commencement date. In such a case the manufacturer or dealer lessor shall restrict selling profit to that which would apply if a market rate of interest were charged.
• A manufacturer or dealer lessor shall recognise as an expense costs incurred in connection with obtaining a finance lease at the commencement date because they are mainly related to earning the manufacturer or dealer’s selling profit.

 Subsequent measurement

• A lessor shall recognise finance income over the lease term, based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment in the lease.
• A lessor aims to allocate finance income over the lease term on a systematic and rational basis. A lessor shall apply the lease payments relating to the period against the gross investment in the lease to reduce both the principal and the unearned finance income.
• A lessor shall apply de-recognition and impairment requirements in Ind AS 109 to the net investment in the lease.
• A lessor shall review regularly estimated unguaranteed residual values used in computing the gross investment in the lease. If there has been a reduction in the estimated unguaranteed residual value, the lessor shall revise the income allocation over the lease term and recognise immediately any reduction in respect of amounts accrued.
• A lessor that classifies an asset under a finance lease as held for sale (or includes it in a disposal group that is classified as held for sale) applying Ind AS 105, Non-current Assets Held for Sale and Discontinued Operations, shall account for the asset in accordance with that Standard.

 Lease modifications

• A lessee shall account for a lease modification as a separate lease if both:

(i) the modification increases the scope of the lease by adding the right to use one or more underlying assets; and

(ii) the consideration for the lease increases by an amount commensurate with the stand-alone price for the increase in scope

• For a modification to a finance lease that is not accounted for as a separate lease, a lessor shall account for the modification as follows:

(i) if the lease would have been classified as an operating lease had the modification been in effect at the inception date, the lessor shall:

(a) account for the lease modification as a new lease from the effective date of the modification; and

(b) measure the carrying amount of the underlying asset as the net investment in the lease immediately before the effective date of the lease modification.

(ii) otherwise, the lessor shall apply the requirements of Ind AS 109.

5.3 Operating leases

• A lessor shall recognise lease payments from operating leases as income on either a straight-line basis or another systematic basis.
• A lessor shall recognise costs, including depreciation in accordance with Ind AS 16 and impairment in accordance with Ind AS 36, incurred as an expense.
• A lessor shall account for a modification to an operating lease as a new lease from the effective date of the modification, considering any prepaid or accrued lease payments relating to the original lease as part of the lease payments for the new lease.

6. Sale and leaseback transactions

If an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) and leases that asset back from the buyer-lessor, both the seller-lessee and the buyer-lessor shall account for the transfer contract and the lease applying the guidance below.

6.1 Transfer of the asset is a sale

If the transfer of an asset by the seller-lessee satisfies the requirements of Ind AS 115 to be accounted for as a sale of the asset:

(a) the seller-lessee shall measure the right-of-use asset arising from the leaseback at the proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller-lessee. Accordingly, the seller-lessee shall recognise only the amount of any gain or loss that relates to the rights transferred to the buyer-lessor.

(b) the buyer-lessor shall account for the purchase of the asset applying applicable Standards, and for the lease applying the lessor accounting requirements in this Standard.

If the fair value of the consideration for the sale of an asset does not equal the fair value of the asset, or if the payments for the lease are not at market rates, an entity shall make the following adjustments to measure the sale proceeds at fair value:

(a) any below-market terms shall be accounted for as a prepayment of lease payments; and

(b) any above-market terms shall be accounted for as additional financing provided by the buyer-lessor to the seller-lessee.

The entity shall measure any potential adjustment required by paragraph 101 on the basis of the more readily determinable of:

(a) the difference between the fair value of the consideration for the sale and the fair value of the asset; and

(b) the difference between the present value of the contractual payments for the lease and the present value of payments for the lease at market rates.

6.2 Transfer of the asset is not a sale

If the transfer of an asset by the seller-lessee does not satisfy the requirements of Ind AS 115 to be accounted for as a sale of the asset:

(a) the seller-lessee shall continue to recognise the transferred asset and shall recognise a financial liability equal to the transfer proceeds. It shall account for the financial liability applying Ind AS 109.

(b) the buyer-lessor shall not recognise the transferred asset and shall recognise a financial asset equal to the transfer proceeds. It shall account for the financial asset applying Ind AS 109.

7. Transition

7.1 Lessee:

• Method to apply Ind AS 116:

(i) Retrospectively to each prior reporting period presented applying Ind AS 8.

(ii) Retrospectively with the cumulative effect of initially applying the Standard recognised at the date of initial application:

An entity may choose to either:

(a) recognise a lease liability and a right-of-use asset at its respective its carrying amount with the difference being recognised in opening reserve.

(b) recognise a right-of-use asset equal to lease liability with no amount being recognised in opening reserve.

• A lessee shall apply the election of the method consistently to all of its leases in which it is a lessee

• Calculation of lease liability: The lessee shall measure that lease liability at the present value of the remaining lease payments, discounted using the lessee’s incremental borrowing rate at the date of initial application.
• Calculation of carrying amount of right-of-use asset: The carrying amount shall be calculated as if Ind AS 116 had been applied since the commencement date, but discounted using the lessee’s incremental borrowing rate at the date of initial application.
•  No adjustment shall be made for a lease which was previously classified as an operating lease and for which underlying asset is of low value and recognition exemptions has been opted for.
• If a lessee elects to apply this Standard in accordance with method (ii) above, for leases that were classified as finance leases applying Ind AS 17, the carrying amount of the right-of-use asset and the lease liability at the date of initial application shall be the carrying amount of the lease asset and lease liability immediately before that date measured applying Ind AS 17.

7.2 Lessor:

An intermediate lessor shall:

(i) reassess subleases that were classified as operating leases applying Ind AS 17 and are ongoing at the date of initial application, for classifying it as operating lease or finance lease applying Ind AS 116 on the basis of the remaining contractual terms and conditions of the head lease and sublease at that date.

(ii) for subleases that were classified as operating leases applying Ind AS 17 but finance leases under Ind AS 116, account for the sublease as a new finance lease entered into at the date of initial application.

No other chang is required to be made by a lessor when transitioning from Ind AS 17 to Ind AS 116.

7.3 Sale and leaseback transactions:

An entity shall not reassess sale and leaseback transactions entered into before the date of initial application to determine whether the transfer of the underlying asset satisfies the requirements in Ind AS 115 to be accounted for as a sale.

If a sale and leaseback transaction was accounted for as a sale and a finance lease applying Ind AS 17, the seller-lessee shall continue to account for the leaseback in the same way as any other finance lease and continue to amortise any gain on sale over the lease term.

If a sale and leaseback transaction was accounted for as a sale and operating lease applying Ind AS 17, the seller-lessee shall continue to account for the leaseback in the same way as any other operating lease and adjust the leaseback right-of-use asset for any deferred gains or losses that relate to off-market terms recognised in the balance sheet immediately before the date of initial application.

8. Practical expedients

(i) A lessee may elect, by class of underlying asset, not to separate non-lease components from lease components, and account for each component as a single lease component. A lessee shall not apply this practical expedient to embedded derivatives that meet the criteria in paragraph 4.3.3 of Ind AS 109, Financial Instruments.

(ii) An entity may apply this Standard to a portfolio of leases with similar characteristics if the entity reasonably expects that the effects on the financial statements of applying this Standard to the portfolio would not differ materially from applying this Standard to the individual leases within that portfolio. If accounting for a portfolio, an entity shall use estimates and assumptions that reflect the size and composition of the portfolio.

(iii) Practical expedients on transition for lessees:

i. An entity is not required to reassess whether a contract is, or contains, a lease at the date of initial application. Instead, the entity is permitted to apply Ind AS 116 to contracts that were previously identified as leases applying Ind AS 17 and not to it to contracts that were not previously identified as containing a lease applying Ind AS 17.

ii. A lessee applying Ind AS 116 in accordance with method (ii) stated in the Transition paragraph to leases previously classified as operating leases applying Ind AS 17 is permitted to apply these practical expedients on a lease-by-lease basis:

– a lessee may apply a single discount rate to a portfolio of leases with reasonably similar characteristics.

– a lessee may rely on its assessment of whether leases are onerous applying Ind AS 37, immediately before the date of initial application as an alternative to performing an impairment review. If a lessee chooses this practical expedient, the lessee shall adjust the right-of-use asset at the date of initial application by the amount of any provision for onerous leases recognised in the balance sheet immediately before the date of initial application.

– a lessee may elect to apply the requirements of short term lease to leases for which the lease term ends within 12 months of the date of initial application. In this case, a lessee shall account for those leases as short-term leases and follow its disclosure requirements.

– a lessee may exclude initial direct costs from the measurement of the right-of-use asset at the date of initial application.

– a lessee may use hindsight while applying Ind AS 116.

9. Issues clarified by ITFG bulletins

9.1 ITFG bulletin 21, Issue 1:

Where a lease agreement (including any addendum thereto or a side agreement) is entered into for a period of 12 months or less and does not grant a renewal or extension option to the lessee, it qualifies as a short-term lease within the meaning of the standard (provided it also does not grant a purchase option to the lessee). This is so even if there is a past practice of the lease being renewed upon expiry for a further one year at a time with the mutual consent of the lessee and the lessor.

9.2 ITFG bulletin 21, Issue 5:

Lease liability is not covered by the exemption provided by paragraph D13AA of Ind AS 101. Foreign exchange differences relating to the lease liability recognised by the company should be expensed off immediately as they arise.

9.3 ITFG bulletin 22, Issue 2:

Ind AS 116 does not carry forward the carve out that Ind AS 17 made from IAS 17 and requires operating lease rentals to be recognised as an expense/ income on a straight-line basis (or on another systematic basis if such other basis is more representative). In view of the change, under Ind AS 116, a company is required to recognise operating lease rental expense/ income from the office building given on lease on a straight-line basis over the lease term, notwithstanding that the lease rentals are structured to increase in line with expected general inflation to compensate for its expected inflationary cost increases.

10. IFRS 16 and covid-19 – Accounting for covid-19-related rent concessions applying IFRS 16 Leases

The International Accounting Standards Board (IASB) has published a document responding to questions regarding the application of IFRS 16 ‘Leases’ during the period of enhanced economic uncertainty arising from the COVID-19 pandemic. A summary of the said document is reproduced below.

Force majeure

Changes in lease payments that result from clauses in the original contract such as force majeure or in applicable law or regulation are part of the original terms and conditions of the lease, even if the effect of those clauses (arising from an event such as the covid-19 pandemic) was not previously contemplated. In such a case there is no lease modification for the purposes of IFRS 16.

Changes in payments that are not lease modifications

If a change in lease payments does not result from a lease modification, that change would generally be accounted for as a variable lease payment. In this case, a lessee applies paragraph 38 of IFRS 16 and generally recognises the effect of the rent concession in profit or loss. For an operating lease, a lessor recognises the effect of the rent concession by recognising lower income from leases.

Partial lease liability extinguishment

If a change in lease payments results in the extinguishment of a part of a lessee’s obligation specified in the contract (for example, a lessee is legally released from its obligation to make specifically identified payments), the lessee would consider whether the requirements for de-recognition of a part of the lease liability are met applying paragraph 3.3.1 of IFRS 9 Financial Instruments.

Impairment of assets

IAS 36 Impairment of Assets applies in determining whether right-of-use assets (for lessees) and items of property, plant and equipment subject to an operating lease (for lessors) are impaired. The circumstances that give rise to rent concessions as a result of the covid-19 pandemic are likely to indicate that assets may be impaired. For example, loss of earnings during the period covered by a rent concession may be an indicator of impairment of the related right-of-use asset. Similarly, longer-term effects of the covid-19 pandemic could affect the expected ongoing economic performance of right-of-use assets. Lessors will also need to consider the applicable requirements of IFRS 9, for example when accounting for any impairment of lease receivables.

Disclosure

Lessees and lessors must also apply the disclosure requirements of IFRS 16 and other IFRS Standards, such as IAS 1 Presentation of Financial Statements. For example, IFRS 16 requires both lessees and lessors to disclose information that gives a basis for users of financial statements to assess the effect that leases have on their financial position, financial performance and cash flows. The information disclosed will need to be sufficient to enable users of financial statements to understand the impact of covid-19-related changes in lease payments on the entity’s financial position and financial performance (paragraph 31 of IAS 1).

Reference material:

1. Ind AS 116 “Leases” –  https://www.mca.gov.in/Ministry/pdf/RuleIndAsEng_30032019.pdf

2. ITFG Bulletins 21 – https://resource.cdn.icai.org/56773indas46019.pdf

3. ITFG Bulletins 22 – https://resource.cdn.icai.org/57122asbitfgcn22.pdf

4. IFRIC Update June 2019 – https://www.ifrs.org/news-and-events/updates/ifric-updates/june-2019/#4

5. IFRS 16 and covid-19 – https://cdn.ifrs.org/-/media/feature/supporting-implementation/ifrs-16/ifrs-16-rent-concession-educational-material.pdf