Tally Automation
Feb 15, 2024

How to Account for Leases under Ind AS 116

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Nishtha Arora

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Leases are common in many businesses, as they allow entities to use assets without owning them. However, accounting for leases has been a controversial and complex topic for a long time. The previous accounting standard, Ind AS 17, was criticized for not providing a faithful representation of the economic substance of lease transactions, especially for lessees.

To address this issue, the Ministry of Corporate Affairs notified a new accounting standard, Ind AS 116, on 30 March 2019. Ind AS 116 is applicable for annual reporting periods beginning on or after 1 April 2019. Ind AS 116 is based on the International Financial Reporting Standard (IFRS) 16, which was issued by the International Accounting Standards Board (IASB) in January 2016.

The principles for the recognition, measurement, presentation, and disclosure of leases are outlined in Ind AS 116. Ensuring lessees and lessors provide pertinent information in a way that accurately depicts those transactions is the goal. Users of financial statements can use this information as a foundation to evaluate how leases affect an entity's cash flows, financial performance, and financial position.

In this blog post, we will provide a brief overview of Ind AS 116 and its main features. We will also highlight some of the benefits and challenges of Ind AS 116 for lessees and lessors.

What is a lease?

Ind AS 116 defines a lease as a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for some time in exchange for consideration. Under Ind AS 116, a contract is or contains a lease if the contract gives the customer (the lessee) the right to control the use of an identified asset for some time.

Control is the ability to direct the use of the asset and to obtain substantially all of the economic benefits from that use. An identified asset is an asset that is either explicitly or implicitly specified in the contract and that is physically distinct or represents substantially all of the capacity of a physically distinct asset.

Ind AS 116 applies to all leases, except for some specific exemptions, such as leases of biological assets, service concession arrangements, and licenses of intellectual property.

Also Read: Golden Rules of Accounting: A Simple Guide for Accountants

What are the main changes for lessees?

The most significant change introduced by Ind AS 116 is the introduction of a single lessee accounting model. Under this model, a lessee has to recognise a right-of-use asset and a lease liability for all leases, unless the lease is a short-term lease (12 months or less) or a lease of a low-value asset (such as a tablet or a personal computer).

A right-of-use asset is an asset that represents the lessee’s right to use the underlying leased asset. A lease liability is a liability that represents the lessee’s obligation to make lease payments. The right-of-use asset and the lease liability are initially measured at the present value of the future lease payments, discounted using the interest rate implicit in the lease or the lessee’s incremental borrowing rate.

The right-of-use asset is subsequently measured at cost less accumulated depreciation and impairment losses, adjusted for any remeasurement of the lease liability. The lease liability is subsequently measured at amortized cost using the effective interest method, adjusted for any lease modifications or reassessments of the lease term or the lease payments.

The lessee has to recognise the interest expense on the lease liability and the depreciation expense on the right-of-use asset in the statement of profit and loss. The lessee has to present the right-of-use asset within property, plant and equipment or investment property, and the lease liability separately or within borrowings in the balance sheet. The lessee has to disclose various information about its leases in the notes to the financial statements.

The main impact of Ind AS 116 for lessees is that it increases the assets and liabilities on the balance sheet, and affects the recognition and classification of expenses and cash flows in the statement of profit and loss and the statement of cash flows. Ind AS 116 may also affect the lessee’s financial ratios, covenants, tax position, and key performance indicators.

Also Read: 7 Easy Steps for Flawless GST Reconciliation in Tally

What are the main changes for lessors?

The accounting for lessors under Ind AS 116 is largely unchanged from Ind AS 17. A lessor has to classify each lease as either an operating lease or a finance lease, based on whether the lease transfers substantially all the risks and rewards of ownership of the underlying asset to the lessee.

A lessor has to recognise lease income from operating leases on either a straight-line basis or another systematic basis over the lease term. A lessor has to recognise lease income from finance leases over the lease term based on a pattern reflecting a constant periodic rate of return on the net investment in the lease.

A lessor has to present the underlying assets subject to operating leases within the appropriate category of assets, and the underlying assets subject to finance leases as receivable in the balance sheet. A lessor has to disclose various information about its leases in the notes to the financial statements.

The main impact of Ind AS 116 for lessors is that it aligns the definition and requirements of a lease with those for the lessees, and enhances the disclosure requirements for the lessors.

Final Words

Ind AS 116 is a new accounting standard that aims to provide a faithful representation of the economic substance of lease transactions, especially for lessees. Ind AS 116 introduces a single lessee accounting model that requires the recognition of a right-of-use asset and a lease liability for almost all leases. Ind AS 116 also guides the definition, recognition, measurement, presentation, and disclosure of leases for both lessees and lessors.

Ind AS 116 has significant implications for lessees and lessors, as it affects their financial statements, financial ratios, tax position, and business decisions. Ind AS 116 also poses various challenges for the lessees and lessors, such as identifying and assessing the leases, determining the lease term and the lease payments, measuring the right-of-use asset and the lease liability, accounting for the lease modifications and reassessments, and disclosing the relevant information about the leases.

We hope this blog post has given you a brief overview of Ind AS 116 and its main features.

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