Understanding Ind AS 116 Lease Accounting Changes

IND AS - 116 Prepared By: Abhishek Aggarwal

IND AS 116 Overview Effective date 1stApril 2019 Eliminates the accounting difference between an operating lease and an finance lease for lessee Lessee s with operating leases will have a major impact in accounting For lessor the accounting and classification is done based on existing operating/finance lease model

Pre-requisites of Lease Identifiedasset Lessee obtains substantially all of the economicbenefits Lessee directs theuse If all the above conditions are fulfilled the Contract will classify as lease.

Finance Lease vs. Operating Lease Finance lease is a lease under which the risks and rewards of ownership are transferred to lessee. Operating lease is any lease other than a finance lease.

Ind AS 116 Is lease more than 12 months No Short term Lease Y es Adherence to the Standard is optional; the transaction may be expensed as a revenue item Other than short term lease Other than low value assets Low value assets Recognition of the right to use and lease liability is compulsory.

Short term Leases Short-term leases upto12 months lease tenure are excluded from the Standard. Lease tenure includes the right to renew, if it is reasonablycertain that the right will be exercised.

Lessor accounting Finance Lease Recognition of the asset Receivable at an amount equal to the net investment in the lease. Recognition of the Income 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. Operating Lease Recognition of the asset capitalised. Recognition of the Income Either straight-line basis or another systematic basis which is more representative of the pattern in which benefit from the use of the underlying asset is diminished.

Lessee accounting Initial Recognition Recognise assets and liabilities for all leases for a term than 12 months, unless the underlying asset is of low value. of more recognise a right of use asset representing its right to use the underlying leased asset and a lease liability representing its obligations to make lease payments. Measure right-of-use assets similarly to other nonfinancial assets (such as property, plant and equipment) and lease liabilities similarly to other financial liabilities. Recognise depreciation of the right-of-use asset and interest on the lease liability (as per IND AS 17 the same was classified as rent in case of operating lease on a straight-linebasis). Recognise interest cost as finance cost.

Lessee accounting Initial Recognition Lease liability = Present value of lease rentals + present value of expected payments at the end of lease. The lease liability will be amortised using the effective interest rate method. Lease term = Non-cancellable period + renewable period iflessee 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. The asset will be depreciated as per IND AS 16 Property plant and equipment.

CASE STUDY In books of lessee Rent of Rs. 10 lakhs per annum. Discount rate 10%. Lease tenure 5 years. Treatment in books of lessee Right of use asset will be recognised at Rs. 37,90,986 (Present value of 5 instalments of Rs. 10 lakhs each) and will be depreciated over a period of 5 years.

Lease liability Year Opening Interest Payment Closing 1 37,90,787 3,79,079 10,00,000 31,69,865 2 31,69,865 3,16,987 10,00,000 24,86,852 3 24,86,852 2,48,685 10,00,000 17,35,537 4 17,35,537 1,73,554 10,00,000 9,09,091 5 9,09,091 90,909 10,00,000 -0

P&L impact Rs. In lakhs 1.20 1.00 1.00 1.00 1.00 1.00 1.00 0.38 0.32 0.25 0.17 0.80 0.09 0.60 0.40 0.76 0.76 0.76 0.76 0.76 0.20 - FY1 FY2 FY3 FY4 FY5 Depreciation Interest Cash Rental

Snapshot of Ind AS 116 Lease Accounting Lessor Lessee Operating Lease Short tenure ( up to 12 months) Finance Lease Long term Treat as FA and depreciation to be charged At the option of he lessee, lease rental can be charged to P&L Treat as receivable Recognised as right of useAsset Obligation to pay lease rental on liability side If transfers ownership or certainty of exercise of purchase option depreciation charged over the useful life of the asset If no transfer of ownership, asset to be depreciated from lease commencement date till earlier of end of useful life or end of lease term

Impact Balance Sheet Companies with operating leases will appear to be more asset-rich, but also more heavily indebted. Statement of Profit &Loss Total lease expense willbe front-loaded even when cash rentals are constant. Favorable impact expected EBITDA Adverse impact expected Net assets Totalassets Interest coverage ratios

AS 19/Ind AS 17/Ind AS116 N o Particular AS-19 IND-AS 17 IND AS 116 Excludes lease agreement to use land. Profit/Loss must be deferred and amortized over the lease term in proportion to the depreciation of the leased asset. 1 Scope & coverage Land is covered. Land is covered. It states that the gains/loss should be deferred and amortized over the lease term. The ratio is not defined. Sale & Leaseback Transactions of Finance Lease Gains/loss should be deferred and amortized over the lease term. The ratio is not defined. 2 straight line method should not be used when the rentals are increased based on inflations 3Operating Lease rentals and inflation The standard is silent on its treatment The standard is silent of its treatment Lessor has an option to either defer the booking of cost and allocate to income over the lease term in proportion to the recognition of rent income, or are recognised as an expense in the statement of shall be added to the carrying amount of the leased asset and recognised as an expense over the lease term on the same basis as the lease income. Treatment of Initial Direct Cost Operating Leases 4 Same as IND-AS 17.

AS 19/Ind AS 17/Ind AS116 No Particular AS-19 IND-AS 17 IND AS 116 Included in the initial measurement of the finance lease receivable and reduced in the amount of income recognised over the lease term.. The lessor and lessee shall recognise the aggregate cost of incentives as a reduction of rental income over the lease term. Included in the initial measurement of the net investment in the lease and reduce the amount of income recognised over the lease term. Recognized immediately in the statement of profit and loss or allocated against the finance income over the lease term. Treatment of Initial Direct Cost Finance Leases 5 No specific discussion of lease incentives. The incentives are recorded as deduction from rentals. 6 Lease Incentives Lessee will follow Single Lease Accounting. There is no classification as operating or finance Lease for lessee. Classification of Lease in hands of lessee Leases were recorded as per their classification into Operating and Finance Lease Leases were recorded as per their classification into Operating and Finance Lease 7

AS 19/Ind AS 17/Ind AS116 No Particular AS-19 IND-AS 17 IND AS 116 Lessee will recognize assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. Accounting and Presentation in financial Statement by lessee by lessee Under Operating lease, asset was not recorded in books and recognized lease payments as expense in the profit and loss account. Under Operating lease, assets was not recorded in books and recognized lease payments as expense in the profit and loss account 8 Lessee would recognize depreciation expense on the right of use asset and interest expense on the lease liability, classify the lease payments into principal and interest component.

AS 19/Ind AS 17/Ind AS116 No Particular AS-19 IND-AS 17 IND AS 116 Additional Requirements of disclosure for lessor such as disclosure of maturity analysis of lease payments; quantitative and qualitative explanation of significant changes in carrying amount of new investment in finance lease. Additional requirements as disclosure of maturity analysis of lease payments; quantitative and qualitative explanation of significant changes in carrying amount of new investment in finance leases. Exemption granted to small and medium sized companies for certain disclosures. Disclosures Requirements of lessor 9 Exemption removed. Disclosures Requirements of lessee 10 NA NA