Practical approach to implement Ind AS 116


In this article we will discuss about the accounting treatment in books of lessee only.

Basics on applicability of Ind AS 116 "Leases"

• Ind AS 116 is proposed to be effective from annual periods beginning on or after 1st April, 2019.

• Ind AS 116 introduces a single lessee accounting model and requires a lessee to recognise right of use assets and lease liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value.

• The lease liability is initially measured at the present value of the lease payments to be made over the lease term. The right-of-use asset is initially measured at the amount of the lease liability, adjusted for lease prepayments, lease incentives received, the lessee's initial direct costs (e.g., commissions) and an estimate of restoration, removal and dismantling costs.

• Under Ind AS 116, a lessee subsequently measures & depreciates right-of-use (ROU) assets similarly to other non-financial assets (such as property, plant and equipment).

• The lease liability is measured in subsequent periods using the effective interest rate method.

The above are general and basics of Ind AS 116 'Leases'.

Now we will discuss practical approach to how to apply Ind AS 116 which is proposed to be effective from 1.4.2019.

As a practical expedient, 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:

(a) to apply this Standard to contracts that were previously identified as leases applying Ind AS 17, Leases.

(b) not to apply this Standard to contracts that were not previously identified as containing a lease applying Ind AS 17.

So if any old contract or arrangement is not considered as lease arrangement as per Ind AS 17 then it need not be evaluated for lease accounting under this standard.

After identifications of any arrangement / contracts as lease then the next step is by what amount ROU assets and lease liabilities need to be recognized

Once contract is identified as a lease arrangement on transition, the standard gives various options to recognize ROU assets and Lease Liabilities as below assuming that Ind AS 116 is notified and applicable from 1.4.2019:

(1) Option 1 - Retrospective approach:

Under this option, the entity is requiredto determine the carrying amount of ROU and lease liabilities at the earliest comparative period as if those leases had been accounted for under Ind AS 116 since inception of the contract. Under this option:

• Difference between the ROU assets and liabilities are adjusted to retained earnings as on 1.4.2018

• Previous year PnL number is to be restated and give the impact for changes of Depreciation, Interest cost and lease liabilities in FY 2018-19

(2) Retrospective with cumulative effect (modified retrospective impact) :

a. Option 2- Retrospective but using the incremental borrowing rate on transit date

• Under this option, the Lease liabilities are recognized based on incremental borrowing rate on the initial application date (1.4.2019) and ROU assets are recognized based on option 1.
• The difference between Lease Liabilities and ROU Assets is adjusted to Retained earnings as on 1.4.2019
• No change in FY 2018-19 numbers

b. Option 3 - ROU assets equal to the lease liability:

• Under this option, the Lease liabilities are recognized based on incremental borrowing rate on the initial application date (1.4.2019) and same amount is recognized for ROU assets

• No any impact to Retained earnings or any previous year numbers

Note: lessee's incremental borrowing rate : The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.

Let's understand by way of Example:


Particulars

Remarks

Lease arrangement

01-04-15

Arrangement period

10 years

Lease end date

01-04-25

Lease Rent per annual

100000

Incremental borrowing rate as on 1.4.2015

12%

Incremental borrowing rate as on 1.4.2019

9%

Incremental borrowing rate as on 1.4.2015

12.00%



Year End

Opening Lease Liabilities

Lease Rent

Interest Charges

Payments against Lease Liabilities

Closing Lease Liabilities

Depreciation (SLM Method)

Net Book Value
(ROU Assets)

31-Mar-16

565,000

100,000

67,800

32,200

532,800

56,500

508,500

31-Mar-17

532,800

100,000

63,936

36,064

496,736

56,500

452,000

31-Mar-18

496,736

100,000

59,608

40,392

456,344

56,500

395,500

31-Mar-19

456,344

100,000

54,761

45,239

411,106

56,500

339,000

31-Mar-20

411,106

100,000

49,333

50,667

360,438

56,500

282,500

31-Mar-21

360,438

100,000

43,253

56,747

303,691

56,500

226,000

31-Mar-22

303,691

100,000

36,443

63,557

240,134

56,500

169,500

31-Mar-23

240,134

100,000

28,816

71,184

168,950

56,500

113,000

31-Mar-24

168,950

100,000

20,274

79,726

89,224

56,500

56,500

31-Mar-25

89,224

100,000

10,776

89,224

(0)

56,500

-



Incremental borrowing rate as on 1.4.2019

9.00%    

Year End

Opening Lease Liabilities

Lease Rent

Interest Charges

Payments against Lease Liabilities

Closing Lease Liabilities

Depreciation (SLM Method)

Net Book Value
(ROU Assets)

31-Mar-20

450,000

100,000

40,500

59,500

390,500

75,000

375,000

31-Mar-21

390,500

100,000

35,145

64,855

325,645

75,000

300,000

31-Mar-22

325,645

100,000

29,308

70,692

254,953

75,000

225,000

31-Mar-23

254,953

100,000

22,946

77,054

177,899

75,000

150,000

31-Mar-24

177,899

100,000

16,011

83,989

93,910

75,000

75,000

31-Mar-25

93,910

100,000

6,090

93,910

(0)

75,000

0


Considering the above, following are the accounting treatments:


 

Options available

Particulars

Option - 1 Under Full Retrospective

Option 2 - Under Modified Retrospective
(Retrospective but using the incremental borrowing rate on transit date)

Option 3 - Under Modified Retrospective
(ROU assets equal to the lease liability)

As on 1.4.2018

NA

NA

ROU Assets

395,500

Retained Earning

60,844

Lease Liabilities

(456,344)

FY 2018-19 ( Restated)

NA

NA

Dep

56,500

Accumulated Dep

(56,500)

Interest expenses

59,608

Lease Liabilities

40,392

Cash / Bank payments[1]

(100,000)

As on 1.4.2019

NA

ROU Assets

339,000

450,000

Retained Earning

111,000

Lease Liabilities

(450,000)

(450,000)

FY 2019-20

Dep

56,500

56,500

75,000

Accumulated Dep

(56,500)

(56,500)

(75,000)

Interest expenses

54,761

40,500

40,500

Lease Liabilities

45,239

59,500

59,500

Cash / Bank payments

(100,000)

(100,000)

(100,000)


[1] Previously, this amount was charged to P&L as rent expense. In the restated P&L for 2018-19, the rent expense will not exist.

IND AS 116 is expected to have a significant impact on the financial statements of a lessee as below:

Statement of financial position

• Recognition of right of use asset and a corresponding lease liability results in an increase in the amount recognized for financial liabilities and assets for entities that had material operating leases.

• New accounting requirements for lessees will impact debt equity ratios and may also cause entities to breach existing debt covenants.

Statement of comprehensive income

• De-recognition of operating lease charges and recognition of depreciation and finance costs would positively impact EBIT and EBITDA.

• Recognition of depreciation on right to use assets and unwinding of finance cost on lease liabilities result in higher costs being recognized during the beginning of the lease term.

Statement of cash flow

Presentation of lease payments as 'cash flow from financing activities' has a favorable impact on 'cash flow from operations'.

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Nirmal Shah 
on 26 February 2019
Published in Accounts
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