Ind AS 116

Introduction:

The objective of this standard is to ensure that lessees and lessors provide relevant information in a  manner which provides basis for users of financial statements to assess the effect that leases have on the financial position, financial performance and cash flows of the entity.

Let us understand the meaning of important terms before understanding the standard

Lease: A contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.

Lease term

:

The non-cancellable period for which a lessee has the right to use an underlying asset, together with both:

(a) It includes the period at which the lessee has an  option to extend such lease if it is reasonably certain; and

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

Right-of-use asset: An asset that represents a lessee’s right to use an underlying asset for the lease term. Short Term lease:A lease that, at the commencement date, has a lease term of 12 months or less. A lease that contains a purchase option is not a short-term lease.

Applicability of the standard:

The effective date of Ind AS 116 is 1^st April 2019.

An entity shall apply this Standard to all leases, including leases of right-of-use assets in a sublease, except for:

• leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources;
• Leases of biological assets;
• service concession arrangements within the scope of Appendix D, Service Concession Arrangements, of Ind AS 115, Revenue from Contracts with Customer;
• licenses of intellectual property granted by a lessor within the scope of Ind AS 115, Revenue from Contracts with Customers; and

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.

Recognition exemptions:

A lessee may elect not to apply the requirements in paragraphs 22–49 to;
(a) short-term leases; and
(b) leases for which the underlying asset is of low value.

low-value assets:

An underlying asset can be of low value only if:

• the lessee can benefit from the use of the underlying asset on its own or together with other resources that are readily available to the lessee; and
• the underlying asset is not highly dependent on, or highly interrelated with, other assets.

Examples of low-value underlying assets includes tablet, personal computers, small items of office furniture, telephones, etc.

Accounting treatment in the books of lessee:

The major difference between Ind AS 17 and the current Ind AS 116 is, there is no bifurcation of operating lease and finance lease. As per Ind AS 116, the lessee shall recognize the right-of-use asset in the books.

Initial recognition and measurement

a. Recognize a lease liability at the date of initial application amounting to the present value of the lease payments, discounted using the lessee’s incremental borrowing rate
b.Recognize a right-of-use asset.

Q: What are the costs to be considered for right-of-use asset?

• the amount of the initial measurement of the lease liability at the PV of lease payments that are not paid at that date;
• any lease payments made at or before the commencement date, less any lease incentives received;
• any initial direct costs incurred by the lessee; and
• 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.

Q: What are the payments/amounts incurred in lease liability?

• fixed payments less any lease incentives receivable;
• variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date;
• amounts expected to be payable by the lessee under residual value guarantees;
• the exercise price of a purchase option if the lessee is reasonably certain to exercise that option; and

payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease.

Subsequent measurement:

Lessees accrete lease liability to reflect the interest and reduce the lease liability to reflect lease payments made. The right-to-use asset is depreciated in accordance with Ind AS 16 Property, Plant and Equipment. Interest expense on the lease liability and depreciation results in higher expense charged to P&l in the initial periods of a lease.

Q: Till which period the depreciation is charged on right-of-use asset?

A:  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.

Q:What are the implications of Ind AS 16 on right-of-use asset other than depreciation?

A:If right-of-use assets relate to a class of property, plant and equipment to which the lessee applies the revaluation model in Ind AS 16, a lessee may elect to apply that revaluation model to all of the right-of-use assets that relate to that class of property, plant and equipment

Summary:

Lease liability = Present value of lease rentals + present value of expected payments at the end of lease. The lease liability will be amortized using the effective interest rate method.
Lease term = non-cancellable period + renewable period if lessee reasonably certain to exercise.
Right to use asset = Lease liability + lease payments (advance)-lease incentives to be received if any initial + initial direct costs + cost of dismantling/ restoring etc.

Acounting entries in the books of lessee:

• When asset is taken on lease

        Asset/right-to-use asset    a/c     Dr
                           To Lease liability a/c

• Finance expense is charged to P&L using the discount rate

        Finance expense a/c             Dr
               To Lease liability a/c

• When payment made to lessor

        Lease liability a/c     Dr
                          To Bank a/c

Accounting treatment in the books of lessor:

• A lessor shall classify each of its leases as either an operating lease or a finance lease.

• A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards 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. Examples of situations that individually or in combination would normally 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 for it to be reasonably certain, at the inception date, that the option will be exercised;

• the lease term is for the major part of the economic life of the underlying asset even if title is not transferred;

• 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; and

• the underlying asset is of such a specialized nature that only the lessee can useit without major modifications.

• Indicators of situations that individually or in combination could also lead to a lease being classified as a finance lease are:
• 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 equaling 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.

Initial Measurement:

Lessor recognizes the following

FV of the leased property (or)
The present value of the minimum lease payments, whichever is lower.

Minimum lease payments are the payments over the lease term that the lessee is or can be required to be made, excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor, together with, for a lessee, any amounts guaranteed  by the lessee or by a party related to the lessee.

In case of Finance lease (In the Books of lessor)

• When an asset is given for Finance lease

             Lease receivable a/c        Dr
                  To Asset a/c

• Finance income as per Implicit rate

             Lease receivable a/c       Dr
                   To Finance income (P&L) a/c

• When cash received from the lessee

                   Cash a/c                       Dr
                       To lease receivable a/c

Accounting treatment in case of Operating Lease:

• A lessor shall recognize lease payments from operating leases as income on either a straight-line basis or another systematic basis. The lessor shall apply another systematic basis if that basis is more representative of the pattern in which benefit from the use of the underlying asset is diminished

• lessor shall recognize costs, including depreciation, incurred in earning the lease income as an expense.

In case of Operating lease (In the Books of lessor)

• Recognition of rental income

                  Lessee a/c    Dr
                       To  Rental income

• When amount received

                       Bank a/c     Dr
                            To Lessee a/c

Q: Can lease of land for 99 years can be treated as ‘Finance Lease’?

A: Land has an indefinite economic life and it is expected that the value of land generally appreciates. The lease of 99 years cannot be considered as a major economic life for land. As long as any other conditions specified in Finance lease are not satisfied, it is an operating lease.

Sublease classification:

 A sublease can be classified as an operating lease or finance lease.

• If the head lease is a short term ( not more than 12 months) lease then the sublease shall be classified as an operating lease.

• In other cases, 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.

Q:  Suppose A has given a lease of Machinery having an economic life of 8 years for a period of 4 years to B. Now B has subleased the same machinery for 4 years to C. Classify the type of lease from the point of A & B?

 A:   In the first transaction between A&B, from the viewpoint of A the lease can be  classified as an operating lease as the same is not falling under the definition of  Finance lease.The transaction between B & C will be classified as ‘Finance lease’  because Mr. has the right to use the machinery for 4 years and the machinery is subleased for the same period.

Key Impact on Ind AS 116:

Impact on Profit and loss a/c:

The rental expense being debited in case of an operating lease is now replaced by
(a) amoritisation of lease liability; and (b) depreciation of the R-T-U asset.

Impact on Balance sheet:

Now, there will be an additional lease liability in the liabilities side and an equal amount of right-of-use asset in the Assets side.