In the current Indian accounting system, all lands are being shown as fixed assets in the financial statements of any Company and are being depreciated based on their lives accordingly.
After the introduction of Ind-AS for Indian Companies, there is a need to evaluate such lands related payments and their structures whether it falls under Operating leases or Finance lease and account them accordingly. Building/ Structures made on these lands will then be depreciated separately based on their own useful lives.
Para 58 of Ind-As 16 "Property, plant & equipment" states that Land and buildings are separable assets and are accounted for separately, even when they are acquired together.
Para 4 of Ind-As 17- "Leases" states that A lease is an agreement whereby the lesser conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.
A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred.
An operating lease is a lease other than a finance lease.
Now, there could be a situation where land has been purchased and a legal title has been passed to the entity or it is in a process to getting it transferred in the name of the entity then such lands will be shown as Land under fixed assets and will not generally be depreciated considering that there is an unlimited useful live for any land.
If the land which has not been legally transferred/ in a process to transfer (considering all possible legal terms) in the name of the entity then it could either be Operating or Finance lease assuming that the entity has got right to use such lands based on the other classification criteria which defines operating or finance leases. The broad accounting can be summarized as below –
1. Assuming an entity has obtained a lease land for around 30-35 years for some business purposes and there is some upfront premium which entity has paid at the inception of such arrangements to the land owner and it requires some monthly rental payments to be made over the period of the lease term. Now, there is a current practice to show this upfront premium paid as fixed assets component and hence it is being depreciated from the fixed assets schedule, however after the applicability of Ind-As these premium paid will be treated as prepaid rent on operating leases and will be required to re-class such amounts from fixed assets schedule to current/ non-current assets to show as prepaid rent and amortize it over the period of such operating leases through Profit and Loss account. The normal monthly payments of such land will continue to charge into profit and loss as it is being done in the current practice,
2. Now, suppose there is a land which has been given around 70-80 years by paying some upfront premium at the inception with some monthly rentals. Assuming that after considering all criteria to satisfy it being a finance lease, the Management of the entity classifies the same as finance lease (assuming that it covers major economic life of the land), then because of the introduction of Ind-As which require to separate land & building, then the entity needs to calculate PV of all minimum lease payments and finance lease accounting will then be followed separately. Here one can argue that if the lease period for which such lands has been given for use is for longer period let’s say 90 or more years then the fair value computation for finance lease will have no material difference comparing to its carrying value, these can be documented by making a policy for evaluating finance lease computation (for example the management can make a policy that all lands upto 30 to 60 years will be evaluated for operating leases and upto 60 to 90 years will be for finance leases purposes, rest all will not be considered because of immaterial effect),
3. At the transition, all such fixed assets within land and building will be reclassified to other parts of balance sheet (current assets/ non-current assets),
4. All the structures/ building which are being made upon these lands will be evaluated for their expected useful lives and presented separately in the fixed assets schedule and will be depreciated accordingly,
5. Lease equalization will be required in case rentals which are being paid for using these lands , however Ind-As 17 has brought with a CARVE OUT (carve out means difference in Ind-As comparing to IFRS as issued by IASB) which requires no adjustment if such changes are normal inflation rates whereas IASB issued standard on Leases i.e. IAS-17 on "Leases" requires to make lease equalization irrespective of inflation is expected one or not. One can argue that there could always be difference in the expected inflation rate and the escalation clauses rates which has exempted from any adjustment by the Ind-As 17,
6. If there is any rent free period/ or any other incentives which has been provided to the entity, then the same will be required to be adjusted in the rent equalization,
7. There could be some instances where lease agreement of land has some restriction to use it in a specific manner and does not give lessee a right to get further renewal after the expiry of the terms mentioned in the contract, then usually it will be significant notion while deciding the classification be it operating or finance lease,
There is one more interesting thing to note that as per IAS-40 "Investment Property" (Standard issued by IASB) which gives an option to classify such operating leased land into Investment property and show them at fair value through profit and loss account however by using a CARVE OUT Indian version of this standard i.e. Ind-As-40 does not give such option to use Investment property for such operating leases.
These are some snapshots about the changes related to lands classification in our existing accounting system and how internationally accredited standards i.e. IFRS require to do that. These will change some of the perception/ planning from management point of view as well as it changes fixed assets schedule and ratios as well.
Above mentioned all interpretations/ explanations are based on best practices which are broadly used by large industries using IFRS frameworks and should not be construed as advice because there could be many terms/ instances where measurement/ classification could change/ differ what has mentioned above.
The author can also be reached at anujagarwalsin@gmail.com
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