03-Sep-2024 Bringing Leases On-Balance Sheet: Understanding the Implications of IND AS 116

What is IND AS 116?

Ind AS 116, which stands for Indian Accounting Standard 116, was introduced by the Institute of Chartered Accountants of India (ICAI) and is part of the broader convergence with International Financial Reporting Standards (IFRS). This standard replaces the previous leasing standard, Ind AS 17, and aligns India's lease accounting practices more closely with global standards.

The core principle of Ind AS 116 is to bring most leases on-balance sheet for lessees, eliminating the distinction between operating and finance leases that existed under Ind AS 17. This means that lessees now recognize a right-of-use asset and a lease liability for almost all leases. The objective of this standard is to ensure that lessees and lessors provide relevant information in a manner that faithfully represents those transactions.

Applicability:-

It applies to leases of Property, Plant and Equipment and other assets with limited exclusions.

Defining Lease:-

A lease is defined as a contract or part of a contract that conveys the right to control the use of an identified asset for a period of time in exchange for 

consideration. 

Whether a contract contains a lease needs to be determined at the inception date of the lease i.e. earlier of the date of the lease agreement or date of commitment by parties of the terms and conditions of the lease.

Cases where exemption is granted from the applicability of Ind AS 116 requirements:-

Under Ind AS 116, there are certain recognition exemptions available for lessees related to leases of low-value assets and short-term leases whereby an option has been given whether to elect these exemptions. Lets have a look at the exemptions:- 

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• Leases of Low Value Assets: 

Ind AS 116 provides an exemption for leases of low-value assets, allowing lessees to opt not to recognize right-of-use assets and lease liabilities on the balance sheet for leases of assets that are considered low value.

Ind AS 116 does not specifically define what constitutes a low-value asset, but it suggests that the concept relates to assets such as personal computers, small items of office furniture, and other similar items. The low value is to be construed with respect to the value of the underlying asset which is given on lease and not the value of lease rentals.

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• Short Term Leases:

Ind AS 116 also provides an exemption for short-term leases. ie. Where the lease term is 12 months or less from the commencement date of the lease.

Recognition Criteria for Low Value Leases and Short Term Leases.

Lessees can choose not to recognize right-of-use assets and lease liabilities on the balance sheet. Instead, lease payments are expensed on either straight line basis over the lease term or another systematic basis.

The exemption for short-term leases and leases of low value assets simplifies accounting for leases and avoid the complexity of measuring and recording right-of-use assets and corresponding lease liabilities.

Recognition Criteria of Leases under Ind AS 116:

 For Lessees:-

In the books of accounts of lessees, right-of-use asset and a corresponding lease liability on the balance sheet at the commencement of the lease is recognized by the lessees for the leases with the lease term of more than 12 months.

Subsequently, the right-of-use asset is depreciated, and interest expense is recognized on the lease liability over the term of the lease.

For Lessors:-

Under Ind AS 116, classification is required from the lessors point of view into finance lease or operating lease at the inception date for each of the leases. It is only reassessed if there is modification in lease. Leases are classified based on how they transfer risks and rewards incidental to ownership of an asset to the lessee. The standard distinguishes between two main types of leases: finance leases and operating leases as follows:

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• Finance Lease:

A finance lease, under Ind AS 116, is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset to the lessee. In essence, this type of lease is similar to a purchase of an asset financed by borrowing.

The accounting for the said type of leases involves lessor derecognizing the leased asset in its books of account and recognizing finance lease receivable account.

• Operating Lease:

An operating lease, as defined by Ind AS 116, is any lease that is not a finance lease. In other words, an operating lease does not transfer substantially all the risks and rewards incidental to ownership of an asset to the lessee.

The accounting for the said type of leases involves the lessor continuing to recognize the underlying asset in its books of account and treating the lease rentals received as an income over the lease term.

Disclosures Relating to Leases to be given in the Books of Accounts:

Under Ind AS 116, the required disclosures in financial statements include detailed information about lease arrangements. For lessees, disclosures typically involve describing the nature of lease arrangements, including lease terms, lease payments, and significant leasing arrangements, carrying value of right of use assets, carrying value of Lease Liabilities etc. These disclosures aim to provide transparency and enable users of financial statements to understand the impact of leasing activities on a company's financial position, performance, and cash flows.

What is the Difference between IND AS 116 and IFRS 16?

The main difference between Ind AS 116 and IFRS (International Financial Reporting Standards) primarily lies in the scope of application and certain specific requirements.

While Ind AS 116 largely aligns with IFRS 16 in terms of recognizing leases on the balance sheet for lessees, there may be certain nuanced differences in implementation due to local regulatory considerations and interpretations. However, the fundamental principles of lease accounting, such as distinguishing between finance leases and operating leases and recognizing lease assets and liabilities, remain consistent between Ind AS 116 and IFRS 16.

In conclusion, Ind AS 116 represents a significant shift in lease accounting practices, bringing leases onto the balance sheet and enhancing transparency in financial reporting. By understanding the types of leases, recognition criteria, exemptions, and disclosure requirements under Ind AS 116, businesses can navigate the complexities of lease accounting effectively and comply with the new standards, ultimately improving the quality and reliability of financial information disclosed to stakeholders.

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