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New Era of Lease Accounting

Ind AS 116 Leases enumerates the principles for recognizing, presenting, measuring, and disclosing leases. The purpose is to ensure that lessees and lessors provide relevant information in a manner that faithfully represents those transactions. This information has shown the base for the users of financial statements to determine leases’ effect on an entity’s financial position, financial performance, and cash flows. Ind AS 116 will replace current Ind AS 17 Leases from dated 1 April 2019. An entity will apply this standard usually to contracts with similar characteristics and in similar circumstances.

Ind AS-116 defines a lease as a contract that conveys the right to use an asset for the stipulated duration substituted for consideration. Hence, Ind AS 116 has enhanced the disclosure requirements for both lessors and lessees as compare to Ind AS 17.

Lessor Accounting
Finance lease

  • Assets recognized under the finance lease have been shown as receivable at an amount equal to the lease’s net investment.
  • It is based upon the pattern that shows a consistent periodic rate of return on the lessor’s net investment in the lease, finance income over the lease period.

Operating lease

  • Recognition of asset- Assets held under the operating lease will have to be capitalized in the books.
  • Recognition of income- The lease payments from operating leases have to be recognized under income either as a straight-line basis or as a systematic basis that benefits from diminished use of the underlying asset.
  • Recognition of expenses- The expenses assorted with earning of lease income, like depreciation, will be recognized as expenses.

Lessee Accounting

  • Recognize assets and liabilities for entire leases for a period of more than 12 months, unless the underlying assets are of low value.
  • Recognize interest cost as a finance cost.
  • The lease liability is computed in the subsequent periods using the interest rate in implicit in the lease if the interest rate is readily determined. If the interest rate cannot be readily determined, the lessee’s incremental borrowing will cost.
  • A lessee measures right-of-use assets comparably to other non-financial assets (like property, plant and equipment) and leases liabilities similar to other financial liabilities.
  • Recognize a right of use asset represents its right to use underlying lease asset and a lease liability representing its obligations to make lease payments.

Impact on the financial statements
The lessee was previously required to screen and analyze each lease arrangement as either an operating (off-balance sheet) or finance lease (on balance sheet). Ind AS 116 requires lessees to determine a ‘right-of-use asset’ and a ‘lease liability’ for almost all of the leasing arrangements

  • Statement of financial position
    Recognition of the right of use assets and the significant lease liability results in an increase in the amount earmarked for financial liabilities and the assets for entities that had material operating leases. New accounting requirements for leases will impact debt-equity ratios and can also cause the entities to breach existing debt-covenants.
  • Statement of comprehensive income
    Decertifying of operating lease charges and certifying of depreciation and finance costs will have a positive impact on EBIT AND EBIDTA. Recognition of depreciation on the right to use assets and non-consideration of finance costs on lease liabilities results in higher costs being calculated during the lease term’s commencement.

Impact on profit and loss statements
A lessee will recognize a ‘right-of-use asset’ and its corresponding’ lease liability.’ The outcome is that instead of lease rental recognized earlier, it will now recognize depreciation and interest expense in its statement of P&L. This can lead to an increase in the interest expense as well as an increase in EBITDA in the P&L. The new lease standard would not support the accounting treatment that a lessee required to be followed for operating or finance leases. Therefore, the total costs pertaining to leasing arrangements are unlikely to change over its entire life cycle. There would be an impact in between various reporting periods during the life cycle of the lease.

However, Ind AS-116 will impact the profit and loss statement since total expenses will be higher during the initial period of leases and lower later. Still, the lessor will continue to classify leases as operating or finance, depending on whether significantly all of the risks and rewards incidental to ownership of the underlying asset have been relocated.

Transition requirements
On transition, full retrospective application is optional; i.e., lessees can choose whether to calculate the impact with the complete retrospective application or elect to apply the simplified approach, which includes certain reliefs and does not require a recapitulation of comparatives.

Disclosure requirements 
Ind AS 116 Leases requires improved qualitative and quantitative disclosures for both lessor and lessees.

At MAS, we assist our clients in bookkeeping, payroll, auditing, taxation, secretarial compliances, and preparation of financial statements ensuring compliance with applicable accounting standards. If you have any questions or wish to know more about Lease Accounting, kindly contact us.