Ind. AS 116 on Leases which is primarily to bring in line with IFRS 16 is presently in Exposure Draft Stage waiting for feedback in the form of comments on any aspect of the proposed Standard that is planned to be operative from annual periods beginning on or after 1st April, 2019. Whence it will be operative, it will supersede Ind. AS 17.
Major Sea Change under Ind.AS 116 on Leases:
Lease as per Ind. AS 17 is 'An agreement whereby the lessor conveys to the lessee in return for payment the right to use an asset for an agreed period of time'.
Lease as per Appendix A of Ind. AS 116 is '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'.
Under Ind. AS 116, 'right-of-use' model replaces the 'risks and rewards' model. Lessees are required to recognise an asset and liability at the inception of a lease.
When once it becomes operative, there will be a sea change for lease accounting especially in the books of the lessee because 'Operating leases' are virtually given goby/send off to rope in Balance Sheet a 'Leasehold Asset' with corresponding liability.
In other words, the distinction between operating and finance leases is practically eliminated for lessees in the books of lessee.
Any exemptions provided:
However, as per Para 5 of the Standard 'A lessee may elect not to apply the requirements as spelt out in paragraphs 22- 49 to:
1. Short term leases: A lease which has a lease term of not more than twelve months on the date of commencement is regarded as a short term lease.. .
2. Leases for which underlying asset is of low value (as described in paragraphs B3- B8) of the Standard,
How to account Short Term Leases?
In the light of the above, short term leases as spelt out earlier in (5a) above are kept outside the purview of leased asset sensing it is expenditure to be charged off in the respective years.
How to handle in different situations to account Low value Leases?
As Para 8 of Ind. AS 116, the election for leases for which the underlying asset is of 'low value' can be made on a lease-by-lease basis.
Hence, where several assets of low value are given on lease under a single contract, each of the assets qualifies to be a low value asset and the entity can elect to apply the low value asset exemption to all of the assets under the contract. However, it is ideal and relevant to refer to Para B5 of the Standard which lay down the situation as to when the underlying asset can be of low value.
As per Para B5 an underlying asset can be of low value only if:
- 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
- the underlying asset is not highly dependent on, or highly interrelated with, other assets.
It is therefore crystal- clear that both the above conditions are to be met to qualify for exemption.
How to lever a contract that contains a lease component and one or more additional lease or non-lease components?
As per Para 13 of the Standard, 'a lessee shall allocate the consideration in the contract to each lease component on the basis of the relative stand-alone price of the lease component and the aggregate stand-alone price of the non-lease components'.
Again as per 14of the Standard, 'The relative stand-alone price of lease and non-lease components 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.
As a practical expedient, a lessee may elect, by class of underlying asset, not to separate non-lease components from lease components, and instead account for each lease component and any associated non-lease components 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 (Para 15).
Unless the practical expedient in paragraph 15 is applied, a lessee shall account for non-lease components applying other applicable Standards ( Para 16)'.
Lease of Assets outside the Scope of the Standard:
Para 3 of the Standard spell-out in 'black and white' the kinds of leases that are outside the purview of the Standard. Para 4 of the Standard indicates where there is option.
AS per Para 3 of the Standard,
'An entity shall apply this Standard to all leases, including leases of right-of use assets in a sublease, except for:
(a) leases to explore for or
use minerals, oil, natural gas and similar non-regenerative resources;
(b) leases of biological assets within the scope of Ind. AS 41, Agriculture, held by a lessee;
(c) Service concession arrangements within the scope of Appendix D, Service Concession Arrangements, of Ind. AS. 115, Revenue from Contracts with Customer;
(d) Licences of intellectual property granted by a lesser within the scope of Ind. AS 115, Revenue from Contracts with Customers; and
(e) 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'.
As per Para 4 of the Standard 'A lessee may, but is not required to, apply this Standard to leases of intangible assets other than those described in paragraph 3(e).
Lessee Accounting -Right-of-use model:
A lessee would recognise a right-of-use asset and a lease liability for all leases of more than 12 months.
At the commencement date, a lessee shall measure the right-of-use asset at cost that comprise (as per Para 24)
- the amount of the initial measurement of the lease liability, as described in paragraph 26;
- 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 to the condition required by the terms and conditions of the lease, unless those costs are incurred to produce inventories.
The right-of-use asset also includes any costs incurred that are directly related to entering into the lease
How to Measure the Lease Liability at the Commencement?
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.
How to measure the 'right-of-use asset' and liability after commencement?
After the commencement date, the right-of-use asset should be measured using a cost model unless it applies the measurement model described in Para 35 of Ind. AS 116. Under the cost model, the right-of-use asset is measured at cost less any accumulated depreciation and any accumulated impairment losses adjusted for any re-measurement of the lease liability specified in Para 36(c) of Ind. AS 116.
A lessee shall apply the depreciation requirements in Ind. AS 16,Property, Plant and Equipment, indepreciating the right-of-useasset.
After the commencement date, the lease liability is measured by:
- increasing the carrying amount to reflect interest on the lease liability;
- reducing the carrying amount to reflect the lease payments made; and
- re-measuring the carrying amount to reflect any reassessment or lease modifications specified in Para 39 to 46 of Ind.AS 116, or to reflect revised in-substance fixed lease payments.
Interest on the lease liability in each period during the lease term shall be the a Interest on the lease liability in each period during the lease term shall be the amount that produces a constant periodic rate of interest on the remaining balance of the lease liability (also refer Para37 of the Standard).
As per Para 30, 'to apply a cost model, a lessee shall measure the right-of-use asset at cost:
(a) less any accumulated depreciation and any
accumulated impairment losses; and
(b) adjusted for any re measurement of the lease liability specified in paragraph 36(c).
31 A lessee shall apply the depreciation requirements in Ind. AS 16, Property, Plant and Equipment, in depreciating the right-of-use asset, subject to the requirements in paragraph 32.
32 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.
33 A lessee shall apply Ind. AS 36, Impairment of Assets, to determine whether the right-of-use asset is impaired and to account for any impairment loss identified.
Presentation in Balance Sheet in the books of lessee:
As per Para 47 of the Standard ' A lessee shall either present in the balance sheet, or disclose in the notes:
(a) right-of-use assets separately from other
(b) lease liabilities separately from other liabilities';
But except in the case of assets that meet the definition of investment property, which shall be presented in the balance sheet as investment property.
Presentation in Profit and Los in the books of lessee:
As Per Para 49 of the Standard:
'In the statement of profit and loss, a lessee shall present interest expense on the lease liability separately from the depreciation charge for the right-of-use asset. Interest expense on the lease liability is a component of finance costs'.
.Presentation in Cash Flow Statement in the books of lessee:
As per Para 50 of the Standard, 'in the statement of cash flows, a lessee shall classify:
(a) cash payments for the principal portion of the
lease liability within financing activities;
(b) cash payments for the interest portion of the lease liability within financing activities applying the requirements in Ind. AS 7, Statement of Cash Flows, for interest paid; and
(c) Short-term lease payments, payments for leases of low-value assets and variable lease payments not included in the measurement of the lease liability within operating activities.
Ind. AS 116-Lessor Accounting:
Does not materially change from the current practice.
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.
- For financing arrangements or sales, the balance sheet reflects a lease receivable and the lessor's residual interest, if any.
- 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.
- Continue to reflect the underlying asset subject to the lease arrangement on the balance sheet for leases classified as operating.
Ind. AS 116 on Leases which is primarily to bring in line with IFRS 16, whence once operative, there will be significant notable transformation especially in the books of Lessee because 'Operating leases' are virtually given goby/send off to rope in the Balance Sheet as a 'Leasehold Asset' with corresponding liability. In other words, the distinction between operating and finance leases is practically eliminated for lessees in the books of lessee.
The impact will be on all the financial statements of the Lessee:
- on the Balance Sheet: lease hold assets will be hosted on the asset side of the balance Sheet especially in the books of Lessee
- And as a result, there will be consequential impact on the Profit and Loss. The impact at the start of the lease on account of high depreciation and unwinding of lease liabilities is likely to be substantial.
- Therefore, there will be resulting bang in cash Flow statement- favourable impact on the cash flow from operations
- Besides, for lessees, debt equity ratio will be in tandem depending on the size of the lease.
As spelt out earlier, there is no significant effect on lessor books for reasons spelt out earlier.
Regarding presentation in Balance Sheet/ Profit and Loss/ Cash flow, revisit the related areas dealt with above as well provisions the proposed Standard. As per Part - A of Schedule III both under Division I and Division II, 'Assets under lease shall be separately specified under each class of asset.